Oxbridge Notes | Guarantee V Indemnity

Why are guarantees and indemnities important? They are a common way in which creditors protect themselves from the risk of debt default. Lenders will often seek guarantees and indemnities 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.

	Guarantee	Indemnity
What is it?	A promise to ensure that a third party fulfils its obligations and/or promise to fulfil those obligations if a third party fails to do so.	A promise to be responsible for another’s loss.
Primary or Secondary Obligation	It is a contractual agreement that creates a Secondary Obligation to support a primary obligation of one party to another	It is a contractual agreement that creates a Primary Obligation given by the indemnifier to the person to be indemnified.
Contingent	The guarantor’s obligation is contingent on the borrower’s primary obligation. It will never be greater than that of the borrower under the primary agreement.	It is independent to, and not contingent on the obligation of the borrower.
What’s the obligation	The obligation is usually a payment obligation, but it can also be a performance obligation (such as a guarantee to take over building works under a construction contract.)	If the underplaying transaction is set aside for any reason, the indemnity will remain valid.
Courts	The courts are protective of guarantors and guarantors have a number of important rights both against the underlying obligor and against the lender.	The Lender will want any guarantee to be supported by an indemnity in order for the lender to be properly protected.
Distinguishing Test = connection with the transaction + the extent of the promise + Actual words	A promisor unconnected with the underlying transaction, except by means of a promise to pay has been held to be a guarantor + It is a guarantee if the promise can be construed as being the main purpose of the transaction, + The true construction of the actual words in which the promise is expressed	A promise made by someone that will derive some benefit for the transaction gives an indemnity (Courtier v Hastie) + It is an indemnity if the promise can be construed as being incidental to the main purpose of the transaction. + The true construction of the actual words in which the promise is expressed
Proving, Onus	On the beneficiary (the lender or Bank) to prove that the document is a guarantee (secondary obligation)	On the beneficiary (the lender) to prove that the document is an indemnity (primary obligation)
Advantages	By s.4 of Statute of Frauds 1677 A guarantee must be in writing and signed by the guarantor or a person authorised by it. If the primary obligation ceases to exist for any reason, the guarantor cannot be liable for it because the guarantee is dependent on the primary obligation. This means that the beneficiary can be prevented from claiming repayment form the guarantor when it most needs to relay on the guarantee. Guarantees are vulnerable if any changes are made to the underlying contract. Amendments to the contract after the giving of the guarantee, will discharge the guarantor’s liability under the guarantee unless: The guarantor consents the variation The variation is patently insubstantial or incapable of adversely affecting the guarantor	Formalities s.4 of Statute of Frauds 1677 do not apply to indemnities i.e. flexibility. Thus it does not need be in writing to be enforceable. An indemnity is a primary obligation from the promisor to the beneficiary. This is more robust than a guarantee which is a secondary obligation as it creates a “stand alone” (or primary) obligation which is independent of the liability or default or the other party. If a primary obligation is set aside as illegal, and the beneficiary has an indemnity, then the indemnity would survive the setting aside of the loan between the borrower and the beneficiary.
Rights	Guarantee automatically provides the following rights to guarantor: 1. Indemnity form the underlying obligor: Principal contractually obliged to indemnify guarantor Guarantor can claim indemnity from the obligor without waiting for a demand for the amount in debt, Guarantor has right of set-off against the obligor 2. Subrogation Once the guarantor has fulfilled all the borrower’s obligations (i.e. repaid the beneficiary (i.e. the Bank)) the guarantor is entitled to step into the shoes of the beneficiary (the Bank) and take the benefit of any rights of set-off and any security that the beneficiary has taken from the borrower. 3. Marshalling (PLC article in WS 4) An equitable remedy available to a creditor when: Creditors A&B take security over debtor’s asset X A has also taken security over debtor’s asset Y. A enforced its security over asset X but not Y B entitled to use asset Y to repay its secured debt. 4.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.	INDEMNITY Rights are NOT automatically provided by an indemnity.

Challenging a Guarantee

The main grounds upon which a Guarantee may be challenged.

Contractual formalities: Guarantees & Indemnities Follow basic contract requirements:

(offer+acceptance+intention to create legal relations +consideration+Certainty). Consideration for both can be problematic and deemed as insufficient (unless it is a bank guarantee). Therefore guarantees are usually executed as deed to overcome any argument about whether good consideration was given. Execution of a guarantee as a deed extends the period during which the beneficiary of the guarantee may claim under the guarantee.

Formalities:

Not in writing or...

Buy the full version of these notes or essay plans and more in our Finance and Capital Markets Notes.

Guarantee V Indemnity Notes

Updated Guarantee V Indemnity Notes

Finance and Capital Markets

Guarantee V Indemnity

Need instant answers? Our AI exam tutor is here to help.

More Finance And Capital Markets Samples