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What Is a Parent Company Guarantee?

As Caterpillar is the parent company of Electro-Motive Diesel, it might have to step in if EMD failed to deliver locomotives to a railroad.
An authorized letter of guarantee must sometimes be notarized.
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  • Written By: Malcolm Tatum
  • Edited By: Bronwyn Harris
  • Last Modified Date: 01 August 2014
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A parent company guarantee is a declaration issued by a parent company in regard to one or more of its subsidiaries. Often, the guarantee is aimed at providing assurance to a potential client or partner of the subsidiary that the business is capable of honoring all obligations that are connected with the proposed business relationship. Unlike some other type of assurances, this guarantee commits the parent to stepping in and honoring the terms of the contract if the subsidiary should fail to do so for any reason.

There are a number of situations where obtaining a parent company guarantee may be a good idea. One has to do with the authorization of a line of credit or the extension of a business loan. Should the lender have some concerns about the ability of the subsidiary to manage the line of credit properly, or to repay the loan according to terms, the lender may solicit a guarantee from the parent company. This guarantee affirms to the lender that the parent is aware of and approves the actions of the subsidiary, and that the parent believes the subsidiary is capable of honoring the obligation. Along with supporting the actions of the subsidiary, the parent is also entering into a covenant to honor the debt even if the subsidiary ultimately cannot comply with the contractual provisions that govern the extension of credit.

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In most jurisdictions, the declaration must be in the form of an authorized letter of guarantee. This means the letter must be on the official letterhead stationery of the parent company, and the body of the letter must specifically address the concerns of the party who requested the transaction guarantee. The document must be signed by an authorized officer of the parent, and in some jurisdictions, it must be notarized before it is considered legally binding.

Since there is some variance in what constitutes a legal parent company guarantee from one jurisdiction to another, it is important for companies to consult legal professionals when drafting this type of document. Attorneys and similar professionals can provide guidelines to ensure the guarantee is structured in the exact manner required by local laws. Taking the time to make sure the format and content of the guarantee is in compliance with relevant laws and statutes will minimize the chances of any delays in its processing, and allow the subsidiary to move forward with its project sooner rather than later.

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Discuss this Article

epiphany5
Post 4

@superjd - Another way to answer your question is to consider how the reputation of a parent company can have an affect on its subsidiaries. For example, if a company is involved in a major lawsuit or scandal that brings a lot of negative attention, then this attention could possibly be placed on its subsidiaries. This especially occurs when it is widely known that the two companies have close business ties. Even though subsidiaries have little to know influence over the actions of their parent companies, these actions can greatly affect them.

drhs07
Post 3

@SuperJD - In response to your question, yes, there are times in which having a parent company can negatively impact a subsidiary company. This can occur when the parent company faces extreme financial loss, or even bankruptcy. When this happens, the company is forced to make cuts to its assets and or liabilities. It may choose to no longer guarantee the liabilities of the subsidiary, or to sell the subsidiary entirely. In either of these cases, the troubles of the parent company trickle down to the subsidiary companies.

Testy
Post 2

Good overview! I'm getting my MBA, so I have to read about this stuff all the time and know way more than anybody should about parent companies and subsidiaries.

I'd just like to add that in addition to guaranteeing the payback of their subsidiaries loans and other investments, parent companies often times guarantee bonds issued by the subsidiaries. In the event that a company cannot issue payments to bond holders, the parent company will make these payments. Either bond interest, principles, or both can be covered under a parent company guarantee.

Parent companies do not always guarantee the entire liability. In some cases, the bond principle, or interest, but not both, will be paid by the parent company in the event that the subsidiary cannot pay its investors. When this type of guarantee agreement occurs, a company might arrange for more that one parent company to insure its liabilities.

SuperJD
Post 1

Is there ever a situation in which having a parent company guarantee is undesirable? For example, is it possible that the parent company's interference could negatively impact the subsidiary?

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