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| Credits – www.william-pitt.com |
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.
1. Warranty
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.
2. INDEMNITY
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 [1962] 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.
3. GUARANTY
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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| credits – texasconstructionlawblog.com |
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.
DEMAND GUARANTEE:
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.
3. Nature
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”
4. Liability
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.
5. Obligations
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.
6. Discharge
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).
7. Remedy
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.
9. Limitations
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.
Conclusion
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.
REFERENCES
websites
Articles
- 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
