Insurance, indemnity and guarantee are distinct contractual arrangements with different purposes. The distinction among these contracts poses difficult questions of construction and interpretation, but the categorisation of the contract has a significant effect on the rights and obligations of the parties. While the principle of indemnity applies to both insurance and guarantee, there are a number of distinctions between a simple indemnity and guarantee, and a number of further distinctions between insurance and guarantee.
Guarantee and indemnity
Both a guarantee and an indemnity have the object of ensuring that a creditor receives back the money laid out in a transaction, but the method by which that “object” is attained decides the class to which the document belongs.
The classic definition of a guarantee is that it is a contractual promise by the guarantor or surety, to make good the debt or default of a principal debtor. In other words, the guarantor becomes bound to pay the debt for which the principal debtor is liable to pay. If the principal debtor fails to pay a debt or defaults under a contract, not only do they breach their own contract, but they also put the guarantor in breach of the principal debtor’s contract. The creditor is then at liberty to sue the guarantor directly for the unpaid debt and damages pursuant to the principal contract. Thus, the guarantor’s contract is that the principal debtor would carry out their contract – failing which the guarantor undertakes that they would make good the loss suffered by the creditor.
Indemnity is a contractual obligation by which one party undertakes to make good a loss suffered by another. In a contract of indemnity, the person who has promised to indemnify the other is liable as principal.
Thus, an indemnity is an original undertaking, but a guarantee is a collateral undertaking. In a guarantee, the liability of the guarantor is co-extensive with that of the principal debtor. In an indemnity, the obligation to compensate rests solely with the party who has promised to indemnify – creating a principal liability.
Guarantee and insurance
A contract of insurance is distinct from a contract of guarantee. Insurance generally involves an element of futurity about the risk covered, but a guarantee is founded in past events. Insurance provides an indemnity against “losses by the acts or omissions of strangers”, but in a guarantee, the principal debt is already incurred, or if not incurred, is defined, and may be defaulted by the principal debtor in future.
In a contract of guarantee, the principal debtor does not pay any fee to the guarantor. The guarantee is generally provided without a fee from motives of friendship towards a debtor. In a contract of insurance, the would-be insured – or “creditor” by analogy – seeking to have the risk covered approaches the insurer (or “guarantor”), directly and pays a premium for the “guarantee” (insurance). The insurer’s liability is not a secondary but a primary one. The undertaking is a direct promise to pay if a certain event occurs; and it is not contingent upon the failure of another person to meet their obligations.
Thus, insurance is an original undertaking, but a guarantee is a collateral undertaking. A guarantor promises to make good the default of the principal debtor, for which the guarantor and the principal debtor are both co-extensively liable. In insurance, the insurer (as principal) promises an indemnity to its insureds against perils equivalent to the risk of accident.
Indemnity and insurance
The differences between a contract of indemnity and a contract of insurance emerge from the above analysis about the differences between a guarantee and insurance. A simple indemnity is a necessary element of both a contract of guarantee and insurance. The primary obligation under both a contract of guarantee and insurance is the obligation to “indemnify”.
An indemnity, as a matter of practical commercial observation, is often contained within a contract where the indemnity obligation is ancillary or collateral to the principal purpose of the contract and the primary obligations under the contract. In contrast, an insurance contract’s main purpose is the provision of indemnity against risk of loss and damage.
Conclusion
Guarantee, indemnity, and insurance each provide a framework for managing risk and protecting against loss, but they do so through fundamentally different legal mechanisms. A guarantee is a collateral promise – secondary to the obligations of a principal debtor – triggered only upon that debtor’s default. An indemnity is a primary undertaking to compensate for loss, operating independently of any third party’s liability. Insurance also involves a primary obligation, but its essence lies in transferring defined risks to the insurer in exchange for a premium, with liability arising on the occurrence of specified future events. While the principle of indemnity runs through all three, their legal character and commercial function diverge significantly – making correct categorisation essential for determining the rights, obligations, and remedies available to the parties.
Note: This is a general guide only. Circumstances may vary and advice should be sought about your specific circumstances.
References
Trafalgar House Construction (Regions) Ltd v General Surety: Guarantee Co Ltd [1996] 1 AC 199.
Coutts & Co v Browne Lecky [1947] KB 104 at 112.
