Guarantees and indemnities are legal terms that commonly appear as clauses in loan agreements. These clauses are included to protect lenders from risks posed by borrowers. However, an indemnity and guarantee differ from one another, with each serving a distinct purpose.
In this article, we’ll explain what guarantees and indemnities are and what the key differences between guarantees and indemnities are.
What is a Guarantee?
A guarantee is a contractual promise where a third party, ‘the ‘guarantor’, accepts responsibility for the failure of another party, known as (the ‘obligor’) obligations they owe the ‘beneficiary’.
Essentially, one party will answer for the payment or performance of another person’s debt or obligation if the party that is responsible fails to fulfil their obligations.
There are three parties to a guarantee:
- The ‘guarantor’ offers the promise
- The ‘obligor’ fulfils the obligation
- The ‘beneficiary’ is the party to which the obligor owes the obligation
The obligations owed are not limited to money but can also include promises to perform duties. Guarantees are complicated because they are promises to fulfil the obligations of a third party. However, you should be aware that a guarantor isn’t required to guarantee the obligor’s performance.
Instead, a guarantor is required to compensate for the loss caused to the beneficiary by the obligor failing to fulfil the obligation.
There are three parties involved in a contract. These are Party A (Bob), Party B( Tim) and Party C ( Rachel). In this situation, Bob (the obligor) has agreed that he will paint the beneficiary Rachel’s house before a particular date. Tim is Bob’s guarantor. Therefore, Tim agrees to compensate Rachel for the loss she may suffer if Bob fails to paint Rachel’s house by the date specified in the contract.
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What is an Indemnity?
An indemnity is a contractual promise made by one party (the ‘indemnifier’) to compensate for a loss suffered by another party (the ‘beneficiary’) in the course of performing the contract. Essentially, the indemnifier protects the beneficiary against loss from entering into a transaction with them. An indemnity involves two parties:
- The ‘indemnifier’ promises to compensate for the loss suffered by the beneficiary
- The ‘beneficiary’ is protected by the indemnifier if they suffer harm as a result of entering into a transaction with them
Indemnities are more simple than guarantees as they involve only two parties where one party promises to compensate for the loss they cause to another party.
There are two parties involved in a contract that are Party A( Sally) and Party B( Molly). Sally is the indemnifier, and Molly is the beneficiary. Sally has promised to provide a catering service to Molly. If Sally fails to perform her obligations under the contract and Molly suffers a loss. Sally must indemnify Molly for the loss that arose due to her failure to comply with the contract.
What is the difference between Guarantees and Indemnities?
It can be difficult to understand the differences between a guarantee and an indemnity. However, the differences between the two are significant. The key characteristic that differentiates guarantees from indemnities is that a guarantee involves a third party.
Therefore, whether the guarantor gets involved depends on whether the obligor has failed to fulfil the obligations they owe the beneficiary. There are two liabilities associated with guarantees:
- The liability of the obligor to the beneficiary
- The liability of the guarantor to the obligor
In a guarantee, a guarantor isn’t required to answer on behalf of the obligor if the obligor has fulfilled the obligation they owe the beneficiary. If a contract is unenforceable or void, the guarantor is not liable to the beneficiary. It’s also important to note that guarantors are only liable to the extent that the obligor was liable to the beneficiary.
For example, if the obligor owes the beneficiary $75,000, the guarantor would only be liable to compensate the beneficiary for this amount of money.
In contrast to guarantees, indemnity involves ‘primary liability’. This is because in an indemnity clause, the indemnifier is directly liable to the beneficiary, and there is no involvement of a third party. If the beneficiary experiences loss from their transaction with the indemnifier, the indemnifier is directly liable to compensate for the loss they have caused the beneficiary to suffer.
Therefore, unlike a guarantee, there is no third party that has agreed to compensate the beneficiary for any loss caused by the failure to fulfil the contractual obligations, and the liability of the party who has failed to perform under the contract is direct.
To summarise, a guarantee refers to when a guarantor takes responsibility for the actions of the obligor and agrees to compensate the beneficiary where the obligor fails to meet their contractual obligations.
Whereas an indemnity refers to an indemnifier being directly responsible for the obligations they owe a beneficiary and promising to indemnify the beneficiary for any loss suffered if they fail to perform under the contract.
It can be difficult to differentiate between an indemnity and a guarantee. If you’re still feeling unsure, you should hire a lawyer for legal advice to ensure you’re aware of your obligations and liabilities pursuant to contracts that contain these clauses.
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