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Guarantee V Indemnity Notes

LPC Law Notes > Finance and Capital Markets Notes

This is an extract of our Guarantee V Indemnity document, which we sell as part of our Finance and Capital Markets Notes collection written by the top tier of Cambridge And Oxilp And College Of Law students.

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Banking Workshop 4

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 What is it?

Primary or Secondary Obligation

Contingent

What's the obligation

Courts Distinguish ing Test =
connection with the transactio n
+
the extent of the promise
+
Actual words Proving, Onus

Indemnity

A promise to ensure that a third party fulfils its obligations and/or promise to A promise to be responsible for fulfil those obligations if a third party another's loss. fails to do so. It is a contractual agreement that creates a Secondary Obligation to support a primary obligation of one party to another 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. 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.) The courts are protective of guarantors and guarantors have a number of important rights both against the underlying obligor and against the lender. 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

It is a contractual agreement that creates a Primary Obligation given by the indemnifier to the person to be indemnified. It is independent to, and not contingent on the obligation of the borrower. If the underplaying transaction is set aside for any reason, the indemnity will remain valid. The Lender will want any guarantee to be supported by an indemnity in order for the lender to be properly protected. 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.
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The true construction of the actual words in which the promise is expressed

On the beneficiary (the lender or On the beneficiary (the lender) to Bank) to prove that the document is a prove that the document is an guarantee (secondary obligation) indemnity (primary obligation)

Banking Workshop 4

Advantage s

By s.4 of Statute of Frauds 1677 A guarantee must be in writing and signed by the guarantor or a Formalities s.4 of Statute of person authorised by it. Frauds 1677 do not apply to indemnities i.e. flexibility. Thus it If the primary obligation ceases to does not need be in writing to exist for any reason, the guarantor be enforceable. cannot be liable for it because the guarantee is dependent on the An indemnity is a primary primary obligation. This means that obligation from the promisor to the beneficiary can be prevented from the beneficiary. This is more claiming repayment form the robust than a guarantee guarantor when it most needs to relay which is a secondary obligation on the guarantee. as it creates a "stand alone" (or primary) obligation which is Guarantees are vulnerable if any independent of the liability or changes are made to the underlying default or the other party. contract. Amendments to the contract after the giving of the If a primary obligation is set guarantee, will discharge the aside as illegal, and the guarantor's liability under the beneficiary has an indemnity, guarantee unless: then the indemnity would survive
- The guarantor consents the the setting aside of the loan variation between the borrower and the
- The variation is patently beneficiary. insubstantial or incapable of adversely affecting the guarantor

Banking Workshop 4

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

Rights

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 INDEMNITY beneficiary has taken from the Rights are NOT automatically borrower. provided by an indemnity.

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-of. 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.

Challenging a Guarantee The main grounds upon which a Guarantee may be challenged.

1. 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

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