Guarantees and Indemnity a Complete Guide
“Guarantees are personal security given to creditors by a third person that he agrees to be answerable for the debts of another person (the principal debtor) if he fails to pay or abide the terms of an agreement. The person who provides personal security is often referred to as the Surety or Principal Guarantor and the agreements are generally known as Contracts of Surety”.
Many people in the UK provide personal securities but without really knowing the legal implications of doing so. In this article, we will explore the idea of providing personal security to a third party which is generally provided either as a guaranty or indemnity or both.
The contracts of surety grant the creditors/ lenders a right of action against the surety (the person who has provided the personal security and agreed to pay the creditor if the debtor defaults). This right is a personal right against the surety instead of a real right over a property.
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What is included?
- Introduction to Personal Security
- Types of Guarantees
- Once-Off and Continuing Guarantees
- Demand and Conditional Guarantees
- Revocation of Guarantee
- Duress and Undue Influence
- Discharge of the Guarantee
In business law A guarantee is simply an undertaking and legally enforceable promise given by a third party, that he will be responsible for the debt or obligation upon another person’s default, i.e. if the debtor defaults then the guarantor will pay the defaulted debt to creditors.
The guarantee is a secondary obligation as the principal guarantor will only be responsible for the debts once the principal debtor defaults. If there is no default, then the guarantor will not be held accountable or asked to pay. The primary obligation to pay the creditors in line with the Surety agreements lies with the principal debtor. This makes the guarantee as a secondary obligation. A common example of guarantees includes a parent guaranteeing a child’s loan, a director providing a personal guarantee to secure a loan for the company or a parent company guaranteeing a loan to a subsidiary company.
John agrees to be the guarantor for Michael in a credit agreement with PBS bank. John agrees to be responsible for Michael’s debt if he defaults. John has provided a guarantee which can only be enforced upon the default of Michael. If Michael continues to fulfill his obligations under the agreement with PBS bank, then John’s guarantee will never be called upon.
Indemnity is also an undertaking or promise by a third party (surety) to pay the creditors but irrespective of the default of the debtor, which makes it a primary obligation. The indemnity is not based on the default of the debtor. It is a personal obligation and independent of the debtor and creditor’s relationship. It is like please supply goods to Michael and I will be responsible for the payment.
In practice, a guarantee from a third-party surety may not be sufficient where the debtor is not creditworthiness or where the risk of lending and default is very high. In these circumstances a creditor will demand guarantee and indemnity from the Surety. Indemnity is also a personal obligation and undertaking.
Types of Guarantees
The guarantees could be a once-off and continuing guarantees, and demand and conditional guarantees.
Once-Off and Continuing Guarantees
As the name suggests a once-off guarantee is a one off-obligation provided to secure a single transaction until the obligations of the debtor under the agreement (surety contract) are discharged.
The guarantee can also be a continuing one for example a guarantee provided under commercial leases, rental agreements, equipment hire agreements and overdrafts. The guarantee could be Once-off and continuing or both at the same time.
Demand and Conditional Guarantees
The conditional guarantees are conditional upon the occurrence of a specified event, such as the production of a written statement of default of principal debtor or court judgment in favor of the creditor, etc.
The liability under demand guarantee is invoked on the demand of the creditors. It is the creditors who have the powers, confirmed through an agreement, to invoke the guarantor’s liability in the circumstances provided in the agreement.
Revocation of Guarantee
A guarantee can be revoked unilaterally or with an agreement with the parties involved( bilaterally) depending on the type of agreement. Generally, the terms of the contract provide the process to follow to revoke the guarantee.
Duress and Undue Influence
A guarantee will be void if it is obtained by the creditor through duress, misrepresentation and undue influence. The guarantee will also be void for duress and misrepresentation by the debtor provided the debtor was acting as an agent of the creditor or where the creditor knew about the improper conduct of the debtor.
Discharge of Guarantee
A guarantee is discharged when a creditor does something which alters the guarantor’s rights such as variation or amendments or extinction of guarantor’s rights. The Guarantee will also be deemed discharged when a debtor is discharged from his liability.