Guarantees - a brief guide on enforceability

Guarantees - a brief guide on enforceability

In the recent case of Bioconstruct GmbH v Winspear and another [2020] EWHC 7 (QB), the claimant (Bioconstruct GmbH) brought proceedings in respect of unpaid sums it claimed were owed under a guarantee.

The court dismissed the claims, stating that among other things, the guarantee in question was not validly executed as a deed due to pre-signed signature pages being affixed to the document after material changes had been made. It was therefore ruled that the claimant was attempting to create a legally binding deed where no such deed existed. 

In light of the above judgment we felt it prudent to revisit the topic of guarantees with an emphasis on valid execution. A link to our previous article on this topic can be found here.

Requirements for valid execution of a guarantee:

A guarantee is a contract, such instruments must be in writing by virtue of the Statue of Frauds 1677. If the guarantee is drafted as a contract under hand then there is a requirement to evidence consideration (e.g. “in consideration of providing credit to the borrower”). Parties will often circumnavigate the requirement for consideration by executing a guarantee as a deed.

If the guarantee is drafted as a deed there are heightened execution requirements. These were set out by the Law Society in the Mercury Principle guidelines following the case of R (on the application of Mercury Tax Group and another) v HMRC [2008] EWHC 2721 which ruled similarly to the case in the case of Bioconstruct above, that adding a signature page to a deed or using a signature page from a previous draft of the deed in a final draft would not constitute valid execution.

However, where the execution formalities for a guarantee have not been met, it may be possible for a beneficiary to have the benefit of an indemnity – subject of course to the drafting.

Is my guarantee in fact an indemnity?

A guarantee is a secondary obligation which secures the obligations of a third party. For a guarantee to crystallise and be called upon, the third party must have failed to comply with one or more of the guaranteed obligations (e.g. a borrower not paying back a loan to a lender).

An indemnity, although similar to a guarantee, is not the same and lacks the formal requirements detailed above. Indemnities are contractual promises to accept liability for another’s loss. Unlike guarantees, indemnities are primary obligations in favour of a beneficiary and exist independently of any obligations of a third party. An indemnity may, therefore, be enforceable even if the principal is not in default of its obligations, and will still be enforceable in the event that the underlying transaction is set aside.

This distinction is very important as guarantees are often subject to challenge and complex rules of interpretation may also render them unenforceable. It is therefore common in practice for documents to be drafted so as to include a combination of guarantee and indemnity provisions in order to best protect a beneficiary. Whether this makes the document a guarantee or indemnity then becomes a difficult matter of interpretation for the court and may result in a line by line analysis of the document in support of one argument or another.

From a practical perspective, it will always be safer to comply with formal requirements of a guarantee. Of course, arguments around whether a document was validly executed tend to arise only when a guarantee is called upon and there is an unwillingness or an inability to satisfy the guaranteed obligations.

Jonathan Porteous, Head of Banking and Finance at Stevens and Bolton LLP, comments:

The ruling in Bioconstruct is a clear cautionary statement to parties entering into guarantee arrangements. The parties must correctly identify the nature of the agreement and comply with the ensuing execution formalities in order to ensure the terms of the agreement and rights of the parties under it are enforceable.

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