Guarantees and indemnities strengthen contractual obligations. As such they are an effective way to reduce the chances of a breach of contract and costly legal disputes that may follow. It’s important to understand the way guarantees and indemnities differ from a legal perspective: In short, a guarantor agrees to discharge someone else’s obligation under a contract if that party fails to do so. (The obligation is usually to make a payment of some sort). An indemnity on the other hand is a legal obligation to make good a loss that someone else has suffered.
Naturally, the robustness of any guarantee/indemnity protection is dependent on the ability of the guarantor or indemnifying party to discharge any debt. In this respect it’s essential to be satisfied as to the solvency of any guarantor or indemnifying party. And of course guarantors and indemnifiers assume substantial legal risk so they should always seek legal advice before agreeing any terms.
Nath Solicitors in London provides specialist advice to those considering providing some kind of contractual guarantee or indemnity as well as to businesses and individuals who are negotiating commercial agreements in which guarantees and indemnities are proposed.
Guarantees And Indemnities: More Important Than Ever
Against the backdrop of Covid19, we’ve seen how the chances of contractual frustration have risen, for example by increased reliance on the concept of force majeure. This only serves to heighten the need to ensure you understand the difference between guarantees and indemnities and that, when included in a contract, these forms of surety are expertly and clearly worded.
The distinction between the two types of clause can be critical. In the event that an alleged breach or default occurs, whether a guarantee or indemnity exists will dictate the legal remedies and defences available. So how do guarantees and indemnities work? And what are differences between them?
What Is A Guarantee?
A guarantor promises to ensure that a third party will fulfill specified contractual obligations. The guarantee will usually involve an undertaking by the guarantor to pay sums owed under the contract if the third party fails to do so. It’s a secondary obligation because it is subject first to the obligation of the third party (i.e. the principal party to the contract) to comply with the contract terms.
Guarantees are generally considered to favour a guarantor because they give the guarantor certain legal rights, including the right to indemnity. (This means that when the guarantor pays the beneficiary under the terms of the guarantee, the guarantor has a right to claim indemnity from the defaulting principal).
What Is An Indemnity?
An indemnity is a contractual agreement by the indemnifying party to shoulder the cost of another’s loss. It is a primary obligation (unlike the secondary nature of a guarantee) because it is completely separate from the obligation of a third party (principal) to the indemnified party.
Indemnities tend to be more advantageous to the beneficiary because they are primary obligations – even if the contract itself is overturned the indemnity will still be enforceable.
Brown Forman v Bacardi (2021)
The 2021 High Court judgment involving drinks giant Bacardi provides a useful summary of the rules relating to guarantees and indemnities. Bacardi UK entered a cost-sharing agreement with US based drinks company Brown Forman (the claimant). The agreement contained several guarantees and indemnities that Brown Forman was attempting to enforce.
The High Court judge highlighted the indemnity/guarantee distinction we’ve outlined above. He also explained that when interpreting contractual provisions like these, courts consider, among other things, the natural, ordinary meaning of the words used, the overall purpose of the provision, and how the notion of commercial common sense affects the meaning of the particular provision.
The judgment in Bacardi reminds us that when entering commercial agreements with guarantees and indemnities, courts will often look at the contract in the context of commercial common sense. Each party should ensure that they are clear on whether a particular provision is an indemnity or a guarantee and in what precise circumstances provisions should take effect. Unless there is evidence to the contrary, the courts will legitimately treat the contract as a commercial agreement, freely entered into. It’s perfectly possible for a clause to be construed as an indemnity even thought it is referred to as a guarantee. As ever, effective drafting is crucial.
Contact Us
We advise on all aspects of commercial contracts and dispute resolution. Please contact Shubha Nath at Nath Solicitors on 44 (0) 203 983 8278 or get in touch with the firm online.
