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The differences between an indemnity and guarantee

30 January 2019

The differences between a guarantee and an indemnity are often overlooked and underappreciated. Indeed, it is not uncommon for people to mistakenly view the two obligations as synonymous.

In commercial transactions, parties are often asked or required to provide a guarantee, an indemnity, or both. These types of obligations can usually be found in everyday commercial contracts such as supply agreements and loan documents.

It is, therefore, important to understand and appreciate what the differences are between a guarantee and an indemnity before agreeing to them.

The differences between a guarantee and an indemnity obligation were recently highlighted by the English High Court in Catalyst Business Finance v. Very Tangy Television Limited, Richard Tuckwell, Very Tangy Media Limited [2018] EWHC 1669 (QB).

The case provided a vital reminder that a guarantor is obligated to answer for another party’s default. The guarantee creates a secondary obligation on the guarantor; so that, in a supply agreement for example, the supplier can look to the guarantor for recovery of damages upon a purchaser’s default under the agreement. However, it is worthwhile to note that a guarantor, in these circumstances, is entitled to the benefit of any defences available to the defaulting party. On the facts in the case, the English High Court determined that the guarantor in a loan agreement was entitled to a right of set-off as this defence was available to the defaulting primary obligor.

On the other hand, an indemnity obligation creates a primary obligation on the party providing the indemnity. An indemnifier undertakes an original and independent obligation owed to the principal party. This means that the indemnifier’s obligation, unlike that of a guarantor’s obligation, is not contingent on the actions of the defaulting party, and, in a loan agreement for example, the creditor does not need to establish liability of the borrower for the principal debt. The party giving the indemnity cannot rely on any defences or right of set-off that the borrower may have. Also, the amount required to be paid under an indemnity obligation could potentially be greater than the amount required to be paid under a guarantee obligation. This is because the indemnity creates new obligations.

Often, as in the English High Court case, the terms “guarantee and indemnity” are used together in a contract. Naming an obligation as a “guarantee”, an “indemnity”, or both would not be determinative of whether it creates a guarantee, indemnity, or both. Therefore, it is important to carefully examine the contract to determine what the obligation is. Further, creditors and suppliers should carefully consider the wording in their contracts to ensure that obligations in those documents will protect them.

Should you wish to discuss any of the above and how it may affect you, please do not hesitate to contact Mike Roberton (DDI: (09) 356 8240; m............@glaister.co.nz) and Peter Liao (DDI: (09) 914 3520; p.........@glaister.co.nz).