The failure to include in a guaranty agreement a standard clause addressing changes in payment obligations can serve to absolve the guarantor from liability. See Associated British Ports (A company created by statute) v. Ferryways NV, Sweet & Maxwell (Case Reporting Team CA (Civ Div) Jacob, L.J.; Maurice Kay, L.J.; Sir Anthony Clarke, M.R. Judgment date: March 18, 2009).
Guaranty or Indemnity?
The initial matter before the court was whether the agreement at issue imposed an obligation of a guaranty or indemnity.
This issue usually arises because the law treats the two concepts differentially in terms of formality requirements. A guaranty is subject to the formal requirements of section 4 of the Statute of Frauds 1677, but an indemnity is not. A guaranty is, in the words of the Statute, a promise "to answer for the debt default or miscarriage of another person." There must be another person who is primarily liable. The liability of the guarantor is secondary. By an indemnity, on the other hand, the surety assumes a primary liability.
The current case illustrates another difference between a guaranty and an indemnity. Because the liability of a guarantor is secondary, it usually is discharged by a bilateral variation of the contract between the creditor and the debtor. In a contract that provides for a guaranty, absent an express provision to the contrary, if a creditor extends additional payment time to the debtor, this action generally serves to discharge the guarantor.
The same action, however, will not have that effect if the suretyship is one of indemnity; the liability of the surety, being a primary liability, survives.
Ferryways was a Belgian company formed to operate a roll-on, roll-off ferry service between Ostend and Ipswich, and as such, entered into a series of agreements with Associated British Ports (ABP) culminating in a revised agreement (the Primary Agreement). In essence, Ferryways promised a certain throughput of units through the port of Ipswich. ABP agreed to spend a significant sum on improvements to the port, and naturally wanted to secure a long-term commitment from Ferryways.
Ferryways shareholder MSC Belgium (MSCB) entered into a second agreement with ABP through a letter (the Letter Agreement) to secure ABP's position by providing recourse against MSCB in the event that Ferryways did not meet its obligation to send sufficient volume of units through the port under the Primary Agreement.
Some time later, ABP and Ferryways concluded a third agreement—the Time to Pay Agreement—which took the form of a supplementary memorandum to the Primary Agreement.
In due course, Ferryways ceased trading and ultimately was put into liquidation. ABP sought to recover sums due from Ferryways under the Primary Agreement, and from MSCB under the Letter Agreement.
Judgment ultimately was rendered in favor of ABP against Ferryways for damages to be assessed, but the claim against MSCB was dismissed.
Guaranty: Secondary Liability
Whether a document is a guaranty or an indemnity, or whether it imposes secondary or primary liability, depends on "the true construction of the actual words in which the promise is expressed."
The court was prepared to conclude that the Letter Agreement was a guaranty rather than a nonbinding letter of comfort. It was not prepared to accept that it constituted an indemnity. As a guaranty, the agreement created secondary liability. In other words, if Ferryways could not meet its liabilities to ABP "as and when they fall due" (the primary liability), then the secondary liability of MSCB would accrue by way of guaranty.
In the current case, the court further found that the creation of the Time to Pay Agreement had the effect of discharging the liability of MSCB under the Letter Agreement.
Notwithstanding the Time to Pay Agreement, the Letter Agreement would have been sufficient to protect ABP had it included a common provision found in guaranties, which expressly provides that subsequent variation or time to pay agreements between the creditor and the debtor do not act to discharge the surety.
"... [I]n practice any well-drawn contract of suretyship will nowadays expressly permit variation of the obligations or the giving of time, without discharging the surety."
The failure to include this type of language in the Letter Agreement proved to be a fatal flaw from ABP's perspective.
The usual practice when seeking guaranties is to express the obligations of the guarantor as "primary" and not merely as surety. However, there can be no assurance that a court will accept the premise that this wording alone gives rise to a primary obligation, if the true construction of the agreement is that of a guaranty.
Draftsmen have attempted to remove this problem by excluding specific events that normally would extinguish the primary obligation and thereby release a guarantor.
One typical example, as arose in the current case, is to state that variation of the primary obligation will not act to discharge the guarantor. Other typical exclusions relate to the insolvency of the primary obligor.
But perhaps most importantly, given the complexity of the laws relating to guaranties, is the practice of including a stand-alone provision stating that the guaranteed obligations also are given by way of indemnity. The effect of the indemnity is to create a primary obligation of the "guarantor," which is not released by the actions of the primary obligor.
At a time when there is significant upheaval and uncertainty over the performance of counterparties in all types of business, great care should be taken to ensure that "guaranties" have been correctly drafted and are ideally given both as "guaranties" and "indemnities." Short-form documents purporting to create assurances of performance by counterparties may miss some of these key ingredients, and leave the injured party without any meaningful remedy.