UNDERSTANDING THE SUBTLE DIFFERENCE BETWEEN A CONTRACT OF GUARANTEE AND A CONTRACT OF INDEMNITY

Contract of guarantee (in the context of security of obligation) is an undertaking by a party called the guarantor to answer for the payment or performance of the debt or obligation owed to another party (creditor/obligee) in the event of default by the person primarily responsible for it (debtor/obligor).

Contract of indemnity is an agreement by a party called the indemnifier to recompense any loss incurred to the other party (indemnity holder) due to the acts or omission of the indemnifier or any other party. Here, a contractual duty to keep the indemnified harmless is created.

Both are accessory contracts (made pursuant to a principal contract) and also contingent contracts (made pursuant to the occurrence of event) used mainly for protection against the risk of default or loss arising from performance or non-performance of the main contract. However, they differ materially in the scope and nature of liabilities created, and the rights conferred.

The differences are aptly captured as follows:

1. Nature of Contract

Contract of Guarantee is by its nature dependent on another enforceable contract. It is made subject to a principal obligation and extinguishes once the principal obligation extinguishes.

Contract of Indemnity is independent of the principal contract.

2. Status of the Parties

A guarantor is a co-signor of sort, whose liability is coextensive with that of the principal debtor and never more. If a part of the principal obligation extinguishes or is waived, the guarantor becomes released of such part.

An Indemnifier is regarded as an independent promisor whose liability is only limited by the scope of the indemnity. Bentworth Finance (Nig) Ltd V. Ibrahim (1969) NCLR P.272 at p.277.

3. Liability

The liability of a guarantor is secondary. It arises when the primary obligor/debtor defaults and demand made on him.

The liability of an indemnifier is primary. It arises whenever the contingent event occurs.

4. Number of Parties

Contract of guarantee involves three parties, viz; the guarantor/surety, the principal obligor/debtor and the creditor/obligee.

Contract of indemnity involves only two parties, viz; indemnifier and the indemnity holder.

5. Number of Contracts

In a contract of guarantee, there are three sub-contracts:

• between the creditor and the principal debtor,
• between the creditor and the guarantor,
• between the guarantor and the principal debtor (right to subrogation)

In a contract of indemnity, there is only one contract - between the indemnifier and the indemnity holder.

6. Variation of the Main Contract

Any variation of the main contract without the guarantor’s consent in a way that increases or extends the guarantor’s liability discharges the guarantor (except the guarantee agreement provides for such variation or extension of liability). This is because a guarantee agreement is construed strictissimi juris (in the strictest interpretation of the law) against the creditor and liberally against the guarantor. Extension of tenor discharges the guarantor, while any variation is treated as a new contract. Bolton V. Salmon, (1891) 2 Ch. 48.

Variation of the main contract does not affect the liability of an indemnifier. His responsibility is to keep the creditor harmless from loss or damages as covered in the indemnity agreement.

7. Discharge of the Principal Debtor

Discharge of the principal debtor amounts to discharge of the guarantor.

Discharge of a debtor in whose stead an indemnity was given does not affect the contract of indemnity.

8. Right to Subrogation

The guarantor enjoys right to subrogation over the debtor, such that upon discharging the liability, he assumes the position of the creditor and can sue the debtor for recompense.

Upon discharging his liability, an action by the indemnifier cannot lie against a third party (the debtor) based on the indemnity agreement unless there is an assignment in his favour by the indemnity holder.

9. Nullity of the Primary Contract

When the primary obligation is void or set aside, the guarantee agreement terminates.

Nullity of the main contract between the debtor and the creditor does not affect the contract of indemnity. In Yeoman Credit Ltd V. Latter (1961) 1 WLR 828 (26), a minor bought a car on hire purchase. The sale was declared void while the indemnity given in the minor's stead by an adult was held to be valid and enforceable.

Conclusion

Knowledge of the nature of a contract and the scope of liabilities is very sacrosanct in every contractual relationship towards ensuring a true manifestation of parties' intention. Parties or their representatives should at all times be apprised of the exceptions imposed by law and the vitiating factors that may vary or vitiate the parties intentions, and ensure that such occurrence is circumvented. For instance, a contract of guarantee cannot be terminated merely by a letter of withdrawal from the guarantor, while by the provisions of section 4 of Statute of frauds Act, it is required to be in writing.

Concepts like guarantee, warranty and indemnity are often erroneously used interchangeably albeit having distinct legal meanings and implications, but ignorance of the law affords one no excuse.