Guarantee or Indemnity – Which is best for your Business?

October 17, 2019

If there is one thing business loathes, it is uncertainty.  And for the last three years, British businesses have had to deal with so many political roller coasters; stability feels almost abnormal.  

Whether the UK leaves with or without a Brexit deal, there remains a recession risk.  The predictions for a 2020 global downturn are dire.  Therefore, the pressure will be on contracting parties to protect their positions with guarantees and indemnities.  Whether a guarantee or an indemnity clause should be inserted into an agreement and how one should be drafted depends on the nature of the contract.  To ensure your organisation’s best interests are safeguarded, it is essential to understand the difference between the two concepts.

What is a guarantee?

A guarantee is an undertaking by a third party to cover a debt, obligation, or fulfil a promise if the person primarily responsible for it defaults.  The classic example is where a parent guarantees their child’s mortgage. In such a situation, if the child cannot pay the mortgage, the bank will soon come knocking on the parent’s door, demanding the money.

Providing a personal guarantee is often the only way an SME can access finance.  One person can provide the guarantee, or the risk can be spread amongst several directors.

What is an indemnity?

An indemnity is a contractual promise to accept liability for another person’s/business’s loss.  For example, if a company sends an employee to do repairs on your premises and that person suffers an injury, the contract you signed may state that you indemnify the repair company for any unintentional harm, claims or other liability.  Or, if you sell your business, you are likely to be required to indemnify the owner against any Employment Tribunal claims or other litigation brought within a certain period following the sale (for example, 12 months).

Top tip Generally, no one cares about contractual terms unless something goes wrong.  If you want to keep your cash flow high and your stress low, read every line of any agreement you enter into.  And if you don’t understand something, get legal advice.

What are the advantages of an indemnity over a guarantee?

Indemnities offer certain advantages over a guarantee, including:

  • An indemnity is a primary obligation from the promisor to the beneficiary. This means it is more robust than a guarantee which is a secondary obligation.  Therefore, an indemnity can survive if the original contract is set aside.  

For example, Company A, a supplier of environmentally friendly products, contracts with a manufacturer, Company B, to make a new range of goods.   Company A is concerned about Company B’s compliance with environmental law, as non-compliance could harm Company A’s reputation and see it face enforcement action.  To secure the business, Company B indemnifies Company A against all loss, including damage to its reputation and any penalties imposed by the enforcement agencies, caused by Company B’s breach of environmental law in making the goods.  If the contract is deemed void at a later date, the indemnity remains enforceable as per its terms. A guarantee would fail with the contract and Company A could find itself liable for its own losses if it was discovered Company B had infringed environmental regulations.

  • Unlike a guarantee, an indemnity does not have to be in writing and signed to be valid.
  • A guarantee can be vulnerable to variations on the original agreement.  The case of Holme v Brunskill [1877] 3 QBD 495 established that unless the guarantor consented to a contractual change or the change was insubstantial and would not affect the guarantor, any amendments to the primary contract would discharge the guarantor’s liability.
  • A guarantor can only be liable to a beneficiary to the same extent the obligor is liable.  For example, if the obligor defaults on a £10,000 loan, the guarantor is only accountable for this amount.  However, as seen in the above case involving the manufacturing of eco-products, an indemnity can cover losses such as regulatory penalties and reputational damage, which can far exceed the obligor’s original liability.

Can all losses be indemnified?

No organisation can claim losses under an indemnity if those losses were caused by the receiving party’s fraud, deliberate acts, or crimes.  Furthermore, if an indemnity clause does not expressly mention cover for the receiver’s negligence, loss caused by a lack of reasonable care on the part of the receiver cannot be claimed.

If an indemnity is considered unfair, the Courts may restrict its scope or extinguish it.  Therefore, it is imperative to invest in expert legal drafting. An experienced Solicitor will examine what losses you might suffer, how the losses would arise, and who should pay for them.  They will also ensure the ‘trigger’ for payment is clearly set out.

Will a guarantee be set aside if the guarantor was pressured to enter it?

A guarantee can be set aside if it was obtained by duress or undue influence.  If you are concerned that there is potential for a guarantee you have secured to be challenged on the grounds of undue influence or misrepresentation, insist the guarantor seek independent legal advice.  Furthermore, obtain evidence of the advice provided and of the guarantor’s acceptance of that guidance.

Final words

It is vital to note that this article barely scrapes the surface of the law of guarantees and indemnities.  We will continue to cover these matters in future posts. However, if you have any questions about the issues discussed, please get in touch for a free quote.