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Guarantees and indemnities: a quick guide
A quick guide to guarantees and indemnities, including their respective advantages, legal and drafting issues to bear in mind, and links to further materials.
Why are guarantees and indemnities important?
Guarantees and indemnities are a common way in which creditors protect themselves from the risk of debt default. Lenders will often seek a guarantee and indemnity if they have doubts about a borrower's ability to fulfil its obligations under a loan agreement. Guarantors and indemnifiers take on a serious financial risk in entering into such transactions, and it is important that they are aware of all the implications.
What is a guarantee?
A guarantee is a contractual promise to:
Ensure that a third party fulfils its obligations (pure guarantee); and/or
Pay an amount owed by a third party if it fails to do so itself (conditional payment guarantee).
A guarantee is a secondary obligation because it is contingent on the obligation of the third party (principal) to the beneficiary of the guarantee (beneficiary).
A guarantee is distinct from a demand guarantee ( www.practicallaw.com/6-502-0561) (also called an on demand bond). The latter is a guarantee that imposes a primary obligation on the guarantor to pay the beneficiary on its first demand for payment, where the principal fails to perform the contract. For more on demand guarantees and how they differ from true guarantees, see Practice note, Bonds, guarantees and standby credits: overview: The guarantor's obligation ( www.practicallaw.com/4-107-3649) .
What is an indemnity?
An indemnity is a contractual promise to accept liability for another's loss. It is a primary obligation because it is independent of the obligation of a third party (principal) to the beneficiary of the indemnity (beneficiary) under which the loss arose. For more information on indemnities, see Practice note, Contracts: indemnities ( www.practicallaw.com/w-004-0860) .
Advantages of a guarantee
Guarantees tend to be more advantageous to the guarantor because they confer certain rights including:
Right to indemnity. Once the guarantor pays the beneficiary under the terms of the guarantee, it has a right to claim indemnity from the principal provided that the guarantee was given at the principal's request.
Right of set-off. Where the principal satisfies its obligations by way of set-off against the beneficiary's liabilities to the principal, the guarantor is also entitled to that right of set-off and will be discharged from its obligations under the guarantee.
Subrogation. A guarantor who fulfils the principal's obligations under the terms of the guarantee is entitled to all the rights of the beneficiary against the principal under the primary agreement, including any rights of set-off and any security that the beneficiary had taken from the principal.
Marshalling. The equitable doctrine of marshalling ( www.practicallaw.com/6-503-8622) applies to guarantees so that a guarantor may be able to obtain the benefit of another creditor's security over the principal's assets that it would otherwise not have security over.
For more on guarantor rights, see Practice note, Enforcing guarantees: guarantor's rights ( www.practicallaw.com/5-562-6805) .
Advantages of an indemnity
Indemnities tend to be more advantageous to the beneficiary.
No specific formal requirements. Unlike a guarantee, an indemnity need not be in writing or signed by the indemnifier in order to be effective.
More robust. Being a primary obligation, an indemnity will be valid even if the underlying transaction is set aside; unlike a guarantee, which is dependent on the underlying transaction. Furthermore, any variation to the underlying transaction will discharge a guarantor's (but not an indemnifier's) liability, unless the guarantor consents to the variation, or the variation is insubstantial or incapable of adversely affecting the guarantor. For more information on the variation of guaranteed obligations, see Practice note, Variation of guaranteed obligations ( www.practicallaw.com/7-228-2952) .
Guarantee documents often include both a guarantee and a supporting indemnity so that the beneficiary can have the benefit of both. The exact wording of the terms of the obligation must make this clear. If there is any uncertainty, the court will choose the interpretation that is less onerous for the guarantor and will characterise the obligation as a guarantee, not an indemnity.
A guarantee must be in writing (or evidenced in writing) and signed by the guarantor or a person authorised by the guarantor (section 4 ( www.practicallaw.com/0-508-0478) , Statute of Frauds 1677).
Guarantees and indemnities are often executed as deeds to overcome any argument about whether good consideration has been given. For more information on the formal requirements for deeds, see Practice note, Execution of deeds and documents: Formalities for a deed ( www.practicallaw.com/0-380-8400) .
Even though guarantees need to be in writing and signed by the guarantor, a series of documents is capable of forming a guarantee (see Legal update, E-mail chain can create an enforceable guarantee (Court of Appeal) ( www.practicallaw.com/3-518-4549) ). The name of the guarantor in an e-mail, where there is both an intention that it is a signature and an intention to contract, will constitute a signature for this purpose (see Legal update, Guidance on execution of documents at a virtual signing or closing: Guarantees ( www.practicallaw.com/1-386-0831) ).
For a list of standard form deeds of guarantee and indemnity, see Accessing Practical Law Finance's guarantees resources: Key standard documents and clauses ( www.practicallaw.com/5-523-7995) .
Other legal issues
Contractual issues. Guarantees and indemnities are subject to general contract law principles on offer and acceptance, intention to create legal relations, consideration etc. For more information, see Practice note, Contracts: formation ( www.practicallaw.com/3-107-4828) .
Undue influence and misrepresentation. To avoid potential undue influence and misrepresentation issues when obtaining a guarantee from an individual, the beneficiary should obtain confirmation from the guarantor's solicitor that the transaction and its implications have been explained to the guarantor. For more information, see Practice notes, Guarantees and indemnities: Duress, misrepresentation and undue influence ( www.practicallaw.com/9-200-1437) and Undue influence and the Etridge principles ( www.practicallaw.com/0-107-3967) ..
Capacity to give guarantee or indemnity. Ideally, the constitutional documents of the company giving the guarantee or indemnity should provide an express power to do so. See for example, Articles of association for a public company limited by shares incorporated under the Companies Act 2006 ( www.practicallaw.com/8-503-9324) .
Giving a guarantee or indemnity is likely to be an ancillary power of the company. The directors must therefore show that they are acting to promote the success of the company, and take into account certain related factors (section 172, Companies Act 2006 ( www.practicallaw.com/5-505-5377) (CA 2006)). Generally, it will be sufficient for the board minutes to state that these factors have been taken into account. For more information, see Practice note, Guarantees and indemnities: Capacity to give guarantee or indemnity ( www.practicallaw.com/9-200-1437) .
If there is any doubt about the benefit to the company or the capacity of the directors, a shareholders' resolution should be sought. For an example of such a resolution, see Standard document, Written resolution of members under Companies Act 2006 (approving a guarantee) ( www.practicallaw.com/8-534-6139) .
Disclosure. The beneficiary is not obliged to disclose any information to the guarantor, unless the guarantor makes specific enquiry, or unless the information is unusual and relates to the relevant contractual relationships. For more information, see Legal update, Inadvertent variation of guarantees and manifest errors that emerge over time (Court of Appeal) ( www.practicallaw.com/3-505-4010) .
Guarantees and indemnities to directors. Shareholder approval is required before a company can give a guarantee or indemnity to one of its directors in relation to a loan. Where the guarantee or indemnity is to a director of the company's holding company, the members of the holding company must also approve the transaction. No approval is required by members of a company which is not a UK-registered company or is a wholly owned subsidiary (Section 197, CA 2006 ( www.practicallaw.com/1-506-0494) ). For more information, see Practice note, Loans to directors: comparison between Companies Acts 2006 and 1985 ( www.practicallaw.com/6-203-0417) .
Financial assistance. The CA 2006 rules on financial assistance ( www.practicallaw.com/6-107-5751) apply to the giving of guarantees and indemnities. Therefore, in the context of a company acquisition, a guarantee or indemnity given by the target company to the purchaser may constitute financial assistance and result in the guarantee or indemnity being void and the directors being liable for a fine and imprisonment. For more information, see Practice note, Financial assistance ( www.practicallaw.com/8-382-5504) .
Unfair contract terms and consumer rights. Under certain circumstances it is necessary to take into account consumer rights legislation and the extent to which the Unfair Contract Terms Act 1977 ( www.practicallaw.com/7-505-7728) , the Unfair Terms in Consumer Contracts Regulations 1999 (SI 1999/2083) ( www.practicallaw.com/6-508-2455) and the Consumer Rights Act 2015 ( www.practicallaw.com/0-606-7466) apply when drafting guarantees and indemnities. For more on the application of unfair contract terms and consumer rights protections, see Practice note, Guarantees and indemnities: Consumer Rights and Unfair terms ( www.practicallaw.com/9-200-1437) and Article, When is your guarantee subject to consumer law? ( www.practicallaw.com/w-004-3596) .
Co-guarantors. Guarantees can get complicated when a lender or other beneficiary has the benefit of a guarantee from more than one guarantor. For a note that explains the implications of a lender taking guarantees from more than one person over the same debt and that considers the legal position from the perspective both of the lender and the co-guarantors, see Practice note, Co-guarantors ( www.practicallaw.com/w-004-0185) .
Insolvency. In theory, the insolvency of a principal does not affect the beneficiary's rights against the guarantor, and the insolvency of the guarantor does not discharge the guarantee. However, in practice, there are a number of issues to consider on the insolvency of any of the parties. For more information, see Practice notes, Corporate insolvency and guarantees: overview ( www.practicallaw.com/6-519-7404) and How to insolvency proof your guarantee ( www.practicallaw.com/9-619-9288) .
Enforcement. Subject to a guarantor's equitable right of marshalling (see Advantages of a guarantee), a beneficiary can enforce a guarantee even when it holds security over the assets of the principal. For more information, see Legal update, Statutory demand against surety valid despite creditor's security over principal's assets (Court of Appeal) ( www.practicallaw.com/0-506-6731) . For a toolkit highlighting materials on the type of legal issues that can arise in the course of enforcing a guarantee, see Practice note, Enforcing guarantees: toolkit ( www.practicallaw.com/1-580-0745) .
Assignment. When assigning the benefit of a guarantee, the beneficiary may also need to assign the benefit of the guaranteed debt. The guarantor's express consent should be obtained before any assignment. For more information, see Practice note, Guarantees and indemnities: Assigning a guarantee or indemnity ( www.practicallaw.com/9-200-1437) .
Practice note, Guarantees and indemnities ( www.practicallaw.com/9-200-1437) provides a fuller analysis of the issues touched upon in this guide.
For a guide to Practical Law Finance's resources on guarantees, including key practice notes and a list of standard form guarantees and indemnities relating to different types of transactions, see Accessing Practical Law Finance's guarantees resources ( www.practicallaw.com/5-523-7995) .