Guarantees and indemnities - what's the difference?

What is a Guarantee?

A guarantee is a contractual promise to ensure that a third party fulfils its obligations.

A guarantee is a secondary obligation because it only becomes enforceable if there is a breach of obligation by that third party.

What is an Indemnity?

An indemnity is a contractual promise to accept liability for another's loss.

An indemnity is a primary obligation because it does not require there to be a breach of obligation. It becomes enforceable where there is a loss.

Does the difference really matter?

Guarantees and indemnities are a common way for creditors to protect themselves from the risk of debt default. Lenders will often seek a guarantee or an indemnity if they have doubts about a borrower's ability to fulfil future financial obligations.

Guarantors and indemnifiers take on a serious financial risk in entering into such transactions, so it is important to be aware of all the implications.

The recent Court of Appeal decision in Deepak Abbhi v Richard John Slade highlights how the distinction can be critical.

The  facts of the case can be summarised as follows:

1. Background

Mr Abbhi’s father-in-law, Mr Singh, was involved in a dispute about a trust and this resulted in him commencing legal proceedings. During the course of those proceedings, Mr Singh changed his solicitors and instructed Richard Slade & Company (“Richard Slade”).

During a meeting with Richard Slade, the son-in-law, Mr Abbhi, explained that Mr Singh was unable to pay any legal fees. It was agreed between the parties orally that if Richard Slade continued to act for Mr Singh, Mr Abbhi would pay the legal fees and disbursements on Mr Singh’s behalf.

The matter proceeded to trial and Mr Singh’s claim was dismissed.

Although partial payments were received by Richard Slade, Mr Singh died on 9 February 2015 and his estate was insolvent.

Richard Slade there approached Mr Abbhi and asked him to pay the outstanding legal fees. Mr Abbhi refused to pay.

Richard Slade commenced proceedings against Mr Abbhi claiming that, pursuant to the oral agreement, he was responsible for payment of their outstanding legal fees. Judgement was awarded in favour of Richard Slade. Mr Abbhi appealed the decision.

2. The Appeal

The basis of Mr Abbhi’s appeal was that his oral agreement to pay Mr Singh’s legal fees did not comply with Section 4 of the Statute of Frauds Act 1677, which states that a guarantee must be in writing and signed by the parties. He therefore argued that his guarantee was invalid and unenforceable in this matter.

The Court of Appeal approached this differently. They held that Mr Abbhi’s promise to pay the Richard Slade fees in this case was not a guarantee but an indemnity. It was a primary obligation which was binding on Mr Abbhi and therefore valid and enforceable.

In making the decision, the Court of Appeal concluded that:-

1. Mr Abbhi had adopted a primary liability to pay Richard Slade’s legal fees independently of any default by Mr Singh; and
2. Section 4 of the Statute of Frauds Act 1677 was not applicable in this claim as the promise was found to be an indemnity not a guarantee.

This Court of Appeal decision highlights the importance of understanding the difference between a guarantee and an indemnity when entering into commercial contracts and how the issue of enforcement can be treated differently for each. It is also a robust reminder that any agreements should be recorded in writing to avoid uncertainty and the resulting costs associated with litigation.

For any queries in relation to this blog, please contact the litigation department on 01242 586 841 or email Andrew Turner.