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Guarantees and indemnities

Guarantee and indemnity distinguished

Pitts v Jones
[2007] EWCA Civ 1301

Summary

This Court of Appeal decision refines (and unfortunately complicates) the distinction between a guarantee and an indemnity, and illustrates that a guarantee must be given in writing if it is to be enforceable. It also illustrates the pitfalls of relying on advice given by another party's solicitor.

Facts

The managing director and majority shareholder of a Company reached a provisional agreement to sell his shares to another company called Birch, subject to the minority shareholders (who were also employees of the Company) waiving their rights of pre-emption. Birch was to borrow the purchase price from the Company itself, which required resolutions to be passed at an EGM of the Company.

The minority shareholders were summoned to the Company's offices unexpectedly for a meeting that was intended to be an EGM (although the necessary notice had not been given, so that the minority shareholders needed to agree to the short notice for the EGM). They had not brought a professional adviser with them, but the managing director's solicitor gave them advice on various points. In particular, they became concerned about their position, and the managing director undertook that, if Birch did not pay them for their shares, he would do so (although his solicitor advised against putting this undertaking into writing). The minority shareholderes then signed an option agreement for the purchase of their shares, and also agreed to the abridgement of the notice period for the EGM.

Birch then became insolvent, and the minority shareholders received nothing for their shares. They looked to the managing director to honour his undertaking, the existence of which he denied. They brought an action for the full value of their shares.

First instance

At first instance, the Recorder found that the managing director's undertaking to pay the full amount per share if Birch failed to pay was not enforceable as a contractual promise because there was no consideration. If he was wrong about that, the claim still failed because, if there was a contract between them and the managing director, it was a contract of guarantee. It was therefore unenforceable under the Statute of Frauds 1667 because it was not evidenced in writing and signed by or on behalf of the guarantor.

The appeal

The minority shareholders appealed to the Court of Appeal, which dismissed the appeal. It disagreed with the Recorder on the issue of consideration, holding that the fact that the minority shareholders had not given any conscious thought to what it was they were giving did not prevent them from having given good consideration, and their co-operation by signing the documents was in return for the managing director's undertaking.

However, the contract was a guarantee and hence unenforceable under the Statute of Frauds. The Court refined (and complicated) the test used to distinguish between guarantees and indemnities: identifying a guarantee will now involve making a distinction between the promisor having a mere motive for making the promise and having a "real interest" in the underlying transaction. In this case, the managing director's undertaking was given in relation to the signing of the share option agreements by the minority shareholders (not the sale of the managing director's shares to Birch, which was deemed to be "a separate transaction"), and the managing director had no interest in the share option agreements in the sense that he could not possibly derive any benefit from them.

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