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An indemnity and a guarantee are different obligations that contracts often include. If you are entering into a contract as a business owner, it is important that you understand the difference between the two. This is so you understand the obligations that you are agreeing to in your contract. This article will: 

  • explain indemnities and guarantees; and 
  • discuss the main differences between the two obligations. 

What Is an Indemnity?

An indemnity is a contractual promise to compensate another party for loss suffered or incurred by the other party.

For example, suppose Party A is providing services to Party B under a contract. Then, Party A may be required to indemnify Party B for any loss arising out of personal injury or death caused by Party A in performing the services. 

Indemnities are designed to manage and allocate risk between the parties. Depending on its drafting, an indemnity clause will typically extend the indemnifying party’s liability beyond what it would otherwise be liable for at law. When agreeing to an indemnity in a contract, it is important to treat it with caution. This is because insurers will typically cover a party for their liability at law. However, they may not cover a party where the party has agreed to an indemnity that extends their liability at law. In other words, if you agree to a broad indemnity, you may be unable to rely on your insurance policies to cover all or part of a claim under the indemnity.

Liability Under an Indemnity

Liability under an indemnity differs from liability for breach of a standard provision of an agreement. This is referred to as a covenant. This is because at law, to claim damages for breach of a covenant, the party making the claim needs to show that:

  • the other party directly caused the loss they have suffered;
  • the loss was not too remote from the event causing the loss;
  • it took reasonable steps to mitigate the loss; and
  • the loss being claimed is proportionate, based on the extent to which the other party was responsible for the loss. 

Depending on the drafting of an indemnity clause, the above considerations may be irrelevant. In other words, the party giving the indemnity would be liable to pay the whole of the loss suffered by the other party. This is regardless of the extent to which it caused the loss.

What Is a Guarantee?

A guarantee is a contractual obligation where one party (the guarantor) agrees to be responsible for the obligations of another party in case the other party fails to comply with its obligations under a contract (i.e. if it defaults). 

You commonly see guarantees in loan agreements. This is whereby a guarantor agrees to repay the debts of a debtor to the bank if the debtor fails to make their repayments when required under the loan agreement. 

For example, someone saving to purchase a property may ask their parents to become a guarantor on their home loan. This often occurs in situations where they do not have enough of a deposit to obtain finance from the bank. In this circumstance there would be two contracts being created, including a: 

  1. mortgage between the homeowner and the bank; and 
  2. guarantee between the parents and the bank. 

In this second contract, the parents are agreeing to repay the loan if their child fails to make their mortgage repayments. 

Guarantee Relationships

The diagram below outlines the relationships in a guarantee. 

However, guarantees do not always have to be over money owing. Parties can also guarantee the performance of an obligation, such as the performance of a service. If a service provider fails to perform its services under a contract, the guarantor may be liable to pay the other party’s loss that it suffers.

For example, Party A may agree to build an office space for Party B by a certain date. However, they fail to do so. In that case, Party C, who agreed to guarantee Party A’s performance, may be liable to compensate Party B for any loss they have suffered by not having their office space built by that date.

Another example of a guarantee is a parent company guarantee. This is where a holding company guarantees the performance of its subsidiary’s obligations under a contract. 

The purpose of a guarantee is to provide protection to a party against loss suffered by entering into a transaction if the other party to that transaction fails to uphold their end of the agreement. The obligation created by entering into a guarantee becomes enforceable if the primary party to the agreement, i.e. the borrower or the service provider, fails to perform their obligations under the agreement. 

Key Differences

Guarantee

Indemnity

  • A third party is involved in the agreement, and it is the third party that agrees to be liable for loss suffered by the creditor.
  • The guarantor’s liability is limited to the amount of the party’s liability it is guaranteeing. For example, if the primary agreement was for $100,000, the guarantor’s liability will be a maximum of $100,000.
  • A guarantor is discharged from their obligations if the principal contract is void or unenforceable.
  • Depending on the State or Territory, guarantees may not have to be in writing to be enforceable.
  • One party to an agreement indemnifies another party to the agreement for any loss they may suffer.
  • The indemnifying party’s liability is dependent upon the drafting of the indemnity clause.
  • An indemnity may survive the expiry or termination of an agreement.
  • Indemnities may be implied into an agreement at law.

Key Takeaways

Indemnities and guarantees can be complicated to understand. Indemnities impose a liability on the person giving the indemnity. Whereas guarantees are provided by a third party in case the primary party to the agreement has failed to uphold their obligations. For legal advice before entering into an agreement where you are required to provide an indemnity or a guarantee, contact LegalVision’s contract lawyers on 1300 544 755 or fill out the form on this page. 

Frequently Asked Questions

What is an indemnity?

It is a contractual promise to compensate another party for loss suffered or incurred by the other party.

What is a guarantee? 

It is a contractual obligation where one party (the guarantor) agrees to be responsible for the obligations of another party, in case the other party fails to comply with its obligations under the legal contract. 

Do guarantees have to be in relation to money?

No, they do not have to be over money owing. Instead, parties can guarantee the performance of an obligation, including the performance of a service.

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