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Guarantees – a brief guide on enforceability

June 4, 2020

In a recent case before the High Court a claimant commenced proceedings in respect of unpaid sums it claimed were owed under a guarantee.

The Court dismissed the claims, stating amongst other things, the guarantee in question was not validly executed as a deed due to pre-signed signature pages being affixed to the document after material changes had been made. It was therefore ruled that the claimant was attempting to create a legally binding deed where no such deed existed.

In light of the above judgment we felt it sensible to briefly visit the topic of the valid execution of guarantees.

Requirements for valid execution of a guarantee

A guarantee is a contract and such instruments must be in writing by virtue of the Statue of Frauds Act 1677. If the guarantee is drafted as a contract then there is a requirement to evidence consideration (for example “in consideration of providing credit to the borrower”). Parties will often look to avoid the requirement of consideration by executing the guarantee as a deed.

If the guarantee is drafted as a deed there are heightened execution requirements which have been set out by the Law Society. It has been ruled that adding a signature page to a deed or using a signature from a previous draft of the deed in a final draft would not and will not constitute valid execution.

However, where the execution formalities for a guarantee have not been met, it may still be possible for the beneficiary of the (defective) guarantee to have the benefit of an indemnity (subject to the wording in the drafting).

Is the guarantee an indemnity?

A guarantee is a secondary obligation which secures the obligations of a third party. For a guarantee to crystallise and be called upon the third party must have failed to comply with one or more of the guaranteed obligations (for example not paying back a loan to a lender).

An indemnity, which in many respects can be similar to a guarantee, is not the same and lacks the formal requirements detailed above. Indemnities are contractual promises to accept liability for another party’s loss. Unlike guarantees (which are secondary obligations), indemnities are primary obligations in favour of the beneficiary and exist independently of any obligations of the third party. An indemnity may therefore be enforceable even if the principal party is not in default of its obligations and will still be enforceable in the event that the underlying transaction is set aside.

This distinction can be very important as guarantees are often subject to challenge and complex rules of interpretation may also render them unenforceable. It is therefore common commercial practice for documents to be drafted so they include a combination of guarantee and indemnity provisions in order to protect the beneficiary. Whether the document is a guarantee or indemnity then becomes a matter of interpretation for the Court and may result in a line by line review of the document in support of one argument or another.

Practically therefore it will always be safer to comply with the requirements of a guarantee. Arguments around whether a document was validly executed tend to arise only when a guarantee is called upon and there is an reluctance or an inability to satisfy the guaranteed obligations.

It is therefore imperative that parties entering into guarantees identify the nature of the agreement and comply with the relevant execution formalities to ensure the rights contained within are enforceable.

If you or your company need further information about guarantees, our Dispute Resolution Team can help you. Contact Aaron Marshall on 01204 377600 or email him at aaron.marshall@afglaw.co.uk