What is the difference between a guarantee and an indemnity?

Suretyship

Both guarantees and indemnities are common forms of what the law terms suretyship. There are important legal distinctions between the two.

What is meant by suretyship?

  • Suretyship refers to a person who is liable for the payment of another’s debt or the performance of another person’s obligations in the event of a failure to perform or a failure in relation to some other condition.

Guarantee

What is meant by a guarantee?

  • A guarantee is a promise to someone that a third party will meet its obligations to them. The best example of this is a promise that if a third party will not pay them then they will meet this obligation and pay them.

  • If for example a tour operator enters into a contract with a hotel to provide accommodation as part of a tour there may well be a guarantee clause contained in the contract. If for example the customer refuses to pay when they check out of the accommodation there may well be a clause in the contract stating that if they don’t pay the tour operator will provide the payment to the hotel.

Indemnity

What is meant by indemnity?

  • An indemnity is a promise to be responsible for another person’s loss and to then provide them with compensation for that loss. If for example, you enter a contract with a travel agent to book a holiday which includes accommodation there may well be a clause relating to indemnity which states that you will be responsible for the loss caused to that hotel by any damage you may have caused and that you will adequately compensate them.

Do both guarantees and indemnities have to be in writing?

  • According to the Statute of Frauds 1677 a guarantee must be in writing or evidenced in writing. If it is not then it is unenforceable. An indemnity can be purely oral.

  • For a guarantee to be fully enforceable there must be an agreement or a note or memorandum of the guarantee signed by the guarantor before they can be liable.

  • It is however, good practice when dealing with both of these forms of suretyship to ensure that they are fully provided for in a written agreement signed by both parties.

Demand

  • For a guarantee it is often the case that there is some form of demand as a condition for the guarantee to come into play. For example there must be some form of demand placed upon either the principal of the guarantor before either can become liable. If we look to the above example this demand will clearly be the demand of payment. If this demand is not met by the principal then it must be met by the guarantor.

  • When concerned with an indemnity there is not often the requirement for a demand to be present. The main issue when concerned with an indemnity is that some form of loss has occurred; it is not concerned with the demand to make good that loss.

Are there any other issues to be examined when establishing the difference between a guarantee and an indemnity?

The following issues are often taken into consideration when establishing whether a contractual provision is in fact a guarantee or an indemnity:

  • The words used in the contract – what the parties’ term the clause is often not actually relevant in establishing what it in fact is. However, the wording used to formulate the clause is often illustrative of the actual intention of the parties.

  • Whether the document states that the party will become liable for a greater sum than is specified under the original contract. If this is to be the case then the clause will seen to be an indemnity not a guarantee.

  • Whether there is a demand placed upon the principal as a condition of the contract – as seen previously this will result in the clause being seen as a guarantee.

Difficulties in distinguishing between the two

  • A recent case clearly highlights the difficulties in distinguishing between the two. In this case the individuals who brought the case were minority shareholders in a company who brought the case against the managing director who was also one of the majority shareholders.

  • The majority shareholder had agreed to sell the company to a purchaser who had already agreed to purchase the shares from the minority shareholders. However, the issue of a time delay was to become apparent due to the fact that the purchaser was running the risk of becoming insolvent.

  • On hearing this, the minority shareholders refused to sign the sale documents and only did following the majority shareholders statement that if the purchaser were in fact to go insolvent he would personally provide them with the money he was owed. This statement was made orally.

  • The court found that the statement was unenforceable as it was in fact a guarantee not an indemnity and due to the fact it was made orally it was unenforceable.