Indemnity and guarantee are common words in commercial contracts, but they serve different purposes. Understanding them helps businesses avoid nasty surprises.
An indemnity is a promise by one party to compensate the other for specified losses, often arising from breaches, third-party claims or certain risks. For example, a software vendor may indemnify a client against copyright infringement claims if the product turns out to use someone else’s IP.
A guarantee, on the other hand, usually involves three parties: creditor, principal debtor and guarantor. The guarantor promises to pay or perform if the principal debtor fails. Bank guarantees and personal guarantees for loans are typical examples.
Indemnity focuses on shifting risk of loss; guarantee focuses on ensuring performance or payment. The legal consequences, limitation periods and discharge rules can differ significantly between the two.
When reading or drafting contracts, it’s important not to treat these words as decorative. The scope, caps, exclusions and procedures around indemnity and guarantee obligations can seriously affect financial exposure if something goes wrong.