If a lender such as a bank has concerns regarding the borrower's ability to repay the loan, it might seek a guarantee to repay the loan from another party such as a director of a company, in the event of default by the borrower. It is common for banks to request personal guarantees from directors of a company, in order to secure loans to the company, particularly in circumstances where the company is relatively new, and does not own significant assets in its own right.
The guarantor agrees with the lender that should the borrower not perform its contractual obligations then, the guarantor will perform them on its behalf. Therefore, the guarantor's obligation is contingent on the borrower's primary obligation, and as a consequence, the guarantor's obligations should never be greater than those imposed under the primary obligation.
It is common for the obligation to be a payment obligation, but it can also be a performance obligation.
A commercial indemnity, like a guarantee, is a promise to be responsible for another's loss, however the difference is that an indemnity is a primary obligation. It is a direct and independent contractual obligation, and not contingent on the obligations of another party.
The advantages of an indemnity include:
1. Section 4 of the Statute of Frauds 1677 applies to guarantees but not to indemnities. It provides that a guarantee must be in writing and signed by the guarantor or a person authorised by it in order to be effective. There is no such requirement for an indemnity. You should speak to your commercial solicitor about the formalities for executing a guarantee.
2. An indemnity is a primary obligation from the promisor to the beneficiary. This means it is more robust than a guarantee which is a secondary obligation. 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.
3. Guarantees, unlike indemnities, are also vulnerable if any changes are made to the underlying contract. Any amendments to the underlying contract, after the giving of the guarantee, will discharge the guarantor's liability under the guarantee unless either:
a. The guarantor consents to the variation.
b. The variation is patently insubstantial or incapable of adversely affecting the guarantor.
The author, Christian Browne is a corporate solicitor and the Managing Director of Summerfield Browne Solicitors
Summerfield Browne Solicitors have offices in London, Birmingham, Oxford, Cambridge, Northampton and Market Harborough, Leicester.
Christian Browne is also a legal advisor with the Institute of Directors in London.
Summerfield Browne Solicitors