When entering into banking transactions in Malaysia, you may be asked to provide a guarantee or an indemnity. While these terms are often used interchangeably, they are distinct legal instruments with different implications for your liability. Understanding these differences is crucial before you sign any document that could expose you to significant financial obligations.
What is a Contract of Indemnity?
Under Section 77 of the Contracts Act 1950, a contract of indemnity is defined as a contract by which one party promises to save the other from loss caused by the conduct of the promisor or any other person. In simpler terms, when you provide an indemnity, you are promising to compensate someone for any loss they suffer.
For example, if you sign an indemnity promising to protect a bank against any losses arising from a particular transaction, you are undertaking a primary obligation. The bank can come directly to you for compensation without first pursuing anyone else.
Rights of the Indemnity Holder
Section 78 of the Contracts Act 1950 sets out what the person holding an indemnity (the indemnity holder) can recover from the indemnifier:
All damages that they may be compelled to pay in any legal proceedings covered by the indemnity, all legal costs incurred in bringing or defending such proceedings (provided they acted prudently and within the indemnifier's instructions), and all sums paid under any compromise of such proceedings (again, provided the compromise was prudent and authorised).
What is a Contract of Guarantee?
Section 79 of the Contracts Act 1950 defines a contract of guarantee as a contract to perform the promise, or discharge the liability, of a third person in case of that person's default. The key parties involved are the surety (the person giving the guarantee), the principal debtor (the person whose default triggers the guarantee), and the creditor (the person to whom the guarantee is given).
Importantly, under Malaysian law, a guarantee may be either oral or written. However, for practical purposes and evidentiary clarity, guarantees in banking transactions are almost always documented in writing.
Key Characteristics of Guarantees
The liability of a surety is, by default, co-extensive with that of the principal debtor under Section 81 of the Contracts Act 1950. This means if you guarantee someone's loan, you could be liable not just for the principal amount but also for interest, charges, and any other sums the principal debtor owes.
A continuing guarantee, as defined in Section 82, extends to a series of transactions. For instance, if you guarantee a business line of credit, you may be liable for multiple drawdowns over time, not just a single transaction.
The Critical Difference: Primary vs Secondary Liability
The fundamental distinction between guarantees and indemnities lies in the nature of the obligation:
An indemnity creates a primary obligation. The indemnifier is directly liable, and the creditor can demand payment without first pursuing the principal debtor. An indemnity is essentially a standalone promise.
A guarantee creates a secondary or collateral obligation. The surety's liability only arises upon the default of the principal debtor. The creditor must typically establish that the principal debtor has failed to meet their obligations before the guarantee can be enforced.
This distinction has significant practical implications. If the underlying contract with the principal debtor is void, unenforceable, or discharged, a guarantee may also fall away since it depends on that primary obligation. An indemnity, being independent, may survive even if the underlying transaction fails.
Defences Available to a Surety
Malaysian law provides several circumstances under which a surety may be discharged from liability:
Variance in Contract Terms
Under Section 86, any variation made without the surety's consent in the terms of the contract between the principal debtor and creditor discharges the surety for transactions after the variance. If a bank agrees with a borrower to change the interest rate or repayment terms without obtaining the guarantor's consent, the guarantor may be released from liability for subsequent defaults.
Release of Principal Debtor
Section 87 provides that the surety is discharged if the creditor releases the principal debtor or takes any action that legally discharges the principal debtor. For example, if a bank settles with a borrower and releases them from their debt, the guarantor is typically also released.
Composition, Time Extension, or Agreement Not to Sue
Under Section 88, if the creditor makes a composition with the principal debtor, grants additional time for payment, or agrees not to sue the principal debtor without the surety's consent, the surety is discharged.
Impairment of Surety's Rights
Section 92 states that if the creditor does anything inconsistent with the surety's rights or fails to do something required to protect the surety's eventual remedy against the principal debtor, the surety may be discharged.
Revocation of Guarantees
A continuing guarantee may be revoked by the surety for future transactions by giving notice to the creditor under Section 83. However, this does not affect liability for transactions that occurred before the revocation.
Additionally, Section 84 provides that the death of a surety operates as a revocation of a continuing guarantee for future transactions, unless the contract states otherwise.
Practical Advice for Those Providing Guarantees or Indemnities
Before signing any guarantee or indemnity in connection with banking facilities, consider the following:
Read the document carefully and understand whether you are providing a guarantee or an indemnity. The label used may not always reflect the true legal nature of the obligation. Look at the substance of what you are promising.
Understand the extent of your liability. Check whether your obligation is capped at a specific amount or whether it extends to all sums owing, including interest, fees, and enforcement costs.
Check for clauses that exclude your defences. Banks often include provisions stating that your liability continues notwithstanding circumstances that would ordinarily discharge a surety. These clauses may convert what appears to be a guarantee into something closer to an indemnity.
Consider the duration of your obligation. Is it a one-time guarantee for a specific facility, or a continuing guarantee that exposes you to ongoing liability?
Seek independent legal advice. Before committing to such a significant obligation, consult with a lawyer who can explain the specific terms and their implications for your situation.
Enforcement in Malaysia
When a creditor seeks to enforce a guarantee or indemnity, they will typically issue a letter of demand before commencing legal proceedings. In the case of a guarantee, the creditor should establish that the principal debtor has defaulted. For an indemnity, the creditor need only demonstrate that a loss covered by the indemnity has been suffered.
Courts in Malaysia will interpret guarantee and indemnity documents according to their terms. Where the language is ambiguous, the doctrine of contra proferentem may apply, meaning the document is interpreted against the party who drafted it, which is typically the bank.
Conclusion
Guarantees and indemnities are powerful legal instruments that can expose you to significant financial liability. Understanding the distinction between them, knowing your potential defences, and seeking proper advice before signing are essential steps to protect your interests in any banking transaction.
Disclaimer: This article provides general information about guarantees and indemnities under Malaysian law and is intended for educational purposes only. It does not constitute legal advice and should not be relied upon as such. The law may have changed since the time of writing, and the application of legal principles depends on the specific facts of each case. If you require advice regarding a guarantee, indemnity, or any other legal matter, please consult a qualified legal practitioner who can assess your individual circumstances.