Letter Of Guarantee

Our brother-in-law Henry is a nice enough guy, but he’s absolutely horrible with money and has several failed business ventures under his belt. Normally, we don’t concern ourselves with his financial ineptitude—that’s our sister’s problem—but his newest business idea has led him straight to our company’s door. We manufacture heavy equipment, and he wants to buy a tower crane for his soon-to-be-formed real estate development company.

A good tower crane can cost about a million dollars to buy, which is why most construction and development businesses rent them instead. But Henry insists he has to buy one, and he wants us to sell it to him. Surprise, surprise, he doesn’t have the money for it up front, so he’ll need to take out a loan. We’re not sure about this, so we request a letter of guarantee from his financial institution.

A “letter of guarantee” is basically a letter from the bank promising that, even if Henry defaults on his tower crane loan payments, the bank will cover his debt. They might not cover all of it—for example, they might just guarantee the principal of the loan but not any interest it accrues—but it does offer us a little financial protection when (er...if) Henry’s big ideas don’t pan out.

Letters of guarantee can also be used in other areas of the financial investment world. If we write a call order for a thousand shares of stock, our bank can issue a letter of guarantee promising that (a) we actually own the stock we’re trying to sell, and (b) those shares will be delivered if the option is exercised.