Guarantees and indemnities: top enforcement issues
In Part 1 of this mini-series, we first explored the difference between third-party guarantees and indemnities; the approach courts and tribunals take when determining which is which; and how language can be important when drafting loan agreements, especially when a dispute arises.
In the second part of our Perspectives, we further explore third-party guarantees and indemnities and issues that commonly arise in enforcement disputes as they relate to loans, in particular where the underlying loan has been transferred in the secondary market. We have seen steadily increasing arbitration activity on these issues, including at the LCIA and SIAC.
Guarantees
Form
Issues as to the form of guarantees, such as where a guarantee is not in writing or has not been given for adequate consideration, are rare. Where issues in relation to form do occur, they more commonly relate to the local foreign laws of the guarantor, for examples questions as to the authority of the signatory.
Issues around primary obligation
The most common issues that arise when it comes to the enforcement of guarantees are, unsurprisingly, to do with whether the primary obligation has in fact been defaulted on, so as to trigger the guarantee. If the underlying debtor disagrees with the creditor, for example where the primary debtor argues the creditor is in breach of contract, or that it has set-off rights where those are not excluded, then the guarantor will normally wait for that to be resolved.
Notably, under English law, a creditor cannot simply rely on a judgment or award against the primary debtor to enforce the guarantee. Unless the guarantor has consented, or has had the opportunity to participate in the underlying proceedings, where a creditor has succeeded, the creditor must prove the debt is due all over again when it comes to enforcing the guarantee (equally, where a guarantor has succeeded, the creditor may say the guarantor cannot rely on the award).
As an aside, there can be issues where there are different forums, for example, the underlying loan is subject to arbitration and the guarantee to court litigation, but these are in practice generally dealt with through stays.
Alterations to the guarantor’s position
Aside from questioning the validity or enforceability of the underlying obligation, the other main defences are around alterations to the guarantor’s position. This takes two forms mainly. The first around altering the substance of the underlying obligation, which will affect what has been guaranteed. The second around altering the guarantor’s rights.
Underlying these arguments are equitable rules, the most commonly raised being the rule in Home v Brunskill (1877) 3 QBD 495, to the effect that any variation of the underlying contract which could adversely affect the guarantor (unless patently insubstantial) will discharge the guarantor from liability unless the guarantor has consented.
Taking each of these two defences in turn:
1. Alteration to the substance of the underlying obligation
It is common for loans, in particular syndicated loans, to be varied. These variations are often as to repayment time, as to amounts (e.g. to allow for further borrowing or to allow for payments-in-kind), as to interest, as to purpose (i.e. where the loan proceeds will be used) and as to identity of the creditor (e.g. where the loan is on-sold in the increasingly active secondary loan markets).
Most of the time, the original guarantee will have provisions allowing for this, in effect providing for the guarantor’s advance consent (or implied waiver) to variations and these will be effective up to a point, so long as they are within the ‘purview’ of the original guarantee. Where they are not within that ‘purview’, which they may not be if, for example, the purpose of lending is varied or the amount is materially changed, then the guarantee may be avoided even with the advance consent, unless there has been a further express consent or even a new guarantee document.
2. Alteration of guarantors’ rights
The creditor is obliged to disclose to a surety any contract or other dealing between creditor and debtor which changes the position of the debtor from what the surety might naturally have expected. In reliance on that principle, a guarantor might argue that actions taken by the creditor against the primary debtor have materially, and adversely, affected its rights of subrogation. For example, if the primary debtor has been made insolvent and an argument can be run that they did not have to be - thus affecting the guarantor’s ability to recover from the primary debtor - or that other forms of security should have been pursued first.
The Loan Market Association’s standard loan transfer documents contain specific provisions detailing that the primary debtor and the buyer of the loan have obtained consent from the guarantor to transfer any guarantee. Similarly, following a recent EU Directive which sought to clarify and standardise documentation used in the market for non-performing loans (NPLs), the European Banking Authority (EBA) implemented templates which include provision for detailing the guarantees applicable to NPLs being sold.
Finally, in circumstances where a guarantor is a consumer, they may also be considered to have a defence under the Consumer Rights Act 2015 (CRA), as was considered in Eternity Sky v Zhang [2024] EWCA Civ 630, discussed in our Perspectives piece here.
Indemnities
Enforcing indemnities generally involves fewer complications.
Trigger point
The most common issue is whether the indemnity has in fact been triggered. Where an indemnity is triggered upon the failure of the principal debtor to pay on time and if there is a dispute as to whether the principal debtor is due to pay at all, then the indemnity should not be triggered.
An example of this can be found in the case of Brown-Forman v Bacardi [2021] EWHC 1259 (Comm) where, among other things, the valid assertion of a defence of set off meant that there had not (yet) been a breach of an obligation to pay by the primary debtor and therefore the indemnity was not triggered. Another example is where there may be an ability to repeatedly defer payment, or part-payment, in the underlying transaction.
Equitable rules
Due to their different nature, equitable rules as to guarantees generally do not apply to indemnities, meaning indemnifiers often cannot rely on fairness-based defences available to guarantors. However, that appears to have been so held only at first instance (GPP Big Field [2018] EWHC 2866 (Comm) and Brown-Forman v Bacardi) and on potentially slim policy grounds. After all, if an indemnifier finds itself indemnifying something very different to what had originally been intended and understood, it would be odd for recourse to equity to be excluded outright.
Form
Issues of form do arise in indemnity cases, generally not on the form of the indemnity (as indemnities are not subject to the same strict rules as guarantees) but on the form of the notice and whether it complies with the form as outlined in the indemnity provisions.
Comment
As demonstrated in Part 1 and Part 2 of this Perspectives mini-series, guarantees and indemnities differ significantly in their nature and enforceability. Indemnities are more onerous than guarantees on the surety, while more straightforward to enforce for the creditor.
Who gets the better outcome at the initial stage of lending depends on the parties’ relative bargaining power and their need to borrow or lend, assuming the drafting is clear and enforceable as intended. Any parties coming in at a later stage of the lending life cycle, in particular participants such as private credit funds or other banks in the secondary loan market, should carefully consider the security given to understand their risk.
This article is for information only and should not be relied upon. The opinions expressed are made in good faith and while every care has been taken in preparing this document, Hausfeld & Co LLP makes no representations and gives no warranties of whatever nature in respect of this document, including but not limited to the accuracy or completeness of any information, facts and/or opinions contained therein.