What Is Avalize?

To avalize is the act of having a third party (usually a bank or lending institution) guarantee the obligations of a buyer to a seller per the terms of a contract, such as a promissory note or purchase agreement. The bank, by "avalizing" the document (usually "by aval" will be written on the document itself), acts as a cosigner with the buyer in the transaction.

Key Takeaways

  • To avalize is the act of having a third party (usually a bank or lending institution) guarantee the obligations of a buyer to a seller per the terms of a contract, such as a promissory note or purchase agreement.
  • The act of avalizing usually entails the third party writing the words "by aval" on the physical contract document.
  • While rarely used, the act of avalizing can be an effective method of securing the rights of the receiving party in the transaction.

Understanding Avalize

While rarely used, the act of avalizing can be an effective method of securing the rights of the receiving party in the transaction. This is an obligation that a bank will only take on with lucrative customers. It is seen as an act of good faith by both parties.

When companies make use of a promissory note, they typically will take the extra step of avalizing it. A promissory note is a debt instrument that allows companies and individuals to obtain financing from a source other than a bank (although banks will also issue them on occasion). This alternative financing source may be an individual or a company willing to carry the note under agreed-upon terms. These terms typically pertain to indebtedness, including the principal amount, interest rate, maturity date, date and place of issuance, and issuer's signature. Since anyone can conceivably issue a promissory note, avalizing with a third party can add an extra layer of security.

In addition to supporting the creation of promissory notes, avalizing can come in handy with a range of purchase agreements, including a bond purchase agreement, cross-purchase agreement, and matched sale-purchase agreement.

A bond purchase agreement is a legally-binding document between a bond issuer and an underwriter. It outlines the terms of a bond sale, including but not limited to the sale price, bond interest rate, bond maturity, bond redemption provisions, sinking fund provisions, and reasons why the agreement may be canceled.

A cross-purchase agreement allows a company's major shareholders to purchase the interest or shares of a partner who has deceased, has become incapacitated, or is retiring. As with a bond purchase agreement and promissory note, the cross-purchase agreement document outlines specific terms. In the case of a cross-purchase agreement, the terms outlined detail how shares will be divided or purchased by the remaining partners.

A matched sale-purchase agreement is a type of selling arrangement. In a matched sale-purchase agreement, the U.S. Federal Reserve sells government securities to an institutional dealer or the central bank of another country. The party purchasing the government securities will agree to sell them back to the Federal Reserve within a short period of time (generally two weeks or less). The Federal Reserve repurchases the securities for the same price at which they originally sold them. The purpose of this is to decrease banking reserves.

In all of these cases, the act of avalizing may be used in order to add an additional layer of security to the agreements.