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To guarantee or not to guarantee. Part 2 of 2

4 min read
09 December 2019

Key Takeaways

  • A guarantee is a promise by one party to a second party to fulfil the obligations of a third party. Such obligations typically include the payment of money.
  • An indemnity is a promise by one party to cover loss and damage suffered by another party. An indemnity typically exposes the person providing the indemnity to an assumption of risk beyond what they would have been exposed to without providing the indemnity.

Three reasons why you should be getting guarantees and indemnities which coincidentally are the three reasons why you should avoid giving guarantee and indemnities Part 2 of 2.

If you aren’t sure what a guarantee or indemnity is you will want to check out Part 1 here before going any further.

1. Assumption of greater liability

Most lawyers will recommend obtaining guarantees and/or indemnities from all parties or other key stakeholders such as directors or substantive entities involved in a transaction/agreement where possible. This is largely to provide clients with the greatest protection possible in the event of any breach/default.

The more people that you have on the ‘hook’, the better your prospects of recovery in the event of a breach. For example, this is why you will typically see banks asking for parents to guarantee loans for their children, parent companies being asked to guarantee the obligations of their subsidiaries and directors being asked to guarantee the obligations of their companies.

By doing so, the bank essentially increases the number of parties who are liable for the company’s performance of a contract, therefore increasing their recovery options should a default occur. In the event of a default, the bank can typically recover from the parent, the company or the directors (either jointly or severally). Quite often the parents, parent company or directors will have more assets than the party they’re guaranteeing and therefore more to lose in the event of a default.

This is largely why most commercial agreements will contain a guarantee, indemnity, or both.  The party providing the goods or services wants to minimise their risk as much as possible in the agreement and maximise their recovery options.

2. Litigation

As lawyers we typically default to the ‘worst case scenario’. That is why you come to see us so we can help reduce your risk in a transaction. Consequently, we will often want to obtain as many protections as we can for you in order to improve your prospects should the other party default. One of the best tools to protect you in the event of another party’s default is a guarantee and/or indemnity. This is largely as a result of the additional liability and the ability to claim from more parties discussed above.

In the event that a guarantee or indemnity is given by a director of a Company, you may be able to join that director as a party to the proceeding and seek compensation from the director as well as the Company to maximise your prospects of success. While there is no guarantee that the directors will have any substantial assets, the net is cast wider and the prospects of recovery increase significantly with each additional party on the ‘hook’.

An indemnity is a particularly useful tool to have in litigation as the breadth of an indemnity can often provide for payment of the indemnified party’s costs in pursuing a claim.

3. Low cost protections

It is somewhat unsurprising that the use of guarantees and indemnities in commercial agreements are almost a standard term, especially given the relative low cost of inserting the relevant provisions, or preparing a Deed of Guarantee/Indemnity. The costs of such protections can vary from matter to matter but are nominal in comparison to the costs of recovery, or writing-off a debt that can’t be recovered.

Given the relative low costs and the increased prospects gained from having a guarantee, it is our recommendation that guarantees and/or indemnities be obtained where possible in clients’ commercial transactions.

Why should you avoid giving a guarantee?

In short, you will be faced with the converse of the above benefits meaning increased risk, exposure and liability and lack of control. If you are the party being asked to give a guarantee or indemnity as a director of a company, it is important to consider that, should you sign the guarantee and/or indemnity, then you will be taking on a personal liability that may not otherwise have been able to be imposed on you due to corporations law.   The additional risk of your personal assets being exposed means that should your company face financial hardship, you may also face the same hardship as creditors can pursue you personally for the payment of a debt which could have been avoided by not giving a guarantee. Subsequently, by signing a guarantee and/or indemnity, your house, car and personal assets become exposed which can cause significant financial hardship for you and your family.

If you would like to find out more about guarantees and indemnities or require other assistance, please contact us.

The information in this blog is intended only to provide a general overview and has not been prepared with a view to any particular situation or set of circumstances. It is not intended to be comprehensive nor does it constitute legal advice. While we attempt to ensure the information is current and accurate we do not guarantee its currency and accuracy. You should seek legal or other professional advice before acting or relying on any of the information in this blog as it may not be appropriate for your individual circumstances.

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