The Court of Appeal recently considered the case of Anthony Pitts and Others v Andrew Jones [2007] EWCA Civ 1301. Anthony Pitts and others were employees and minority shareholders in the company HM Shopfitting Ltd. Andrew Jones was the managing director and majority shareholder of that company. In this case, the Court of Appeal had to decide on two facts: whether an undertaking that was given by Andrew Jones to the employees amounted to a contract, being supported by consideration and, if any contract had been made between the parties, whether it was one of guarantee or indemnity.

A verbal promise to pay

Andrew Jones reached agreement in principle to sell his shares in the company to a third party company called W.G. Birch Limited ("Birch"). Andrew Jones informed the employees about their rights of pre-emption (their right to buy back the shares themselves). He also advised that Birch had offered to acquire their shares at the price paid for the majority shareholding.

The employees agreed to sign waivers of their rights of pre-emption and sell their shares to Birch. Birch then advised that they would require to borrow the purchase price from HM Shopfitting Ltd. Such an arrangement was contrary to section 151 of the Companies Act 1985 and so a resolution needed to be passed at a company Extraordinary General Meeting. The meeting was called at short notice and this resolution was duly passed.

During the meeting Andrew Jones's solicitor told the employees that all their shares were to be paid for later than those of Andrew Jones's and there would be no security available to cover the payment due. Therefore, the employees would have no security to redeem the price of their shares back if Birch should fail to pay or Birch became insolvent before their shares had been paid for.

Andrew Jones gave the employees an undertaking that, if Birch did not pay them for their shares, he would. The employees asked for this in writing, but upon legal advice Andrew Jones did not provide this and the employees accepted Andrew Jones's verbal promise.

Andrew Jones subsequently received the money for his shares from Birch. Birch later became insolvent and the employees received nothing for their shares. The employees requested the money from Andrew Jones. He refused to pay the price that the shares were originally sold for, although he offered them a reduced sum. The employees sued for the original value of their shares.

The importance of consideration

In the initial decision the recorder held that Andrew Jones's undertaking was not a contractual promise as it was unsupported by consideration. The recorder also held that, even if that conclusion were wrong, the claim would still fail. If there was a contract between the employees and Andrew Jones, it was a contract of guarantee and unenforceable because it was not evidenced in writing and signed by or on behalf of the guarantor.

Guarantee or indemnity?

Anthony Pitts and Others appealed the decision to the Court of Appeal. The Court of Appeal concerned itself with two questions:

  • Was Andrew Jones's promise supported by consideration?
  • Was Andrew Jones's undertaking enforceable?

The court held that the employees did give consideration to Andrew Jones. There was a clear link between Andrew Jones's offer of the undertaking and the employees' willingness to sign the share agreement documentation and to agree to the short notice EGM. That was, according to the court, good consideration and the undertaking was therefore said to be a contractual agreement.

On the second question, the court agreed that the contractual agreement appeared to be more like a guarantee than an indemnity. In order to be enforceable, in accordance with section 4 of the Statute of Frauds 1677, a guarantee must be in writing and signed by the guarantor or a person authorised by it. There is no such requirement for an indemnity.

In reaching this decision the Court reviewed the level of interest Andrew Jones had in the arrangement.

The summary was, if his involvement was his promise to pay the loss, it was a contract of guarantee and if he had some benefit from it, it would be a contract of indemnity and section 4 of the Act would not apply. The Court looked at Andrew Jones's interest in relation to both aspects, namely, his share sale to Birch and the signing of the share option agreements by the employees.

Andrew Jones's undertaking related to the second of these, the signing of the share option agreements by the employees. The court ruled that Andrew Jones could not possibly derive any benefit from that and accordingly the promise was a guarantee. Further, since it was not in writing or signed by the guarantor it was unenforceable.

Put it in writing

It is a basic rule in English contract law that a contractual promise with no consideration in return is not recognised as enforceable, unless it is contained in a deed. This still stands but what can amount to consideration appears to have been extended. In this case, even though there appears to have been no intention to give consideration in exchange for Andrew Jones's promise, the employees were regarded as having given good consideration, by their actions.

The clear distinction between a guarantee and an indemnity, where the guarantee requires to have been in writing and signed by or on behalf of the party giving the guarantee to be effective, is straight forward enough. The difficulty lies in the fine distinction between the obligation promised either as a guarantee or an indemnity in the first place. The test proposed related to the level of interest of the party making the promise. A guarantee is used where the intention is that the guarantor stands in another's failure to perform whereas an indemnity is used where the person making the promise is primarily liable. The Court also looked at the level of interest the promisor had in the transaction and distinguished between having a motive to give a promise and having a real interest. It was decided that to have a real interest, there would have needed to be some benefit to the party in response to honouring the promise.

Guarantees and indemnities are often used in property transactions and greater attention is likely to be taken as to the level of undertaking parties intend to make. It is likely that indemnities will now be incorporated in guarantee agreements as a matter of course and most will be documented in writing to avoid uncertainty.

To view the decision in the case of Anthony Pitts and Others v Andrew Jones [2007] EWCA Civ 1301 please click here.