Guarantees and indemnities are common forms of what the law calls ‘suretyship’, and both are commonly found in a commercial context. There are important legal distinctions between the two.
What is suretyship?
Suretyship refers to a person (known as the surety) who is liable for the payment of another’s debt or the performance of another’s obligations, in the event of a failure to pay or perform their obligation. A surety, often known as a guarantor, is usually a third party to the primary contractual arrangement which gives rise to the debt or obligation to perform.
What is a guarantee?
A guarantee is a written contract by which the guarantor promises to meet the obligations set out in the guarantee if the third party, who is contracted to meet those obligations, fails to do so.
If, for example, a tour operator enters into a contract with a hotel to provide accommodation as part of a tour, there may be a guarantee clause contained in the contract. The guarantee may state that if the customer refuses to pay when they check out of the accommodation, the tour operator will make such payment to the hotel.
Does a guarantee have to be in writing?
Yes. Under the Statute of Frauds 1677, a guarantee must be in writing, or at least evidenced in writing. If it is not then it is unenforceable and the ‘guarantor’ does not have to pay. 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 held liable.
There is often a condition in the guarantee by which some form of demand must be made before the guarantor must pay under the guarantee. This is known as a ‘demand guarantee’, and the guarantor must honour the guarantee on the beneficiary’s demand.
What is an indemnity?
An indemnity is a promise to be responsible for another person’s loss, and to compensate them for that loss. If, for example, you enter a contract with a travel agent to book a holiday which includes hotel accommodation, there may be an indemnity to the effect that you will be responsible for any loss caused to the hotel by any damage you have caused, and to adequately compensate them for their losses.
When notified of the loss suffered, the indemnifier must compensate the indemnified as agreed.
Does an indemnity have to be in writing?
No, unlike guarantees, an indemnity can be oral and still be effective. Even if the indemnity is not recorded in writing, it must satisfy the legal requirements for a valid contract to be enforceable. There must, for instance, have been an intention to create legal relations.
So where an indemnity is required to be given, it is good practice to ensure it is recorded in writing, and signed by the giver of the indemnity in case of a future dispute.
What factors dictate whether there is a guarantee or indemnity?
In some cases, it is not always clear whether the promise given is a guarantee or an indemnity. Various factors are relevant to determine whether a contractual provision is a guarantee or indemnity in law, including:
- The words used in the contract:whether or not it is described by a guarantee or indemnity may not be conclusive. The wording used to formulate the clause often demonstrates the actual intention of the parties
- Whether the document states that the party will become liable for a greater sum than that specified in the original contract. If so, the clause will be treated as an indemnity not a guarantee
- Whether there is a demand to be placed upon the principal as a condition of the contract. If so, it is a guarantee