It is important that anyone who is asked to provide a guarantee or indemnity understands precisely what their liabilities are under the arrangements.
In this article, we identify the distinguishing features of both guarantees and indemnities and consider the significant differences between the 2 kinds of arrangements.
Features of a guarantee
A guarantee is a contract by which the promisor (called the surety or guarantor) undertakes to be responsible to the promisee (creditor) for a debt default or miscarriage of a third party (debtor).
A guarantee contract includes three parties, namely the –
The debtor’s obligation is owed to the creditor under a principal contract. The guarantor or surety is liable to the creditor under a contract of guarantee.
The most common example of a contract of guarantee is where one person (guarantor) undertakes to be responsible to a bank (creditor) for the debts of a friend, relative, business colleague or company (debtor) who is borrowing money from the bank.
The liability of a guarantor is a secondary obligation which is only enforceable (contingent) on the debtor failing to perform the obligations which have been guaranteed. If the primary obligation of the debtor is discharged or becomes void, the guarantee falls away.
A further example of a guarantee is where one person (guarantor) guarantees to a third party (guaranteed party) the performance obligations of a second person (eg a subsidiary of the guarantor) under a contract for the supply of goods or services between the subsidiary and the guaranteed party.
Features of an indemnity
An indemnity is a contract by one party to keep the other harmless against loss. Indemnities are also described as an obligation imposed by contract on one person to make good the loss suffered by another.
A contract of indemnity is a primary liability and may arise from an express or implied contract, or in equity.
This means that if you provide an indemnity for the performance of the obligations of someone else you may be called upon to perform those obligations yourself.
There are different types of indemnities which include:
Differences between guarantees and indemnities
The key differences between guarantees and indemnities include:
A guarantee contract is usually used to provide protection to a person, typically a bank or finance company, against loss suffered through entering into a transaction if the obligations of the other party to that transaction are not performed. It reduces the credit risk faced by a bank by giving the bank an entitlement to demand payment from the guarantor in the event of the debtor’s default.
In contrast, indemnities are designed to allocate risk between various parties to a contract, to eliminate the need to show causation as an element of a claim and to avoid the need to mitigate loss.
Indemnity clauses can be found in many different types of commercial contracts, for example, leases, sale of goods, construction contracts, manufacturing contracts and service agreements. It is also important to consider the interaction between an indemnity and a contract of insurance and limitations of liability.
Both guarantees and indemnities can impose complex obligations. As such, they should not be agreed to lightly and should only be considered upon legal advice as to the effect of the specific terms created by the arrangements.
If you or someone you know wants more information or needs help or advice, please contact us on (02) 9238 0060 or email firstname.lastname@example.org.