The differences between an indemnity and a guarantee, and the meaning of the words “without deduction or set off”

An important case decided by the Court of Appeal, Brown-Forman Beverages Europe Ltd v Bacardi UK Ltd [2021] EWHC 1259, involved the careful analysis of a document containing both guarantee and indemnity type clauses.

There are clear takeaways concerning the differences between an indemnity and a guarantee obligation, rights of set off, and the rule in Holme v Brunskill that sureties should note. This article provides an essential overview to the case.

Background Facts

Bacardi U.K. Limited (“Bacardi”) provided a guarantee for its subsidiary Bacardi-Martini Limited (“Subsidiary”) in favour of the Claimant. The guarantee was subsequently varied by an amendment agreement.

The Subsidiary failed to pay the sum of £51,499,402 to the Claimant but asserted claims against the Claimant which at least equalled the sums claimed. Those claims had been referred to arbitration.

In this case, the Claimant sued Bacardi, the parent company, under a guarantee (“the Agreement”) given to secure the obligations of the Subsidiary.

Bacardi asserted the same rights of set off and also asserted that it was discharged by reason of a material variation based on the rule in Holme v Brunskill.

The wording of the guarantee

It was not in issue that the document entered into by Bacardi contained both guarantee provisions and indemnity provisions in separate clauses. The Claimant relied on the indemnity aspect:

“[Bacardi] agrees to indemnify and hold [the Claimant] harmless from and against and in respect of any and all losses, liabilities, claims, judgments, expenses, costs (including attorneys' fees) and settlements incurred in connection with any failure by [the Subsidiary] to timely fulfil its payment obligations to [the Claimant]…"
 

The issues

Bacardi asserted the same rights of equitable set off as the Subsidiary based on the principle that a surety was entitled to the same defence as the principal obligor and also contended that its surety obligations had been automatically discharged by a variation to the guarantee, applying the rule in Holme v Brunskill (1878) 3 QBD 495

The Claimant submitted that the defences should be rejected because:

1. the relevant obligations were primary obligations, not secondary guarantee type obligations,
2. as a matter of construction the obligation to pay had been triggered by the refusal of the Subsidiary to pay in reliance on its equitable set off defence; and
3. the rule in Holme v Brunskill did not apply to primary obligations.

The decision

The Judge distinguished guarantee and indemnity type obligations and explained the differences. He decided that the effect of the provision relied upon (above) was to create an indemnity and not a guarantee.

The next issue was what was covered by the indemnity and whether Bacardi could rely on set off in its defence. The Court confirmed that equitable set off does not apply to an indemnity (in contrast to a guarantee where it does apply).

However, the next question was what was being indemnified. Bacardi’s obligation was to pay those sums which were: " … enforceable against or recoverable from the Subsidiary … " and the scope was limited to losses incurred in connection with ‘any failure by [the Subsidiary] to timely fulfil its payment obligations’

The Judge said that a principal debtor (the Subsidiary) who has not met its obligations to its creditor (the Claimant) because validly and in good faith it has asserted an equitable set off does not owe nor is it to be treated as having defaulted unless either it is not entitled or ceases to be entitled to validly assert the set off. So in this case, the Claimant could not assert a failure on the part of the Subsidiary to fulfil its payment obligations as long as the Subsidiary was entitled validly to assert an equitable set off that equalled or exceeded the sums the Claimant claimed. Hence the sum of c.£51m was not yet due by the Subsidiary and thus not due under the Agreement with Bacardi either.

The Judge also noted in his analysis that the parties did not insert an anti-set off provision, which they could have done if they had intended that sums due should be paid by Bacardi under the Agreement without the ability to rely on set off rights. This was not drafted into the Agreement which was negotiated between commercial parties with the benefit of legal representatives

The Judge also confirmed that Holme v Brunskill had no application in the context of an indemnity.

Implications

Even though this obligation was an indemnity, (so that the indemnitor could not avail itself of a guarantor’s right of equitable set off), the scope of what was being indemnified meant that the indemnitor was not obliged to pay because the principal had not failed ‘to fulfil its payment obligations in a timely manner’ because the principal could rely on set off.

The judgment provides a lengthy and detailed analysis of the differences between a guarantee and an indemnity; the approach to construction of a guarantee document and the law of set off.

Perhaps the most interesting aspect is the Judge’s critique of the drafting of the agreement in this case and the impact of not including the words ‘without deduction or set off’ in an indemnity. We often see attempts to include these words in guarantees and this case explains why such attempts should be rejected – a guarantor does enjoy rights of set off but this important right could be waived by agreeing to these words.