Guarantee or Surety - Definition
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What is a Guarantee?
A Guaranty/ Guarantee is a legally binding agreement in which a person (first party) agrees to be answerable for another person (second party), who wishes to obtain trust or credit from someone/institution (third party), and promises to fulfill the specified obligation of the other person (Second party) in case of default.
What is a Guarantor?
Parties who constitute a Guarantee contract are usually referred to as follows;
- Guarantor or Surety - The person who promises to take responsibility for another persons performance or obligation in case of default.
- Principal debtor or obligor -The person whose performance to an obligation or undertaking has been secured by a surety or guarantor.
- The creditor or obligee-The person or institution whom the guarantor promises to fulfill the performance or requirement of the principal debtor in case of default.
What is required to Execute a Guarantee?
For a guarantee to be legally binding during formation the following common law elements of a contract must be adhered to;
- Mutual consent of all parties involved.
- Invitation to offer and acceptance.
- Parties must be of sound and sane mind.
- The form and content of the guarantee has to be legally correct
- And a valuable consideration.
What is a Surety?
Suretyship can be viewed or classified in three distinct categories;
- Where the relationship between the principal debtor and the surety is formed through an agreement and the creditor is party to the contract.
- Where the relationship between the surety and the principal debtor has been similarly constituted by way of an agreement, but the creditor is not a party to such.
- Where there is no constituted contract to establish a relationship between parties, however, there is a primary and secondary liability expressed for a debt. Should the person with the primary obligation default and the person with the secondary responsibility is forced to make payments, reimbursement of the same from the primary obligor can be sought.
What are the Types of Sureties?
Sureties can be divided into context such as being either;
- Gratuitous and;
Academic Research on Guarantee or Guaranty
- Guaranty funds and risk-taking evidence from the insurance industry, Lee, S. J., Mayers, D., & Smith Jr, C. W. (1997). Journal of Financial Economics, 44(1), 3-24. The paper asserts that the enforcement of state enactments dating back to 1969 and 1981 on guaranty funds increases the risk of an insurer asset portfolio especially for stock insurers.
- Riskbased premiums for insurance guaranty funds, Cummins, J. D. (1988). The Journal of Finance, 43(4), 823-839. The article suggests that the insurance guarantee fund should adopt a risk premium rate charges on policyholders to encourage insurance company to adopt high-risk strategies. The report further presents three formulas and makes a comparison for premium assessment rates.
- Petty Federal Offenses and the Constitutional Guaranty of Trial by Jury, Frankfurter, F., & Corcoran, T. G. (1925). Harv. L. Rev., 39, 917. The article looks at petty offenders and their constitutional Guaranty to be heard, and cases determined by a trial jury as enshrined in the constitution.
- Monitoring, ownership, and risk-taking: the impact of guaranty funds, Downs, D. H., & Sommer, D. W. (1999). Journal of Risk and Insurance, 477-497. The paper presents evidence based on studies on the effects of insurance guaranty funds and the relationship to risk-taking, monitoring, and ownership interest. The article further looks at supporting evidence for a risk subsidy hypothesis.
- Bank Solvency and Guaranty Letters of Credit, Verkuil, P. R. (1972). Bank Solvency and Guaranty Letters of Credit. Stan. L. Rev., 25, 716. The paper looks at the importance of guarantee letters of credit in ensuring continuity of a financial institution solvency. The article focuses the impact of credit letters in relation to bank solvency.
- A financial-economic evaluation of insurance guaranty fund system: An agency cost perspective, Han, L. M., Lai, G. C., & Witt, R. C. (1997). Journal of Banking & Finance, 21(8), 1107-1129. The paper proposes a way to ensure that the insurance guaranty fund adequately protects policyholders in case an insurance company is in financial distress.
- The value of pension benefit guaranty corporation insurance, Pennacchi, G. G., & Lewis, C. M. (1994). Journal of Money, Credit and Banking, 26(3), 735-753. The paper suggests models that can be adopted by the Pension Benefit Guaranty Corporation (PBGC) insurance to ensure consistency in relation to its liability to running pension funds and their economic value.
- An economic analysis of the guaranty contract, Katz, A. W. (1999). The University of Chicago Law Review, 47-116. The paper tries to outline the reasons behind the adoption of guaranty contracts and provides analysis from an economic perspective. The risk factor of a surety is also discussed and whether it is enough to guarantee default.
- What the pension benefit guaranty corporation can learn from the federal savings and loan insurance corporation, Bodie, Z. (1996). Journal of Financial Services Research, 10(1), 83-100. The article makes a comparison between two government bodies tasked protecting funds, that is, the Pension Benefit Guaranty Corporation (PBGC) and the Federal Savings and Loan Insurance Corporation (FSLIC), and what lessons the PBGC can effectively adopt from FSLIC. The issue of underfunding, financial strength and the market risk exposure of PBGC are discussed and legislative reforms to address such.
- Guaranteed trouble: the economic effects of the pension benefit guaranty corporation, Brown, J. R. (2008). Journal of Economic Perspectives, 22(1), 177-198. The paper looks at how the Pension Benefit Guaranty Corporation (PBGC) ended up facing financial distress from the year 2000 stock market decline which affected pension assets. The article further proposes ways to ensure such a scenario never happens again since the enactment of the Pension Protection Act of 2006 that revived the PBGC program.
- Fair insurance guaranty premia in the presence of risk-based capital regulations, stochastic interest rate and catastrophe risk, Duan, J. C., & Yu, M. T. (2005). Journal of Banking & Finance, 29(10), 2435-2454. The paper looks at the Fair insurance guaranty premium and statistically examines the presence of models such as risk-based capital regulations, stochastic interest rate, and catastrophe risk, and presents their impact to a guaranty contract.