In today's ever-evolving economic landscape, it's increasingly common for lenders/funders to seek ways of ensuring that they receive payment when advancing funds. A common way of seeking to ensure that loans advanced to a customer are repaid is to obtain a guarantee from a third party so that in the event the customer fails to make payment the third party is obliged to. Welcome to the world of guarantees!

To help you navigate these intricate contractual arrangements, we'll be offering a concise overview of guarantees and indemnities through a series of insights. In this mini-series, we will cover what guarantees and indemnities entail, their advantages, enforcement considerations, their application across different sectors, and conclude with our top tips and key takeaways.

Throughout this series, we'll be primarily focusing guarantees and indemnities in the context of financial transactions, with a focus on loans as the primary obligation.

What is a guarantee?

Let's get the techy bit out of the way, a guarantee is a contractual agreement that establishes a secondary obligation to support a primary obligation of one party to another. This secondary obligation, often referred to as a guarantee, ensures that if the primary obligant (i.e. the debtor who owes the principal obligation) fails to meet that obligation, the guarantor is contractually obliged to perform the obligations of the primary obligant.

At its core, a guarantee is a promise made by one party (the guarantor) that they will be responsible for the obligations or debts of another party (the debtor) in the event the debtor fails to meet those obligations.

Whilst most often guarantees will be in writing, you can have circumstances where a guarantee is established orally. Verbal guarantees are unusual. Given guarantees are most often given in respect of commercial arrangements, the vast majority of guarantees are formal written contracts. This is advisable given the need of the parties to have clarity on the scope of the obligations under the guarantee and when the guarantee can be enforced.

It's important to note that a guarantee is not an independent obligation but rather a conditional one. It only comes into effect when the principal debtor fails to fulfil their obligation, typically upon the maturity of their financial commitment (i.e. failure to repay a loan on its due debt).

Under Scots law, a guarantor may be referred to as a 'surety' or a 'cautioner' (pronounced kay-shon-er).

When might a guarantee be entered in?

Situations where a guarantee may be requested can include a director being asked to personally guarantee borrowings advanced by a bank or funder who is advancing funds to a company they are a director of. If, for any reason, the company defaults on the loan, the bank possesses the right to seek recourse against the director personally, in their capacity as the guarantor of the loan. This is often referred to as a personal guarantee or PG.

A similar example would be where a parent company, within a group structure, guarantees the obligations of a subsidiary within its group. This is known as a parent company guarantee or PCG.

What is an indemnity?

Often within a guarantee, you will find that it is not just a guarantee but a 'guarantee and indemnity'.

An indemnity represents a promise to assume responsibility for another party's losses. Unlike a guarantee, an indemnity is a freestanding obligation, directly offered by the indemnifier to the party being indemnified. What is important to understand about an indemnity is (that unlike a guarantee) it is not dependent on or contingent upon the obligations of the primary debtor.

This means that, even if the underlying transaction is legally challenged or invalidated, the indemnity remains in force.

However, it's worth bearing in mind that if the language in a document is not sufficiently clear there can be ambiguity regarding whether a promise constitutes a guarantee or an indemnity. In such cases, courts tend to presume the interpretation that is less burdensome for the party providing the document, categorising it as a guarantee rather than an indemnity.

If you require legal advice or guidance concerning guarantees and indemnities, our team is ready to assist you. In our next insight, we will delve into the benefits of utilising guarantees and indemnities, as well as the potential enforcement issues associated with them. Stay tuned for more insights in this series.

Contributors

Sarah Wilson

Solicitor

Lucy McCann

Partner