Guarantees and Indemnities – What’s the Difference?

31st January 2018
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Guarantees and Indemnities – What’s the Difference?

Businesses and individuals alike being asked to guarantee, or provide an indemnity in relation to, another party’s obligations need to understand that guarantees and indemnities are different creatures. What features set them apart from one another and what are the practical consequences of the distinction?

Briefly, an indemnity is a promise by one party to compensate another party for loss, including loss caused by a third party. An indemnity is a primary obligation, not dependant upon the obligations of a third party to whoever is benefiting from the indemnity. A guarantee however is a secondary obligation; a promise by one party to step into the shoes, and fulfil the obligations, of another party in the event that the party defaults under a contract.

There are certain other factors that can help distinguish between a guarantee and an indemnity. For example, unlike indemnities, guarantees must be evidenced in writing and signed by the guarantor. Further, if the surety is liable to pay a sum greater than the one specified in the contract being underwritten, then obligation is likely to be an indemnity rather than a guarantee.

Multiplex Construction Europe Ltd v Dunne

Whether a contract is an indemnity or a guarantee is not always straightforward and the issue was considered in the 2017 High Court case of Multiplex Construction Europe Ltd v Dunne [2017] EWHC 3073 (TCC).

This case involved the building and construction industry. The background facts are that Mr Dunne, in his personal capacity and jointly and severally with one of his companies Dunne Group Ltd (DGL), gave security for payments advanced by the head building contractor, Multiplex, to Mr Dunne’s other company, building subcontractor Dunne Building and Civil Engineering Ltd (DBCE).

Upon both DBCE and DGL being put into administration, Multiplex sought repayment from Mr Dunne personally. Multiplex argued that Mr Dunne had given an indemnity in respect of payment advances to DBCE and sought summary judgment against Mr Dunne for the relevant sums. Mr Dunne on the other hand argued he had given a guarantee and was thereby entitled to rely on certain set-offs and counterclaims, which could not be dealt with at a summary judgment hearing.

Outcome

The Court decided that Mr Dunne had given Multiplex an indemnity. In determining whether the contract Mr Dunne had signed constituted a guarantee or an indemnity, the Court followed the general principle that where obligations are imposed on the surety that are secondary to those of the defaulting party, there will be a guarantee, whereas if the obligation is primary, there will be an indemnity.

The Court looked very closely at the language used in the contract and the events that triggered the obligation to pay. It noted that the relevant clause required Mr Dunne to make payment “immediately” upon the relevant trigger events, one being the insolvency of DBCE.

The Court held that this insolvency trigger event made the obligation to pay Multiplex primary in nature and therefore an indemnity arose. By virtue of its insolvency, DBCE could no longer afford to make the payment. Accordingly, payment from Mr Dunne was due immediately with no further steps to be taken. It would not make sense for there to be a primary obligation on DBCE to make payment upon the trigger of its insolvency as this would, by definition, be impossible. The primary obligation was therefore Mr Dunne’s. The Court said that this interpretation also reflected the commercial purpose of the clause as Multiplex would, at the time the contract was drafted, have expected to be reimbursed immediately by Mr Dunne (or DGL had it not also gone into administration) in the event that DBCE became insolvent.

Comment

A Court will not simply interpret a legal agreement based on headings or definitions contained in it. Indeed, in Multiplex v Dunne, Mr Dunne was referred to in the relevant contract as the “guarantor”. However the Court decided that, as his obligations were primary, he had given an indemnity to Multiplex rather than a guarantee. The case serves as an important reminder to parties assuming responsibility for liabilities of others that care and advice should be taken in relation to understanding, among other things, the circumstances in which payment will be required and whether counterclaims or offsetting claims may be taken into account.

South Bank Legal is a Central London commercial law firm drafting and advising on commercial contracts such as guarantees and indemnities and providing dispute resolution representation to businesses and individuals where the terms or effect of a commercial document leads to disagreement. If you would like a confidential discussion, please get in touch today.

Commerical Law