Guarantees and Indemnities: A Practical Guide for Business Owners

Litigation: 25 March 2026

Author: Caroline Skeoch and Kara Inglese - Our People

Before agreeing to a new contract or credit arrangement, it’s worth knowing which terms could put your personal or business assets on the line.

Business owners regularly come across the terms guarantee and indemnity when dealing with lenders, suppliers, or entering new contracts. These terms sound similar and are commonly used in commercial agreements, but they carry very different legal consequences. Understanding the distinction is essential as it can influence your financial risk, your personal exposure, and the ability of your business to negotiate fair terms.

What Is a Guarantee?

A guarantee is a promise made by one party to assume the liability for obligations incurred by another party, if that other party fails to meet their obligations to the principal.

There are three parties involved in a guarantee, namely:

1. the principal creditor (this is often a lender or a supplier of credit);
2. the principal debtor (this is often the borrower or recipient of credit); and
3. the guarantor (often a third party) who promises to assume the principal debtor’s liability if the principal debtor fails, or is otherwise unable, to fulfill their obligations to the principal creditor.

A guarantee is a secondary promise, which only becomes enforceable if the principal debtor fails to meet their obligations to the principal creditor. Until the principal debtor defaults, the principal creditor cannot take any action to enforce the principal debtor’s obligations against the guarantor.

Guarantees are often included in loan agreements such as mortgages and must be accepted by the guarantor in writing.

Limitations on a Guarantor’s Liability

If a guarantor becomes liable for the default of the principal debtor, the extent of that liability can be limited. Depending on the wording used to bind the principal debtor, the principal creditor might not be able to enforce all of the obligations belonging to the principal debtor against the guarantor. This was observed in Sunbird Plaza Pty Ltd v Maloney (1988) 77 ALR 205 at 208, where the High Court of Australia held that the principal creditor’s claim against the guarantor only sounded in damages for the principal debtor’s failure to complete a contract for the sale of land. The principal creditor’s remedy against the guarantor did not extend to an entitlement to specific performance to compel the guarantor to complete the purchase of land at a settlement. Specific performance was not available to the vendor (the principal creditor) because it had terminated the contract with the purchaser (the principal debtor) on the basis that the purchaser did not complete the sales contract via settlement. The Court held that the vendor could not claim specific performance whilst simultaneously terminating the contract.

A principal debtor’s obligations to the principal creditor may change after the guarantor has already accepted liability for the ‘original’ obligations of the primary debtor. This can limit the extent of the guarantee available in the event of a default. If the principal debtor’s obligations are changed without the knowledge or consent of the guarantor, the guarantor may no longer be liable for all the obligations of the principal debtor if the variation is substantial or prejudicial to the guarantor. As observed in Ankar Pty Lts v National Westminister Finance (Australia) Ltd (1987) 162 CLR 548, the High Court held that the guarantor was not liable for the obligations of the principal debtor because the obligations varied after the guarantor had guaranteed the performance of the ‘original’ agreement. The contract varied the interest repayment obligations of the loan facility (and related terms) which the guarantor did not know or consent to and which had a significant prejudicial effect upon the guarantor in terms the extent of their liability in the instance of default.

The Courts adopt a narrow interpretation of the guarantee when considering its scope or limits. The Courts will carefully consider the wording of the guarantee, the context of the guarantee given within the overall agreement between the principal creditor and principal debtor and the fundamentals of contract interpretation at common law. This demonstrates the importance in accurate and clear drafting.

Guarantors must think critically and carefully about the scope and limits of the guarantee they are providing, as there is a very real risk that the guarantor may become liable for amounts beyond the full amount of the ‘original’ debt such as penalty interest charges, costs incurred by the principal creditor enforcing the guarantee, and other legal, administrative and holding type costs (depending on the specific contractual provisions giving rise to the guarantor liability).

What Is an Indemnity?

In contrast, an indemnity is a separate contract entered into between the indemnifying party and the indemnified party. This contract creates a primary obligation on the part of the indemnifying party. An indemnity carries more risk because the indemnifying party is contractually obliged to compensate the indemnified party upon the occurrence of ANY loss or damage, cost or expense incurred by the principal creditor, regardless of whether or not the principal debtor has defaulted in their obligations.

Indemnities are typically a two-party agreements, between:

1. the indemnified party (being the principal creditor); and
2. the indemnifying party (being the debtor).

Indemnities are widely drafted and often include a vast range of categories of loss and can include indirect or consequential losses incurred by the principal creditor.

Unlike guarantees, indemnities do not need to be in writing and can be implied into an agreement by operation of law. Indemnities are also not impacted by any variations to the ‘original’ agreement between principal creditor and principal debtor such that regardless of knowledge of the variation or the prejudice caused as a result, the indemnifying party remains liable for all losses incurred by the principal creditor.

However, the ultimate extent of liability to the indemnified party depends on how the indemnity clause is drafted in the contract. In Shamrock Civil Engineering Pty Ltd v Honan Insurance Group Pty Ltd [2024] QSC 313 ,heavy rainfall resulted in flooding to trenches which had been dug by Shamrock in preparation for future works the subject of a contract with Honan. The trench became full of contaminated water which required $31M in cleaning costs. Honan claimed it was the indemnified party under the contract with Shamrock, with the indemnity clauses including “loss…arising out of or in the course of… execution of Works”. Shamrock held that it had not identified Honan for an ‘act of god’ being the unusually heavy rainfall which flooded the trench and which caused contamination. The Court construed this clause broadly and considered that indemnity was available to Honan because the trench had been executed by Shamrock in the course of the execution of the Works under the contract.

It is more difficult to defend against claims by an indemnified party for loss and damage, so indemnifying parties need to be careful when entering into agreements of this nature.

Why this distinction is significant

It is imperative that parties fully understand the responsibilities and risks when agreeing to a guarantee and/or an indemnity.

The specific wording and interpretation of agreement terms are essential in determining whether a party is providing a guarantee, an indemnity, or a combination of both. This remains true regardless of the title or label one places on the document or clause, as noted in Allcott Hire Pty Ltd v Silk [2016] NSWSC 1135. In this case, a Director seeking credit from a supplier completed the credit application and ticked the box which said ‘guarantee given’. The box referencing an ‘indemnity’ was not ticked. The Court held that because the credit application required a Director to give both a Guarantee and an Indemnity in order for credit to be supplied (that is, it was a mandatory pre-condition of credit application being accepted), the fact the Director had only ticked the ‘guarantee provided’ box did not prevent the Director from giving an indemnity in the circumstances where the credit application required both in order for it to be approved. As such, calling something a guarantee or an indemnity does not necessarily mean the operation of that clause is a ‘guarantee’ or an ‘indemnity.’

To avoid ambiguity, documents must clearly identify and define each party’s obligations and scope of liability using precise language – certainly using the words “guarantee” or “indemnity” can indicate the parties’ intentions, however these are not determinative, as the overall nature of the agreement must be considered, as reflected in Yeoman Credit Ltd v Latter [1961] 1 WLR 828 at 833.

Lenders and suppliers of credit often include both guarantees and indemnities in their agreements, especially using an indemnity clause as a backup in case the guarantee fails. This is for the benefit of the lender/ supplier/credit provider because it gives them multiple avenues of recovery. For business owners, this means their obligations may be extensive and not easily avoidable, even if the ‘original’ contract is varied, or if the principal debtor becomes insolvent.

Key Considerations for Business Owners

It is in the best interests of all parties concerned if, prior to entering a guarantee and/or indemnity, business owners seek independent legal advice, regardless of whether it is contractually required or not. Such legal advice can help business owners determine:

• When you may become liable for the obligations of another;
• The extent of that liability, such as if it is limited, unlimited, or ongoing;
• Whether the guarantee and/or indemnity can be varied or withdrawn;
• The extent of liability under any indemnity; and
• Whether the insolvency or bankruptcy of any party changes any obligations.

Guarantees and indemnities are effective risk-management tools for creditors, however, they are also potential sources of significant personal and commercial exposure for guarantors and indemnifying parties. Business owners should ensure they fully understand their obligations before agreeing to either a guarantee or an indemnity (or both).

If you’d like clarity on how a guarantee or indemnity may affect your business, our litigation team can help you navigate the risks and negotiate commercial, protective terms. Contact us now now for tailored advice.