Indemnity, guaranty, warranty: Learn how they differ

Have you ever wondered what the difference is between an indemnity, guaranty and warranty agreement? You have probably encountered such agreements or contract provisions in the context of executing an employment agreement, sales contract, lease or real estate contract, or loan-of-credit contract.

This column will focus on defining the three types of agreements as well as identifying key phrases which you should consider including in your indemnity, guaranty or warranty agreements.

Indemnity agreements

Generally, under an indemnity agreement, you would be agreeing to assume all responsibility and liability for any injuries or damages to someone else.

It is common for the parties to an indemnity agreement to provide that in the event that one is held liable, the other shall indemnify it for the consequences. The underlying principle is that the party that is in the better position to avoid liability is given an incentive to do so by being made responsible for the consequences.

Some common phrases contained in indemnity agreements include that the person or entity agrees "to indemnify and hold harmless" or "to defend, indemnify and hold harmless."

If the indemnity agreement includes the obligation to defend, you should also include language requiring the person who is being indemnified to "tender the defense" to you. Or you should include language reserving your "right to control" the defense, including requiring your approval of any settlement.

Without such provisions, the party you are indemnifying can rack up huge attorney's fees and costs which will you be expected to pay. By controlling the defense, you can choose your own attorney and have a say in minimizing litigation costs and expenses.

An indemnity agreement typically covers things like loss, damages, costs, expenses and attorney's fees. However, if the indemnity agreement is silent as to attorney's fees, then the court will not impose this obligation or require the person promising to indemnify to pay attorney's fees. Even if the indemnity agreement includes attorney's fees, this means reasonable attorney's fees, which the attorney has the burden of proving.

There is often confusion regarding the difference between indemnification and contribution. Contribution involves the distribution of liability for damages among culpable parties according to each party's relative percentage of fault. Indemnification, in contrast, shifts the entire loss from one party to the other. In other words, contribution asks another to share, while indemnity requires another to pay it all.

Guaranty provisions

A guaranty is a promise or agreement to answer for the debt, default or other financial liability of another, in contrast to indemnity agreements' promise to answer for the legal liability of another. You would be promising to perform the contract or pay the debt in the event the principal person or entity cannot or refuses to do so. Once the principal obligation has been paid or otherwise satisfied, the guarantor's obligation is terminated. You are likely to be required to sign a personal guaranty as part of a loan to your medical practice or as part of a sales contract for your medical practice.

A guaranty agreement is collateral to some other contract, debt or obligation. It is this contract for which you would be secondarily liable. Therefore, you should review the underlying contract before signing the guaranty agreement.

There are different types of guaranties. A guaranty may be an absolute, unconditional, independent undertaking, or it may be subject to conditions established by the parties. Under an absolute guaranty, the guarantor agrees to pay or perform a contract upon default of the principal without limitation or notice. Consequently, the guarantor is obligated to pay the entire debt at maturity if the principal does not do so.

Under a conditional guaranty, the guarantor's liability does not commence until the creditor has taken certain agreed-upon steps against the principal. The guarantor can choose the condition that triggers the obligations under the underlying contract. A common condition is that the third party must exhaust all remedies against the principal party before pursuing any remedies against you.

A guaranty may also be either restricted, which is limited to a single transaction, or a continuing guaranty, which contemplates a future course of dealing encompassing a series of transactions. A continuing guaranty is for an indefinite period and is effective until revoked or until extinguished by some rule of law.

It is important to choose the language of the guaranty carefully. If a guaranty as part of a sales contract provides that it covers all debts then due or which might become due from a certain medical practice to a third party, the guaranty would be construed to cover purchases made by the medical practice before and after the date of the guaranty. And, it would extend indefinitely.

Consequently, you should consider including a condition, a specific dollar amount for which you will be liable, and a specific time period in the guaranty agreement.

Warranty agreements

A warranty agreement is an assurance by one party to a contract of the existence of a fact, often times relating to the title, quality, or quantity of the subject matter of a contract upon which the other party may rely.

A warranty agreement is intended to relieve a party of any duty to research the fact for himself, and amounts to a promise to indemnify for any loss -- if the fact proves untrue.

You are likely to see a warranty agreement as part of a construction contract in which the refurbishing or renovations are significant, or a real estate contract for your home or office. You should consider including a provision that the office or home work will be performed in accordance with your specifications and in a good, workmanlike manner.

No particular words are required to constitute a warranty if it is clear that the parties intended one. An express warranty will be construed in accordance with the clear and natural import of the language used, as applied to the subject matter of the contract, and liability under a warranty will be enforceable only in accordance with its terms. You can also disclaim any warranties by including a disclaimer provision in your contract.

It is important to remember that even if a contract is labeled as a warranty, indemnity or guaranty, the court may construe the contract as a different type of contract depending on its actual attributes.

The nature and extent of your liability pursuant to the warranty, indemnity or guaranty agreement will be determined in accordance with the terms and conditions of the contact. Therefore, the lesson is to choose the language carefully, as you will be found accountable for the words you use.