Our ever evolving economic climate increases the pressure on us to protect their clients against the common ‘buyer beware’ concept. This means a necessary awareness and adoption of appropriate contractual, and negotiation skills. Client protection takes the form of Warranties, Indemnities and Guarantees. Although these concepts are similar in the sense that they all provide protection for parties, a closer look will reveal that each concept is very different and are all of tremendous importance were the protection of our interest is concerned.
A Warranty is a tool used in a transaction to assure a party to a contract of the existence of a fact, often times relating to the title, quality, or quantity of the subject matter, upon which the other party may rely. A breach of a warranty gives the aggrieved party the right to claim damages but not to treat the contract as repudiated.
Warranties may vary depending on the nature of transaction and the negotiation strength of the parties. Warranties may also provide assurances for other matters including intellectual property rights, ownership of shares, financial matters, quality and performance of products, and employment issues.
In the context of a sale of shares, Warranties serve two main purposes:
1. To provide a buyer with a remedy if the statements made in an agreement later prove to be incorrect. It therefore serves as a form of retrospective price adjustment.
2. To encourage the seller to disclose known and possible problems to the buyer.
A party that breaches a warranty is only responsible for foreseeable losses and damages. A defaulting warrantor is liable to compensate the other party in the amount which will put him in a position he would have been had the warranty been true.
A party claiming for breach of warranty must show the following:
- That A loss/damage was suffered: Such a loss must be a natural consequence of the breach, the type and extent of which a reasonable person would accept in the circumstances
- Damage suffered is not too 'remote'. In other words; at the time the contract was entered into, the loss was fairly and reasonably contemplated by both parties as the probable result of the breach. See Hadley -v- Baxendale,
Damages for breach of warranty are calculated on a contractual basis and aim to mitigate the loss or damage.
An indemnity is a promise to reimburse the other party in respect of a named liability, should it arise. In simple words an indemnity is an agreement to make good a loss suffered by another. Indemnities are appropriate for matters which are specific and known and which clearly fall outside the responsibility of the buyer. They often deal with issues such as environmental risks, litigation and product liability see Hong Kong Fir Shipping Co Ltd -v- Kawasaki Kisen Kaisha Ltd  2 QB 26. The general principle is that the party that is in the better position to avoid liability is given an incentive to do so by being made responsible for the consequences.
An indemnity for a specific sum due on the happening of an event is not a claim in damages, so mitigation and other principles relating to the assessment of damages do not apply. However, where the indemnity is for a general breach of contract by the indemnifier, the default position is that rules relating to remoteness of loss and an obligation to mitigate will apply. If the parties intend to include unforeseen losses, and to exclude the duty to mitigate, such agreement must be expressly stated in the contract.
Indemnities cover situations where one party is simply making sure that he does not have to pay for some failing or stupidity of the other. Indemnities are usually most appropriate to cover specific risks which are of particular concern to the buyer such as
1. Environmental risks.
2. Doubtful book debts.
3. Repayment of loans.
4. Product liability claims in relation to products sold before completion.
5. Litigation for infringement of intellectual property rights that may have a significant impact on business.
An indemnity can also be mutual, where each party to a contract agrees to indemnify the other for any failing of his e.g. in Partnership agreements.
A guaranty is the guarantors promise to perform the contract or pay the debt in the event the obligor/principal cannot or refuses to do so. A guarantee may also create a “see to” obligation to ensure or procure performance or payment by the debtor or else, the guarantor may be held responsible for the completion of the act, or found liable for damage caused by the failure to perform. Guarantees therefore create a liability on a third party to the extent of the liability of a party to a transaction. A guaranty agreement can therefore also be described as a collateral to some other contract, debt or obligation. See Smith V wood (1929) 1Ch. @ P.14 ; R.E.A Vs Aswani Textile Limited (1992; 3 NWLR,pt.227, P.1 at P.13, para ‘G’)
- Guarantee contract includes three parties namely:
- Creditor-party who is granting the loan
- Debtor-party utilizing the loan
- Surety/guarantor-party giving guarantee in favour of the debtor.
A guarantee presupposes the existence of another prior contract under which the principal debtor is primarily liable. A guaranty may be an absolute (unconditional, independent) or conditional, restricted or limited.
1. Absolute Guaranty: the guarantor agrees to pay or perform a contract upon default of the principal without limitation or notice. Consequently, the guarantor is obligated to pay the entire debt or complete performance of an act at maturity if the principal does not do so.
2. Conditional Guaranty: the guarantor's liability does not commence until the creditor has taken certain agreed-upon steps against the principal. The guarantor can choose the condition that triggers the obligations under the underlying contract. A common condition is that the third party must exhaust all remedies against the principal party before pursuing any remedies against you.
3. Restricted and Continuing Guaranty: A restricted guarantee is limited to a single transaction, while a continuing guaranty encompasses a series of transactions for an indefinite period and is effective until revoked or until extinguished by some rule of law or the express intention of the guarantor.
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There also exists a Personal guarantee; this usually takes the form of a guarantee by a company director to a third party such as a bank for the debts of a company. In this way, if the company becomes insolvent, the bank has recourse to the director's personal assets to satisfy the outstanding debt.
The guarantor’s liability crystallizes upon the failure or inability of the debtor to discharge the obligation in the contract. Guarantees are used where one party is under specific obligations to another. The most common use is in a commercial lease or residential tenancy agreement.
A demand guarantee is a hybrid class which merges Indemnity and guarantee. Demand guarantees work by extracting prompt deposit/ payment obligations from the guarantor for the debtor’s obligations in the underlying contract to enable the remedy of a contractual defect, without having to subject the beneficiary to a long winded dispute resolution to ascertain who is at fault. The demand guaranty is the assurance of payment regardless of disputes in the underlying contract.
DIFFERENCE BETWEEN INDEMNITY, WARRANTY AND GUARANTEE
Now to free our minds from what the confusion of the difference between an indemnity, a warranty and guarantee we must consider the following:
1. Number of Parties
Indemnity and warranty contract includes two parties while a guarantee contract includes three parties namely creditor, Principal debtor and surety/guarantor.
2. Number of Contracts
Indemnity and warranty contracts involve one contract only. But a guarantee includes the sub-contracts which includes the principal contract on one hand and the guarantee contract on the other hand.
Warranties and indemnities usually differ from guarantees based on their very nature. Warranties and indemnities both create an obligation to compensate someone for loss or damage and is independent of the obligations of the party whose covenants are being reinforced by the provision of the indemnity or warranty. A guarantee on the other hand creates a secondary obligation.
- In simpler words:
- A guarantor says: “if he does not pay you, I will”.
- An indemnifier says: “I understand that this deal with me may cause you to lose money. If you do suffer loss, I will make it up to you.”
- The warrantor says “if the position appears to be untrue, I will restore you to a position as if it were true”
In guarantee there are be two types of liabilities namely; primary which will be with principal debtor and secondary liabilities which lies with the surety. When a person gives a guarantee or promises to another person, that person will become liable if the original commitment (such as the payment of money or to performance of an obligation) is not performed. Therefore under a guarantee there exists concurrent liability between the debtor and guarantor. In other words, the guarantor cannot be liable for anything more than the client. His duty therefore is to “stand behind” the principal and only come to the fore the debtor has failed in his obligations.
Indemnities and warranties on the other hand create only a primary liability. See Bentworth Finance (Nig) Ltd Vs Ibrahim (1969; NCLR; P.272 at p.277) and (Apugo & Sons Co. Ltd Vs African Continental Bank Ltd (1989; 1CLRQ, p.87). An indemnity provides that the liability of the indemnifier to run with any loss by the person he indemnifies. In essence it is an agreement that the indemnifier will make sure the person he indemnifies does not lose money on the deal in question.
Indemnities arises on occurrence of an event, while obligations contained under a guaranty contract is triggered by a demand which complies with the terms of the contract in affirming that the principal has defaulted.
Liability of the guarantor/surety exists concurrently with that of the principal debtor. This means that where a guarantor is successfully able to argue that the sum for which he is liable is extinguished or diminished, the guarantor liability is equally extinguished. see; Goulston, Discount Co. Ltd Vs Clark; 1964, 2QB, P.493. This is not the case in indemnity and warranty, as the liability remains under the transaction notwithstanding that the debtor is discharged under the main contract. A guarantee under a void transaction also becomes void. The same is not the case for in an indemnity as a void contract will not cancel out the liabilities and obligations in the indemnity. (Wanthier Vs Wilson; 1912, 28 TLR, p.239; Yeoman Credit Ltd Vs Latter; 1961, 1 WLR, p.828).
A breach of warranty will only give rise to a claim in damages. An indemnity generally compensates a party for all loss actually suffered so the difficulties which may arise in respect of a warranty claim regarding quantum of loss can be avoided. However under indemnity the claimant can recover all the loss it suffers as a result of a breach of the relevant indemnity and nothing more. In guarantee, if surety makes payment to creditor, he (surety/guarantor) can recover that amount from principal debtor.
8. Proof of loss
It is necessary for a buyer to prove that losses arise as a result of a breach of warranty and all issues relating to matters such as remoteness of damages apply. With an indemnity, however, a buyer can recover any losses sustained without having to prove that loss.
Under warranties the limitation period starts to run from the date of the breach of the warranty. The limitation period in respect of indemnities starts to run from the date on which the loss is suffered.
It is imperative that individuals involved in transactions acquire a good understanding of the nature, implications and differences between the warranties, guarantees. All these concepts have an important part to play in the preparation and negotiation of commercial transactions.
- Tom Coulson; Common Misconceptions In Contractual Promises
- Mayomi Kolawole Abimbola; The Case For An Analytical Approach To The Construction And Enforcement Of Demand Guarantees In Nigeria
By: Abimbola Laoye
Managing Partner H.B Balogun & co