Introduction

Guarantees and indemnities are commonly used by lenders as a form of risk mitigation in cases of default of a debt by a borrower. They are most preferred by businesses with low credit profiles in securing financial obligations.

Lenders will often require a deed of guarantee and indemnity duly signed by a guarantor/indemnifier to accompany any security agreement. A guarantor promises to pay the outstanding loan should the borrower fail to meet its obligations. Consequently, guarantors take on serious financial risks in entering such transactions. This discourse highlights some of the implications.

What are Guarantees and Indemnities?

A guarantee is a contractual obligation by a guarantor to ensure that a third party (a borrower) will fulfill their payment obligation and an undertaking to pay any amounts owed by the borrower should they fail to pay. Its acts as a secondary obligation to the lender as it is anchored on the payment obligation of the borrower.

Similarly, an indemnity is a pledge to accept liability for another’s loss. It acts as a primary obligation to the lender because it is independent of the obligations of a borrower under a security agreement. In other words, if a security agreement is set aside, an indemnity will remain valid.

Guarantees and indemnities can either be limited or unlimited. A limited guarantee makes a guarantor liable for only a portion of the debt while an unlimited one makes a guarantor liable for the entire debt. They may also identify a specific asset or allow a lender to acquire any of the guarantor’s personal assets if a borrower defaults on a loan. In most cases, guarantees and Indemnities are combined in a single instrument.

Which law governs Guarantees and Indemnities?

Under Kenyan law, deeds of guarantees and indemnities are governed by the principles of the Law of Contract. A deed must encompass all the elements of a contract, namely; offer, acceptance, capacity to enter into a binding agreement, intention to create a legally binding agreement and consideration. Additionally, for a deed of guarantee and indemnity to be enforceable, it must be in writing and signed by a guarantor or a person duly authorized by the guarantor.

What are the major types of Guarantees and Indemnities?

• Personal Guarantees– They are made by individuals. An individual pledges their own personal assets as collateral against a loan facility in the event a borrower defaults on a loan facility. For example, a director of a company guarantees repayment of a loan on behalf of a company; and
• Corporate Guarantees– They are made by corporate institutions such as commercial banks, insurance firms, companies etc. (A corporate institution has a separate legal personality from its founding individuals.) For example, a company guarantees repayment of a loan on behalf of another company for whom it is a director.

Nature of Guarantees and Indemnities by Directors

Corporate guarantees and Indemnities require the approval of the members of a company before a company can issue one in relation to a loan by a third party. On the other hand, members must be informed of a personal guarantee by any director guaranteeing a loan by a company

Where there are multiple guarantors, their liability is normally joint and several, that is, any director who signs a guarantee may be pursued for payment of the debt in the event of a default by a company.

Case study: Kenya Commercial Bank Group (KCB) versus Pearl Beach Hotels T/A English Point Marina

Pearl Beach Hotels T/A English Point Marina (the ‘Company’) borrowed loan facilities of up to Kshs. 4.8 Billion (the ‘Loan Facility’) from the Kenya Commercial Bank Group (KCB). Its directors used the Company’s premises, rental income and issued both corporate and personal guarantees to secure the facility. The personal guarantees were up to Kshs. 1 Billion each.

Pearl Beach Hotels defaulted and KCB seized the English Point Marina and appointed an administrative receiver in line with the Insolvency Act of 2015. The receiver’s main task was to maintain the Company as a going concern and to ensure payment of the debt to KCB and other creditors too.

As a result, the Company applied to the High Court in Mombasa, seeking to bar KCB from selling or subdividing any of its assets. It also sought for an order of temporary injunction restraining KCB from appointing a receiver or an administrator with respect to the loan agreements.

Currently, the Honorable Judge, has ordered the parties to maintain the status quo pending the hearing and determination of the application filed by Pearl Beach Hotels.

If the Company fails to pay the outstanding loan facility, the directors and the Company both risk losing their assets.

Conclusion.

Guarantees and Indemnities provide a secondary avenue for recovery of monies by a creditor should a borrower, individual or corporate, fail to meet their payment obligations. They also facilitate access to finance for individuals and/or businesses in order to secure loan facilities.

It is important to be aware of possible implications caused by guarantees and indemnities as they can cause significant stress for Individuals and businesses and may eventually lead to them losing their assets and incurring of additional costs such as default interest, legal and other fees on default of loans.

Please contact us at info@cfllegal.com should you require further information.