Written by Richard Wee and Khoo Kian Jun
Throughout the world, with the commercialisation of the modern economic world, a new variation of doing business has emerged along with it, being the credit based economy.
In simple terms, a credit based economy is one that utilises credit facilities for the exchange of goods and services. However, along with its many benefits, there are drawbacks, such as the risk of non-payment or a lack of commitment by either one of the parties involved. Therefore, contract law, in particular, has provided securities or safeguards in the form of guarantees and indemnities to avoid these occurrences.
Indemnity & Guarantee
The common meaning of ‘indemnity’ would be a security or protection against a loss or other financial burden. On a deeper analysis of contract law, the contract of indemnity is where one party promises to compensate another for any loss suffered by him or by the act of the promisor or third party. For example, if Person X promises to deliver goods to Person Y for $1000, then Person Z comes in with a promise to indemnify Y’s losses if X fails to deliver goods.
On the other hand, a contract of guarantee refers to the obligation of a third party to either ensure that the principal debtor performs his obligations or to repay the debt himself. An illustration can be made here, where if Person A loans Person B $1000, and Person C then promises A that if B is unable to repay the loan, he would repay it.
To draw a conclusion on this paragraph, it is evident that for a contract of indemnity, there are only two parties involved, while a contract of guarantee would involve three parties.
A common way for the courts to differentiate between a contract of indemnity and guarantee would be through examining the intention of the parties, where this would be central to the interpretation. After determining the method of interpretation, courts would look at the terms of the agreement.
When dealing with a contract of guarantee, the main assumption of secondary liability would be one where the guarantor undertakes, only becoming liable upon the default of the principal debtor. On the other hand, in a contract of indemnity, primary liability would fall upon the indemnifier, where liability would only arise as according to the terms of the agreement.
This explanation draws resemblance to the Malaysian case of United Overseas Bank (Malaysia) Sdn Bhd v Tan Chong Whatt & Ors, whereby the judge decided that the defendants acted as both indemnifiers and guarantors. This is due to wording of certain clauses, specifically the “Principal Debtor Clause”, where it had indicated the intention of the defendants, firstly as guarantors, to then undertake the liability for the repayment of debt, not merely just as sureties, but as principal debtors as well as indemnifiers. Hence, concluding that the guarantee in this case is also a contract of indemnity.
In Craythorne v Swinburne, the principle that upon the payment by the surety of the principal debt, he would be legally entitled to the full rights of subrogation, hence stepping into the creditor’s shoes. This principle applies to both contracts of guarantee and indemnity.
However, if the agreement states that the surety only to such rights as the creditor, then under his discretion assigns to her upon her payment of the principal debt, then it is an agreement of indemnity.
On the other hand, a guarantor is entitled to full rights of the substitution, as only an agreement which claims to give completely different rights to the creditor and surety, would be an indemnity.
Relating this case above, the guarantors should have had their substitution rights, but due to the plaintiff’s action of allowing the liquidator to sell off the charged asset, they had been deprived of their rights. Thus, the defendant’s role as a guarantor was discharged by the court.
To conclude, the distinction of these two elements are important, and especially apparent in areas such as a creditor’s rights and causes of action together with the guarantor’s rights and defences.
With that being said, whether a contract is one of indemnity or guarantee would depend on a case to case basis, where several factors are taken into account to differentiate the two.
Published on 15 July 2022