GUARANTEES and indemnities are both long established forms of what the law terms suretyship. There are important legal distinctions between them.

A guarantee is a promise to someone that a third party will meet its obligations to them – “if they don’t pay you, I will”.

An indemnity is a promise to be responsible for another’s loss, and to compensate them for that loss on an agreed basis – “if it costs you more than £250 to fix that, I will reimburse you the difference”.

Section 4 of the venerable Statute of Frauds 1677 requires guarantees to be in writing if they are to be enforceable; there is no such requirement in the case of an indemnity, although, of course, written agreement is always best as a matter of practice and for proof.

It is not always obvious whether a clause or agreement is a guarantee or an indemnity.

Some of the differences were highlighted by the Court of Appeal in the 2007 case Pitts & Ors v Jones.

The appellants bringing the claim were minority shareholders in a company of which the other party was managing director and majority shareholder.

The majority shareholder had negotiated the sale of the company to a purchaser who had agreed to buy the shares of the minority at the same price.

The appellants were summoned to the sale completion meeting and were told that as part of the terms agreed their shares would be purchased after a delay of six months.

On being made aware of the risk of the purchaser becoming insolvent within this period they declined to sign the documents but relented when the majority shareholder undertook verbally to pay if the purchaser failed to do so.

The purchaser did subsequently become insolvent and could not pay for the minority shareholders’ shares, so they sued the majority shareholder on his undertaking to pay them.

The Court of Appeal found that, while all the other necessary elements of a legally binding contract were present (offer, acceptance, consideration and the intention to create legal relations), the undertaking given to the minority shareholders was unenforceable since it was a guarantee and was not in writing.

The minority shareholders lost the value of their shares and were left with no recourse.

The case illustrates how difficult questions can arise in analysing indemnities and guarantees and underlines the need to seek proper legal advice.

■ David Wilson is a partner and specialist in company law at BHP Law.

Contact him on 0191-221-0898 or at davidw@bhplaw.co.uk