Article reference: UK-IA-LAW32

The difference between a guarantee and an indemnity

Guarantees and indemnities are both long established legal concepts. There are important distinctions between them. This article explains the difference between these two terms with some useful example to provide you a clear idea of which one to use.

 
 

Contents

Basic law and examples

What sort of deal?

How it works in practice

 

 

Basic law and examples

Guarantees and indemnities are both long established legal concepts. There are important distinctions between them.

For example a guarantor says: “if he does not pay you, I will”.

An indemnifier says: “I understand that this deal with me may cause you to lose money. If you do, I will make it up to you.”

A guarantee is usually a simple promise to pay if someone else fails in any of a range of obligations. An indemnity may be subject to all sorts of conditions.

Section 4 of the venerable Statute of Frauds Act 1677 requires guarantees to be in writing if they are to be enforceable. There is no such requirement in the case of an indemnity, although of course written agreement is always best as a matter of practice and for proof.

The liability of the guarantor is no more nor less than the liability of the person whose obligations he is guaranteeing. The document will be interpreted as a guarantee if the obligations of the guarantor are to “stand behind” the principal debtor and only become effective once that debtor has failed in his obligations. That makes a guarantee into a sort of long stop.

An indemnity however, provides for the liability of the indemnifier to run with any loss by the person he indemnifies. So there is no need to “look first” to anyone else to make good a debt or obligation. In essence it is an agreement that the indemnifier will make sure the person he indemnifies does not lose money on the deal in question.

What sort of deal?

Use a guarantee where one party is under specific obligations to another. The most common use is in a commercial lease or residential tenancy agreement.

If you are a guarantor, make sure that anything you are asked to guarantee is actually within your power. For example, in a residential tenancy agreement, guaranteeing the rent may be acceptable, but avoid guaranteeing “the obligations of the tenant” or similar breach. If you do, you may be stuck with obligations you never considered, like making good to the structure after a raucous party or redecorating if the tenant fails to do so. If possible, limit your guarantee to specific financial obligations, like payment of the rent. Then you know what you are in for.

An indemnity is most likely to be required as part of a business deal. The critical factor here is the relative strength of the negotiating hand of the parties. The requirement for an indemnity may be perfectly reasonable. For example, many terms and conditions documents for Internet use provide for the user to indemnify the site owner. That is reasonable. If I allow you to use my website and you post a libellous comment, the person libelled might sue me. That would be unfair. So I make sure you indemnify me against not only what I might have to pay him, but all my legal costs too.

Most indemnities cover situations like the example above, where one party is simply making sure that he does not have to pay for some failing or stupidity of the other.

An indemnity can also be mutual, where each party to a contract agrees to indemnify the other for any failing of his. Partnership agreements sometimes work like this. In law a partner is liable for partnership debts down to his last penny, so he wants his partners to look after his interests as they would their own. But if a partner acts stupidly, it is right that he makes good any loss to the other partners, no matter how great. That applies to all the partners, so the indemnity is mutual.

How it works in practice

It is not always obvious whether a clause or agreement is a guarantee or an indemnity. Here is an interesting recent case which actually relied on the Statute of Frauds - an act now nearly 350 years old.

In the Court of Appeal case of Pitts and Others v Jones, the appellants (who brought the claim) were minority shareholders in a company of which Jones was managing director and majority shareholder.

Jones had negotiated the sale of the company to a purchaser who had agreed to buy the shares of the minority at the same price. But when the day came for completion of the sale, Pits and the others were horrified to hear that their shares would be purchased only after a delay of six months.

Of course they were aware that the buyer might go bust. After all, if he did not have the money now, how could they be sure he would have it in six months’ time. So they obtained a verbal agreement from Jones that if the buyer failed to come good, he, Jones, would give them the money out of his share. So they had a verbal contract, witnessed by all of them.

The buyer did subsequently become insolvent and could not pay for the minority shareholders’ shares, so they sued Jones under his verbal agreement to indemnify them.

The Court of Appeal found that, while all the other necessary elements of a legally binding contract were present (offer, acceptance, consideration and the intention to create legal relations), the undertaking given to the minority shareholders was unenforceable since it was a guarantee and was not in writing. It fell foul of the Statute of Frauds.

The minority shareholders lost the value of their shares and were left with no recourse. Had Jones promise been different in any way, we have no idea whether that difference would have affected their Lordships’ judgment. But the case does show that the “deal” must have been a guarantee and not an indemnity because the base contract to sell the shares was a contract with the buyer and not with Jones. So he must have been a guarantor and not an indemnifier.

 

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