When a seller agrees to supply goods or services on credit, one question matters above all others: how certain is payment at maturity?
A large corporate may offer a promissory note, a corporate guarantee, a bill of exchange or another written undertaking. Each may provide useful evidence of the debt, but they do not all provide the same degree of payment security. The strongest protection normally arises when an acceptable bank adds its own independent payment obligation.
In this article, we compare five commonly proposed instruments and place them in a practical order of security. The ranking assumes that each document is properly authorised, correctly executed and legally enforceable, and that there are no fraud, sanctions or exchange-control issues.
There is one important qualification. A bill merely drawn or issued by the corporate, but not accepted by the intended drawee, would normally rank below all the instruments listed above. Until acceptance, the drawee has not assumed liability as acceptor.
1. Payment guarantee issued by the corporate's bank
A properly drafted bank payment guarantee normally provides the greatest assurance among the five alternatives. Instead of relying solely on the corporate buyer, the beneficiary receives a separate undertaking from the issuing bank.
The strongest form is normally an irrevocable demand guarantee that is payable following the presentation of a simple complying written demand. It should ideally be subject to the ICC Uniform Rules for Demand Guarantees, URDG 758.
The beneficiary should check that the guarantee:
- is issued by a bank whose credit and country risk are acceptable;
- is irrevocable and covers the full required amount;
- contains a clear expiry date and place for presentation;
- remains valid beyond the underlying payment due date;
- does not require a court judgment, arbitral award or proof that is difficult to obtain;
- clearly identifies the guaranteed payment obligation; and
- is authenticated, normally through the banking system.
A bank name alone does not make a guarantee safe. A weak bank in a high-risk jurisdiction may provide less practical comfort than an obligation from a very strong corporate. The wording of the guarantee is equally important. A guarantee that cannot be called without lengthy evidence or litigation may offer considerably less protection than its title suggests.
You can explore the structure, operation and different forms of guarantees in eBSI's Bonds & Guarantees online course.
2. Bill of exchange avalised by the corporate's bank
An aval is a guarantee of payment placed on, or associated with, a bill of exchange. When an acceptable bank avalises the corporate's accepted bill, the holder benefits from the bank's additional payment obligation.
This can provide very strong security and may also make the bill easier to discount. If the corporate fails to pay at maturity, the holder may claim against the avalising bank, subject to the applicable law and the terms of the instrument.
I would normally place a bank-avalised bill just below a well-drafted demand guarantee because negotiable instruments are highly formal. The holder must pay close attention to:
- the wording and placement of the aval;
- the identity and authority of the signatories;
- the party for whom the aval is given;
- possession of the original instrument;
- proper endorsement and chain of title;
- presentation at the correct place and time; and
- any applicable protest or notice requirements.
In jurisdictions with well-established bills-of-exchange law and aval practice, the difference between an avalised bill and a bank demand guarantee may be very small. However, the aval should be provided by a bank acceptable to the beneficiary. A corporate aval does not provide the same degree of credit enhancement.
For a practical introduction to bills, promissory notes, acceptances and documentary collections, see our Export and Import Collections course.
3. Promissory note issued by the large corporate
A promissory note is a direct and unconditional written promise by its maker to pay a specified sum to the payee, or to the payee's order, either on demand or at a stated future date.
Its main advantages are simplicity and clear evidence of the payment obligation. Depending on the governing law, it may also be transferable and capable of being discounted.
However, the note does not by itself improve the corporate's ability to pay. If the corporate becomes insolvent, the holder may remain an unsecured creditor. The note strengthens the evidence and form of the claim, but it does not substitute another party's credit for that of the corporate.
4. Bill of exchange accepted by the large corporate
A bill of exchange is an unconditional order from one party, the drawer, directing another party, the drawee, to pay a specified amount. The corporate drawee becomes primarily liable on the bill only when it accepts the bill.
A properly accepted bill therefore provides a clear payment obligation at maturity and may be transferable or discountable. From a credit perspective, however, an unavalised accepted bill still leaves the holder exposed mainly to the corporate acceptor.
For this reason, an accepted bill and a corporate promissory note are often close in security. I have placed the promissory note marginally higher because it is a simpler two-party undertaking. In a particular jurisdiction or transaction, a well-drafted accepted bill could rank equally with, or even ahead of, the note.
5. Letter of guarantee issued by a large corporate
The value of a corporate guarantee depends on who is providing it and what the wording actually says.
If a financially strong parent company guarantees the debt of a weaker subsidiary, the guarantee may materially improve the seller's position. The seller then has recourse to an additional obligor with stronger financial resources.
If the same corporate that owes the underlying debt gives its own letter of guarantee, there may be little meaningful credit enhancement. The seller still depends on the same company's ability and willingness to pay.
Before accepting a corporate guarantee, check:
- the guarantor's legal identity and financial strength;
- whether it is a parent company, affiliate or the debtor itself;
- the guarantor's authority and corporate benefit;
- whether liability is primary, secondary, conditional or on demand;
- the guaranteed amount, currency and interest;
- expiry, notice and claim requirements;
- governing law and jurisdiction; and
- whether amendments to the underlying obligation could discharge the guarantee.
A strong parent-company guarantee may rank above an unavalised promissory note or accepted bill. A vaguely worded comfort letter, or a guarantee from the debtor itself, would normally rank below them.
What stronger alternatives should a seller consider?
The most appropriate instrument depends on the transaction, bargaining power, cost, country risk and the parties' commercial relationship. Where greater protection is required, consider the following alternatives:
Professionals who want to strengthen their understanding of documentary credits can begin with Letters of Credit Essentials and progress to Letters of Credit Advanced.
The practical recommendation
If the objective is the strongest practical assurance of payment, request an unconditional bank payment guarantee subject to URDG 758 or a standby letter of credit subject to ISP98, issued by a bank acceptable to the beneficiary.
If the transaction requires a negotiable instrument, obtain a bill of exchange accepted by the corporate and avalised by an acceptable bank.
Most importantly, do not judge an instrument by its name alone. Its real value depends on:
- the credit quality of every liable party;
- country, transfer and sanctions risk;
- the exact wording of the undertaking;
- governing law and enforceability;
- expiry and presentation requirements; and
- whether payment depends on documents that the beneficiary can produce.
A beautifully drafted promise from a weak obligor is still a weak promise. A strong bank undertaking with clear and workable demand conditions normally provides much greater assurance.
Take your Trade Finance learning to the next level
Would you like to build a broader practical understanding of payment methods, documentary collections, letters of credit, guarantees and trade finance risk? Explore eBSI's comprehensive Diploma in Trade Finance.
You can also browse our complete range of online courses for Trade Finance professionals.
Important: This article provides general educational information and does not constitute legal, credit or transaction-specific advice. The legal effect of guarantees, avals, promissory notes and bills of exchange varies between jurisdictions. Independent legal and banking advice should be obtained before accepting or relying on any instrument.
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