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Consideration, a necessary component of a valid contract under English law, is frequently absent or difficult to discern for such agreements. This oddity has been commonly explained away by drawing analogy between demand guarantees and letters of credit. An examination, however, of the elements required for both valid letters of credit and demand guarantees highlights the dangers of this assumption.
Courts have not yet addressed the issue because banks have been careful not to risk their reputations by reneging upon a demand guarantee for a technical lack of consideration from the beneficiary of the demand guarantee. For counterparties to banks that have gone into liquidation since the financial crisis, it is questionable whether this rationale continues to offer the same comfort.
This article was originally published in Butterworths Journal of International Banking and Financial Law in June 2015.