In the world where liabilities for debts can be limited by use of a corporate entity, it is not uncommon for contracts to include a personal guarantee and indemnity, requiring a director to personally guarantee the debts of that company.
In simple terms, they are promises made by one party to compensate the other for certain damages or losses. However, their obligations differ fundamentally in nature and scope. It is important to understand the distinctions between the two mechanisms because guarantors and indemnifiers often take on substantial risks.
What is a guarantee and what is an indemnity?
A guarantee is often used to protect a person, typically a bank or finance company, against loss suffered in case the primary obligor fails to fulfil the obligation. It reduces the credit risk faced by a financial institution by giving the institution an entitlement to demand payment from the guarantor.
In contrast, an indemnity is more similar to an insurance policy. It protects a party from potential harm or loss. In essence, the party providing the indemnity claims that it will pay for any loss that the protected party suffers.
Key differences between guarantees and indemnities
There are some key differences between guarantees and indemnities:
A guarantee is a secondary liability – there is always another person who will be primarily liable for the obligation. It is only triggered if the primary obligor fails certain obligations, e.g. to pay back a debt.
The liability of a guarantee is capped by the primary liability, meaning that it cannot exceed the obligation of the primary obligor and will be reduced or extinguished if the primary obligation is defected.
An indemnity imposes a primary liability because it is not dependent on the primary obligor’s failure to perform. Liabilities of an indemnifier is determined by the terms of the indemnity.
Tips for guarantors and indemnifiers
A guarantee must be in writing and signed by the guarantor (s. 55 NCC). A guarantor must be provided a copy of the contract (s.57 NCC).
Before signing a guarantee, a guarantor must be provided (s. 56 NCC):
A copy of the credit contract; and
An Information Statement.
A guarantor can withdraw from the guarantee before the loan is provided (s. 58 NCC).
For indemnifiers, it might be necessary to limit the scope of an indemnity in some circumstances. This could be achieved by limiting the types of claim allowed and the types of loss and damage covered under the indemnity.
Both guarantees and indemnities can impose complex and harsh conditions. It is therefore important for you to obtain legal advice before agreeing to any specific terms or arrangements that may give rise to such obligations.
If you have any concerns about your credit contracts or if you have recently signed a personal guarantee, please contact our experienced commercial lawyers at Longton Legal to discuss.
*Disclaimer: This is intended as general information only and not to be construed as legal advice. The above information is subject to changes over time. You should always seek professional advice before taking any course of action.*
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