The difference between a guarantee and an indemnity |
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| Introduction |
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| Guarantees and indemnities are both long established forms of what the law terms suretyship. There are important legal distinctions between them. |
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| What is what? |
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| A guarantee is For example: |
a promise to someone that a third party will meet its obligations to them “if they don’t pay you, I will” |
| An indemnity is |
a promise to be responsible for another’s loss, and to compensate them for that loss on an agreed basis |
| For example: |
“if it costs you more than £250 to fix that, I will reimburse you the difference”. |
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| 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. |
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| Further, a guarantee provides for a liability co-extensive with that of the principal. In other words, the guarantor cannot be liable for anything more than the client. The document will be construed as a guarantee if, on its true construction, the obligations of the surety are to “stand behind” the principal and only come to the fore once an obligation has been breached as between the principal and the financier. The obligation is a secondary one, reflexive in character. |
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| An indemnity however, provides for concurrent liability with the principal throughout and there is no need to “look first” to the principal. In essence it is an agreement that the surety will hold the financier harmless against all losses arising from the contract between the principal and the financier. |
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| It is not always obvious whether a clause or agreement is a guarantee or an indemnity. |
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| And an example... |
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| Some of the differences were highlighted by the Court of Appeal in the 2007 case Pitts and Ors v Jones. |
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| The appellants bringing the claim were minority shareholders in a company of which the other party was managing director and majority shareholder. |
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| The majority shareholder had negotiated the sale of the company to a purchaser who had agreed to buy the shares of the minority at the same price. |
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| The appellants were summoned to the sale completion meeting and were told that as part of the terms agreed their shares would be purchased after a delay of six months. |
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| On being made aware of the risk of the purchaser becoming insolvent within this period they declined to sign the documents but relented when the majority shareholder undertook verbally to pay if the purchaser failed to do so. |
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| The purchaser did subsequently become insolvent and could not pay for the minority shareholders’ shares, so they sued the majority shareholder on his undertaking to pay them. |
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| 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. |
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| The minority shareholders lost the value of their shares and were left with no recourse. |
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| How to tell which is which |
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| Whether the security document is a guarantee or an indemnity (or both) is a matter of construction. There is a mass of case law on the distinction, but ultimately it comes down to the document in question. Considerations are as follows: |
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- The words used; the fact that one label or another is used is not determinative but it may demonstrate what the parties were attempting to achieve;
- Whether the document purports to make the surety liable for a greater sum than could be demanded under the principal contract, in which case the inference is that he is undertaking an obligation to indemnify;
- Whether a demand upon the principal debtor is defined as a condition precedent to proceeding against the surety – in which case the document may well best be read as a guarantee;
- An indemnity comprises only two parties- the indemnifier and the indemnity holder. A guarantee is a contract between three parties namely the surety, principal debtor and the creditor.
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| Summary |
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| Case law iterates the need to seek proper legal advice and at bare minimum, use a written agreement clearly stating the parties’ intentions. |
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| Click to buy: Shareholder Agreements |
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