Understanding guarantee contracts and security agreements in loan transactions in vietnam and globally – an in-house counsel’s perspective

In loan transactions, distinguishing between guarantee contracts and security agreements is crucial for risk management by all parties involved - including banks, borrowers, in-house counsels, and external lawyers. This article provides an analysis of how these two types of agreements are applied in domestic loans in Vietnam, international loans involving Vietnamese enterprises, and global market practices.

Part 1: Guarantee contracts and security agreements in domestic loans in Vietnam

In Vietnam, domestic loan transactions are governed by stringent regulations, primarily the Civil Code 2015, the Law on Credit Institutions 2010 (amended in 2017), and Decree No. 21/2021/ND-CP on security measures. The Law on Credit Institutions 2024 came into effect on July 1, 2024, with certain provisions becoming effective on January 1, 2025.

Guarantee contracts in domestic loans

A guarantee contract is a commitment made by a third party - often a parent company - to repay the debt on behalf of the borrower if the borrower defaults. However, in Vietnam, financial guarantee contracts are less common in domestic loans due to restrictions under the Law on Credit Institutions 2010 and Circular No. 07/2015/TT-NHNN on bank guarantees.

Although Circular No. 07/2015/TT-NHNN and its amendment Circular No. 13/2017/TT-NHNN were issued based on the Law on Credit Institutions 2010, they remain in force until new guidance under the Law on Credit Institutions 2024 is issued by the State Bank of Vietnam.

Example:

A real estate company developing a housing project may be required to enter into a guarantee contract with a bank through its parent company to secure a loan. This guarantee reduces the bank's risk if the borrower fails to repay the loan.

Security agreements in domestic loans

Security agreements are more common in domestic loans in Vietnam. These agreements involve the borrower pledging specific assets - such as real estate, machinery, or receivables - as collateral. If the borrower defaults, the lender can seize the pledged assets to recover the loan.

The process for registering security interests is governed by Decree No. 21/2021/ND-CP, which requires registration of security measures with the Center for Registration of Secured Transactions (NRAST) to make them enforceable against third parties.

Example:

A manufacturing company in Vietnam may enter into a security agreement with a bank when borrowing to expand its factory, using its existing machinery as collateral. The bank would then register the security interest with NRAST to protect its legal rights.

Part 2: Guarantee contracts and security agreements in international loans

For international loans involving Vietnamese enterprises, both guarantee contracts and security agreements play significant roles in securing debt repayment and minimizing lender risks.

Guarantee contracts in international loans

In syndicated international loans, lenders often require a guarantee contract from the borrower's parent company or major shareholders. This ensures that debt obligations will be fulfilled even if the borrower defaults.

In project finance transactions, a parent guarantee is a common feature to secure the financial obligations of the special purpose vehicle (SPV) established for the project. This helps enhance the project's creditworthiness and facilitates access to capital from international financial institutions.

Example:

A Vietnamese infrastructure company seeking financing from multiple international banks for a highway project may require a parent guarantee from its holding company to reduce credit risk and increase the project's attractiveness to lenders.

Security agreements in international loans

In international loan transactions, security agreements are essential tools to reduce lender risk. Collateral can include project assets, shares, or escrow accounts.

Lenders may also use convertible loans as a flexible financing solution, combining security measures with the option to convert debt into equity.

Example:

An international financial institution may invest in a Vietnamese company through convertible bonds. The bond issuance agreement might include clauses for early repayment or conversion into equity if the company fails to execute an agreed IPO plan.

Part 3: Practices in the U.S. market

In the United States, secured transactions and personal guarantees are more widely used and flexible compared to Vietnam. The Uniform Commercial Code (UCC) provides a standardized legal framework for secured transactions across the country, while guarantee contracts are governed by common contract laws and state-specific regulations.

Key Features of U.S. Practices:

• Asset valuation reassessment to ensure sufficient collateral coverage.
• Self-help repossession of collateral without court intervention under UCC §9-609, provided it does not breach public peace.
• Transfer of secured interests to third parties under UCC regulations.

Example:

A small manufacturing company with weak credit history in the U.S. may be required to provide a personal guarantee from its CEO. If the company defaults, the lender can file a lawsuit to enforce the personal guarantee and seize the CEO's personal assets following a court ruling.

Part 4: Conclusion and key takeaways

The choice between a guarantee contract and a security agreement depends on the nature of the loan and the lender's risk management strategy. In Vietnam, security agreements are more prevalent for domestic loans, whereas for international loans, both types of contracts are commonly used to ensure debt recovery and mitigate risks.

Understanding the differences between these two types of agreements is essential for businesses, legal professionals, and in-house counsels participating in cross-border financial transactions, while ensuring compliance with Vietnamese laws and international practices.

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