Guarantees, Warranties and Indemnities are a means of allocating risk in commercial transactions. In English law, the principle of “caveat emptor” (let the buyer beware) applies, which gives a buyer very little protection in sales and purchase transactions as the seller is not required to disclose any faults before the conclusion of the sale. The buyer can use guarantees, warranties and indemnities to protect themselves in the event that the seller has failed to provide information before the purchase. It is crucial to understand the differences in formalities and remedies for the three means.
A guarantee is a promise to ensure an obligation is fulfilled by the third party. It is a contractual agreement that creates a secondary obligation to support the primary obligation. The obligation under the guarantee is contingent on the primary obligation. It will therefore, never be greater than the primary obligation.
There are two types of guarantee:
- Conditional payment guarantee – these guarantees create a primary obligation on the part of the guarantor to make good a failure to pay money in the event that the person promising to pay the fails to do so.
- Pure guarantee – this guarantee seeks to impose a secondary obligation to ensure or procure performance on the part of the person making the promise which is being guaranteed.
A warranty is a contractual assurance from seller to buyer: they are statements of fact which are terms of a contract and asserted to be true by the person making them. Within commercial transactions, warranties are usually contained in a share or asset purchase agreement. Warranties often take the form of assurances from the seller as to the condition of the target company or business
An indemnity is a contract by which a party undertakes an obligation to make good a loss. They can be used to protect against the specific risks which may be of concern to the buyer, for example, a lender may use an indemnity if they have doubts about a borrower’s ability to fulfil its obligations under a loan agreement. Indemnities are formed by meeting the minimum requirements of a valid contract (offer, acceptance, consideration, intention to create legally binding relations).