Guarantees, warranties and indemnities are a means of allocating risk in commercial transactions and are often seen together (usually in a lease or security documents), but all carry very different obligations:
Guarantees
A guarantee is a contractual promise to ensure that a third party’s obligation is fulfilled if the relevant party fails to perform its obligations (generally referred to as ‘see-to-it’ guarantees or pure guarantee) and/or to pay an amount owed by a third party if it fails to do so itself (conditional payment guarantee).
A guarantee is a secondary obligation because it is contingent on the obligation of a third party, and it sits alongside the primary obligations, usually of a tenant under a lease.
A guarantee must be in writing and signed by the guarantor, otherwise it may not be enforceable. Guarantees are more advantageous to the guarantor as they confer certain rights. Namely; right to indemnity, right to set-off, subrogation and marshalling (allowing a party to “step into the shoes” of another).
Guarantees are widely used in commercial leases and security documents.
Warranties
A warranty is a contractual assurance from one party to another party (usually a seller to a buyer, or a borrower to a lender) that certain information and/or conditions are true. A warranty can be expressed, implied or both.
It is a subsidiary or collateral provision to the main purpose of the agreement, being the sale or the mortgage. The main purpose of a warranty is to apportion risk and liability between a buyer and a seller or the borrower and the lender. Warranties protect a buyer by providing a possible price adjustment mechanism if a warranty proves to be false and, in the context of a sale of the business, by enabling a buyer to gather information on the business through a disclosure process.
When obtaining finance (mortgage) for a property, you would expect to see warranties in the financial documents. The warranties are the statements the borrower makes about itself and the circumstances of the debt or security.
A breach of warranty claim is an action for breach of contract and is subject to the normal legal requirements of proving loss. A party that breaches a warranty is only responsible for the loss and damage that is foreseeable as a result of the breach. The damages for which a seller is liable is the amount necessary to compensate the purchaser for any loss resulting from the breach. The onus is therefore on the buyer or lender to show breach of contract and quantifiable loss.
In the finance documents, a breach of warranty could also constitute an event of default, meaning the lender could have enforcement actions against the borrower.
Indemnities
An indemnity is a promise to protect against, or compensate, a buyer in respect of a particular type of loss or liability, should it arise. An indemnity is a contractual promise to accept liability for another’s loss.
An indemnity claim can arise by law, however, indemnities are usually created by a contract, under which the party providing the indemnity undertakes as an independent obligation to indemnify (make good) a loss. The trigger for payment and the amount payable will depend on the contract's drafting and interpretation. This gives much wider protection and, if drafted correctly, could cover all losses on a full indemnity basis for the party who has the benefit of it.
An indemnity is commonly included within a contract of guarantee because an indemnity, as a primary obligation, is likely to be less vulnerable to challenges than a guarantee.
If you would like advice regarding guarantees, warranties or indemnities in commercial real estate transactions, or any other commercial property issues, please contact our Real Estate Department at Laytons ETL – Partner and Head of Department, David Lewis (david.lewis@laytons.com) and Solicitor, Adele Edwards (adele.edwards@laytons.com).
