Do you wish to secure a large-scale supply?

Three tools, three different levels of security

The difference between suretyship, a bank guarantee, and a bill of exchange is not in which one is "stronger" in general, but in what each of them is based on and against whom its separation from the underlying contract actually applies. Suretyship is tied to the fate of the secured debt: if the debt does not exist or is lower than the creditor claims, the guarantor can defend themselves just like the debtor. A bank guarantee stands on its own commitment of the bank, which is fundamentally independent of the underlying contract.

A bill of exchange is in the middle: against an endorsee who bought it in good faith, the debtor will not succeed with objections arising from the underlying relationship, but against the original creditor who kept the bill of exchange, this protection does not apply in its entirety.

For the customer of a large delivery, this raises a practical question: do you want quick money regardless of a quality dispute, or is it enough for you to have the certainty that the supplier has someone to hide behind if they do not pay? A bank guarantee most reliably answers the first question, as it almost unconditionally excludes the underlying dispute from the payout decision. A bill of exchange answers it only partially, as long as it is held by the person who accepted it directly from the debtor. Suretyship answers the second question, and more cheaply, but with the risk that the payout will be delayed by the entire dispute over the underlying debt.

The choice between the tools is also decided based on who is to provide them. A bank guarantee is issued by a bank and costs a fee as well as potential collateral to the bank. Suretyship can be provided by a parent company, owner, or other related party without the costs of a bank product. A bill of exchange is issued directly by the debtor or their partners, which makes it the cheapest, but at the same time the least secure, unless a solvent person stands behind it.

Suretyship: simple and cheap, but dependent on the underlying debt

Anyone who declares to a creditor that they will satisfy them if the debtor fails to perform their debt becomes the debtor's guarantor; a guarantor's declaration must be in writing (Section 2018 of the Czech Civil Code). The creditor has the right to demand performance from the guarantor if the debtor has failed to perform the debt within a reasonable period, even though the creditor has requested them to do so in writing; no request is necessary if it is unquestionable that the debtor will not perform the debt.

The key characteristic of suretyship is accessoriness: the guarantor may assert against the creditor all objections that the debtor has against the creditor (Section 2023 of the Czech Civil Code). For the creditor, this means that a dispute over the quality of the delivery, the price, or whether the debtor breached the contract at all can also be transferred to the relationship with the guarantor. If the guarantor asserts the debtor's objections, the dispute over the existence or amount of the underlying debt will also be reflected in the enforcement against the guarantor until it is resolved.

If only a part of the debt is secured by the suretyship, partial performance does not reduce the scope of the suretyship, provided that the debt remains unperformed in the amount in which it is secured (Section 2020 of the Czech Civil Code). This gives the creditor the certainty that the suretyship will not be diluted by partial performance, but it does not change the fact that the guarantor can delay payment by arguing about the underlying debt.

Suretyship is therefore suitable where the main risk is the debtor's insolvency, not a dispute over whether the debt arose at all.

Whether suretyship is actually sufficient for a specific delivery, or whether the risk of a quality dispute is so high that it is worth opting for a more expensive tool, is assessed on a case-by-case basis — which is why the Czech legal team at ARROWS law firm always makes this assessment based on the type of performance, rather than a blanket recommendation.

For deliveries with clearly measurable performance, where a quality dispute is not expected, a suretyship from a solvent parent company or owner may be sufficient at a fraction of the cost of a bank guarantee. The weakness of this tool is demonstrated in situations where the guarantor is a person connected to the supplier only formally, without their own assets from which anything could be recovered. Suretyship only has real value if it is backed by another, independent, and sufficiently solvent person. The combination of suretyship with other debt security tools is discussed in the article on cross-guarantees.

Bank guarantee: an independent commitment of the bank with limited defense for the debtor

A financial guarantee is created by a declaration of the issuer in the letter of guarantee that they will satisfy the creditor up to a certain monetary amount if the debtor fails to perform a certain debt to the creditor, or if other conditions specified in the letter of guarantee are met; if the issuer is a bank, it is a bank guarantee (Section 2029 of the Czech Civil Code).

The issuer is liable for the performance of the secured debt up to the amount and under the conditions specified in the letter of guarantee and may assert against the creditor only those objections permitted by the letter of guarantee.

Unless the letter of guarantee provides otherwise, the bank cannot assert against the creditor objections that the debtor would be entitled to assert against them (Section 2035 of the Czech Civil Code). In practice, bank guarantees are therefore issued as unconditional, i.e., payable on first written demand without examining who was right in the underlying dispute.

The strength of this rule was demonstrated in a dispute over the payment of a bank guarantee for the construction of a swimming pool. The contractor sought a court injunction to prohibit the bank from paying the city as the customer, because in their view, there was no entitlement to the contractual penalty covered by the guarantee. The Czech Supreme Court concluded that the debtor has no legal or contractual title to prevent the issuer from providing performance to the creditor under the bank guarantee, and cannot demand that the bank refrain from performing to the creditor in accordance with the letter of guarantee or assert objections about which the letter of guarantee is silent (judgment of the Czech Supreme Court, Case No. 29 Cdo 1807/2021 dated August 30, 2023, available at rozhodnuti.nsoud.cz).

In its reasoning, the court explicitly added that the risk of unauthorized drawing of the guarantee by the creditor cannot be ruled out and the debtor may suffer harm as a result, but this is inherent to the very nature of this security instrument. The Czech Supreme Court did not address the question of whether the debtor could prevent the payout by filing for an interim injunction in this matter, as it was no longer necessary for the outcome of the appeal. Therefore, the specific wording of the letter of guarantee always remains decisive: whoever provides a bank guarantee must expect that without an agreed reservation, the money will go to the creditor regardless of how the dispute over the underlying contract ultimately turns out.

For the customer, a bank guarantee is the strongest tool for obtaining money quickly, precisely because it excludes the dispute over the underlying contract from the payout decision. For the supplier providing it, on the other hand, it is the riskiest tool: if the customer draws the guarantee unjustifiably, the supplier must pay first and only then sue for a refund. The price for this certainty is a bank fee and often a requirement for collateral to the bank, which costs the supplier liquidity for the entire duration of the guarantee.

Bill of exchange: fast enforcement, but not always separated from the underlying relationship

Anyone sued on a bill of exchange cannot raise against the holder objections based on their own relations with the drawer or with previous holders, unless the holder, in acquiring the bill, acted knowingly to the detriment of the debtor (Article I, Section 17 of the Act on Bills of Exchange and Cheques). This limitation protects the person who acquired the bill of exchange from someone else. In the case of a typical security bill of exchange, which is kept by the original creditor the entire time, causal objections from the underlying contract are therefore not excluded in the direct relationship between them and the debtor.

The Czech Supreme Court works with this distinction in its case law on security bills of exchange: causal objections against a promissory note payment order are admissible in such a relationship, but the burden of proof for them is borne by the defendant debtor (judgment of the Czech Supreme Court, Case No. 29 Cdo 3639/2022 dated April 27, 2023, available at rozhodnuti.nsoud.cz). In practice, this means that a bill of exchange significantly facilitates the proceedings for the creditor and concentrates them into a short period, but does not automatically relieve them of the risk that the debtor will open the underlying dispute — it merely gives them a stronger procedural position, as the initiative of proof lies with the debtor.

For deliveries, a blank promissory note is most commonly used: it is issued with an unfilled amount and maturity date, and these details are filled in according to a special agreement only when the debtor breaches the underlying obligation. The creditor can use a petition for the issuance of a promissory note payment order if they present the original bill of exchange to the court; this is a special procedural method that requires the defendant to pay or submit all objections within fifteen days (Section 175 of the Czech Code of Civil Procedure) — however, the court does not order it automatically, it is the plaintiff's choice.

If a blank promissory note has not been filled in as agreed, this cannot be set up against the holder of the bill of exchange, unless the holder acquired the bill of exchange in bad faith or was guilty of gross negligence in acquiring it (Article I, Section 10 of the Act on Bills of Exchange and Cheques). This rule primarily protects the person who acquired the bill of exchange from someone else in good faith. If it is filled in contrary to the agreement directly by the original creditor who kept it, this is their own action, and the debtor can object to such a breach against them — however, they must assert and prove it themselves in timely objections against the promissory note payment order.

The risk of this tool for the person who signs the bill of exchange as a debtor or avalist (guarantor) was demonstrated in a dispute over a loan secured simultaneously by a blank promissory note avalled by a married couple and a bank guarantee from another bank. The creditor decided to enforce the debt only under the bill of exchange against the spouses as natural persons, even though they also had a bank guarantee at their disposal, the validity of which had expired in the meantime.

The Czech Supreme Court concluded that the creditor's mere choice to enforce a claim from only one of several security instruments, without also utilizing the other, does not in itself constitute an abuse of rights, because a prudent creditor who secured the debt in multiple ways must not be in a worse position than one who settled for only one. In the same judgment, the court also confirmed that the holder of a valid bill of exchange does not need to prove anything other than that they are the holder of a valid bill of exchange; whoever objects to the incorrect filling of a blank promissory note bears the burden of proof themselves and must state in timely objections what amount should have been correctly filled in.

The spouses did not succeed in this dispute even with the objection that the agreement on the filling right was disproportionate to them as the weaker party, because it was a relationship between entrepreneurs and the natural persons did not act as consumers in it. How much solvency to require from a specific person and how to verify it before signing varies according to the value of the delivery — which is why a background check on the avalist's assets is conducted by the Czech legal team at ARROWS law firm as a standard step before signing, not only during enforcement.

For a customer who wants security via a bill of exchange, one thing is important: the more solvent the person signing the bill of exchange is, the more valuable the security is, because enforcement against them will be fast and with limited defense if the bill of exchange is already held by another endorsee. For the person signing the bill of exchange, the opposite lesson applies: a combination with other security does not prevent the creditor from enforcing directly under the bill of exchange, even if they could reach elsewhere. The implications of a situation where the debt is paid but the bill of exchange remains in the hands of the creditor are discussed in the article on a bill of exchange remaining in the hands of the creditor after the debt is paid.

How to choose the tool for a specific delivery

The first step is to determine what the main risk is. If it is the supplier's insolvency, a suretyship from a solvent person is sufficient. If it is the risk of a dispute over quality or deadline, where you want the money regardless of the outcome of the dispute, a bank guarantee or a bill of exchange is appropriate, with the bank guarantee keeping the underlying dispute out of the payout decision more reliably than a bill of exchange left in the hands of the original creditor.

The second step is to consider who provides the security and how solvent they are. A bank guarantee is secure because a bank stands behind it, not the supplier. A bill of exchange is only as secure as the person who signed it is solvent; for smaller suppliers, this is usually the managing director or partner as a natural person, and their assets at the time of enforcement may be different from what they were when the contract was signed.

The third step is setting the conditions of the demand. For a bank guarantee, the wording of the letter of guarantee is solely decisive: whether it is unconditional or whether the bank has reserved certain objections. For a bill of exchange, the agreement on the filling right is decisive: when and what amount can be filled in and what evidence of breach of contract will be required, as it is precisely this evidence that the debtor will have to present themselves during their defense.

The fourth step is considering a combination of tools. Securing a large delivery with a bank guarantee and a bill of exchange or suretyship at the same time is neither redundant nor risky from the perspective of abuse of rights; on the contrary, it gives the creditor a choice of which path to choose when the debtor fails to perform. Exactly how to set up the combination of tools in a specific contract depends on the value of the delivery, who the supplier is, and what dispute is most likely for the given type of performance.

Security is only one side of the coin; the other is how sanctions for the supplier's delay are calculated at all and when the customer has the right to assign the work to another supplier. How these two questions relate to each other is discussed in the article on when to charge a penalty for a missed deadline and when to assign work to another.

Mistakes in choosing security for a large delivery

The most common mistake is the automatic choice of suretyship where the customer actually wants money regardless of a quality dispute. Suretyship is cheap, but if the supplier disputes the delivery, the customer will find that the dispute over the debt itself can be reflected directly in the enforcement against the guarantor.

The second mistake is a bank guarantee without clearly set conditions for the demand. If the letter of guarantee does not specify when and how the customer is to document the claim, the bank may assume it is an unconditional guarantee and pay it out on first demand even where the parties did not intend it. The precise wording of the letter of guarantee decides how easily the guarantee can be drawn, and it is worth having it reviewed rather than taking it from a generic template.

The third mistake is a bill of exchange signed by a person without real assets, left moreover in the hands of the original creditor under the assumption that it therefore stands completely outside the underlying dispute. Suppliers often offer blank promissory notes signed by a managing director or minority partner whose assets do not cover the value of the delivery. The security then looks good on paper, but turns out to be worthless during enforcement, and moreover, the underlying cause can return to the dispute. How deeply to check the assets of the person providing the security depends on the value of the delivery — which is why this check for larger contracts is performed by the Czech legal team at ARROWS law firm as a standard part of contract preparation.

The fourth mistake is an unclear agreement on the filling right for a security bill of exchange. Without a precise description of when and what amount can be filled in, space opens up for a dispute over whether the filling was in accordance with the agreement, and this dispute must be led and proven precisely by the debtor who signed the blank promissory note.

The fifth mistake is security set up once and never updated. The value of the delivery, the schedule, and the solvency of the counterparty change during a long-term contract, but the letter of guarantee or the agreement on the filling right signed at the beginning remains the same. For multi-year deliveries, it is therefore worth arranging a regular review of the security, rather than setting it once and for all.

Where the security of a large delivery breaks down

Final Summary

The article has shown that suretyship, a bank guarantee, and a bill of exchange are not interchangeable variants of the same thing, but tools with different degrees of dependence on the underlying contract. Suretyship is the cheapest, but leaves the customer with the risk of a dispute over the debt. A bank guarantee excludes this risk from the payment decision most reliably; a bill of exchange only partially, if held by the original creditor.

For company management, two questions are decisive. The first is whether the main risk is the insolvency of the other party or a dispute over the performance itself; the choice between suretyship on one hand and a bank guarantee or bill of exchange on the other depends on the answer. The second question is how solvent the person providing the security is, because without that, even the strongest legal tool is worthless.

Delaying the setup of security does not pay off. The conditions of the demand for a bank guarantee and the agreement on the filling right for a bill of exchange are resolved when signing the contract, not only when the other party fails to perform. Companies that set up security according to the specific risk of the delivery received money quickly; those that adopted a generic template dealt with a dispute over what the security actually covers.

The choice and setup of a security instrument is only one part of a supplier contract review — the general rules for the entire review are summarized in the text on what a commercial contract review should contain.

The Czech legal team at ARROWS law firm will assess which security instrument corresponds to the risk of your delivery, prepare and review the letter of guarantee and the agreement on the filling right, verify the counterparty's solvency, and represent you in enforcement and court disputes. Write to us at consultation@arws.cz or check out our service contracts and negotiations.