The distinction between a contractual guarantee and an indemnity – and which is best for your business – is a crucial one. It might seem like a highly technical legal issue – one best considered by the specialist lawyers you instruct to draft your contracts. But in the event of a dispute or breach of contract the issue of whether a guarantee or indemnity exists will have real-world consequences for your business. The award-winning commercial lawyers at Bahamas law firm ParrisWhittaker offer specialist advice on contractual issues like this. We’re happy to discuss all aspects of contract law and dispute resolution – you can contact us online or by phone on 1-242-352-6110.
At a time when the global pandemic has injected significant uncertainty into global commerce and the potential for frustration of contracts is high, enforceable guarantees and indemnities are more sought after than ever before. So that your business is as robustly protected as possible it’s important to understand the difference between the two types of clause.
In this article we examine the difference between guarantees and indemnities, and highlight the main advantage and disadvantage of each. We also refer to an English Commercial Court ruling from 2021 involving the drinks giant Bacardi in which a useful judicial analysis of the two concepts was made.
Guarantees And Indemnities: Why They Matter
A well-drafted commercial contract should cover all the clients’ bases. While we’d always urge you to carry out extensive due diligence checks on a party you’re thinking of starting a business relationship with, guarantees and indemnities offer additional protection in the even that one side fails to fulfil its financial obligations under a contract.
Guarantees: Under a guarantee, the guarantor contractually agrees to ensure that a third party (one of the principal parties to the contract) fulfills its obligations. In the event that this principal party doesn’t adhere to the contract terms (by defaulting on a payment for example) the guarantor agrees to pay the amount guaranteed. Guarantees are classified as secondary obligations in a contract. That’s to say they are on a level below the contractual obligations owed by the principal party on whose behalf the guarantee has been provided. This secondary nature of a guarantee has certain legal consequences.Guarantees tend to be more advantageous to the guarantor because they confer certain rights, including the ability of the guarantor to recover any payments he or she has been forced to make to the beneficiary of the guarantee. Remember as well that until the principal party breaches the contract the guarantor has no legal liability whatsoever. There is no liability on the guarantor unless and until the principal has failed to perform his or her.
Indemnities: Under an indemnity a promise is made to accept liability for another party’s loss. For example a company may indemnify directors against personal liability if the company suffers a loss. Unlike a guarantee an indemnity is a ‘primary’ contractual obligation: The indemnifier assumes a liability that doesn’t depend on the default of a third party. It’s a completely independent contractual liability. Often an indemnity is viewed as being a more favourable option than a guarantee from the beneficiary’s perspective.
Brown Forman v Bacardi UK (2021)
The High Court judgment in this case involving drinks giant Bacardi does not give us many details around the facts of the case itself. That’s because the main issues were decided by way of a confidential arbitration process. For our purposes it’s sufficient to note that the defendant, part of the Bacardi group entered a cost-sharing agreement with the claimant, a large global drinks company. The agreement contained several surety provisions –expressed as guarantees and indemnities. Brown Forman, in seeking to enforce these provisions, sought some £50million from Bacardi.
The High Court judge reiterated the indemnity/guarantee distinction:
The liability of the guarantor is always ancillary, or secondary, to that of the principal, who remains primarily liable to the creditor. There is no liability on the guarantor until the principal has failed to perform his obligation.
An indemnity obligation on the other hand imposes a primary obligation that is wholly independent of the liability that arises between the principal debtor and the creditor
How Do Courts Interpret Guarantees And Indemnities?
Having made the distinction between a guarantee and an indemnity clear the judge went on to explain how courts interpret the words of a contract to decipher whether a guarantee or indemnity exists. Judges look at:
The natural and ordinary meaning of the particular provision
Any other relevant provisions of the contract
The overall purpose of the provision
The facts and circumstances known by the parties at the time of the contract
Commercial common sense
It was this last consideration – commercial common sense – that both sides relied on to support their respective positions.
Having looked closely at the contract the judge decided that the disputed provision was in fact an indemnity and not a guarantee. This was because:
Other provisions of the contract were expressly described as ‘guarantees’
The words used in the disputed provision were more associated with indemnities
The document was drafted by specialist lawyers so the court was entitled to rely on the actual language of the agreement
The type of loss covered by the disputed provision extended to losses that might be suffered by entities other than those to whom Bacardi owed its obligations under the contract. This meant the provision was more likely to be an indemnity
So the court decided that the provision at the heart of the dispute was an indemnity. Ironically however it ruled that the losses complained of by Brown Forman were not actually covered by Bacardi’s indemnity: the indemnity was limited to ‘losses incurred in connection with any failure by (Bacardi) to timely fulfil its payment obligations. The losses complained of had not been cause by a ‘timely failure’.
Comment
The judgment in Bacardi reminds us that when entering commercial agreements with surety obligations each party should ensure that they are clear on whether a particular provision is an indemnity or a guarantee and in what precise circumstances provisions should take effect.
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