Discharge of contract and remedies - Guarantees

Learning Outcomes

This article explores the discharge of contractual obligations and the legal role of guarantees and indemnities in the SQE1 FLK1 context, including:

• Methods of contract discharge—performance, agreement, breach and frustration—and how to identify the correct method on SQE1-style fact patterns.
• The distinction between guarantees and indemnities, including secondary versus primary liability, and how this affects enforceability, defences and drafting.
• Formalities for guarantees (writing and signature under the Statute of Frauds 1677) and the role of consideration or execution as a deed in making guarantees binding.
• Co‑extensive guarantor liability, key contractual and equitable defences, and the main circumstances in which a guarantor will be discharged or remain liable.
• Continuing guarantees, revocation for future advances, the effect of death or notice, co‑surety contribution, and a guarantor’s post‑payment rights of subrogation and indemnity.
• Core damages principles (expectation, reliance, causation, remoteness, mitigation), the enforceability of agreed damages clauses, and when equitable remedies such as specific performance or injunctions may supplement monetary claims.
• Practical exam skills such as classifying an instrument as a guarantee, indemnity or on‑demand bond, and predicting the creditor’s most effective remedy against each party.

SQE1 Syllabus

For SQE1, you are required to understand the core principles relating to the discharge of contracts and the specific legal implications of guarantees and indemnities. This includes applying these rules in practical contexts often encountered in dispute resolution and business law, with a focus on the following syllabus points:

• The different ways a contract can be discharged (performance, agreement, breach, frustration).
• The key characteristics distinguishing a guarantee from an indemnity.
• The legal requirements for creating a valid guarantee (including the need for writing).
• The nature of liability under guarantees (secondary) and indemnities (primary).
• Circumstances that may discharge a guarantor from their obligations.
• Advising on the enforceability of guarantees and indemnities in specific factual scenarios.
• The requirement for consideration for guarantees (unless executed as a deed) and practical issues where the guarantee is given after the principal obligation is created.
• The co‑extensive nature of a guarantor’s liability and the main defences available to guarantors (e.g., invalidity of principal obligation; variation without consent; creditor’s prejudicial conduct).
• Continuing guarantees, revocation for future advances, and the impact of death or notice.
• A guarantor’s rights after payment (subrogation to securities, indemnity from principal debtor, contribution among co‑sureties).
• Remedies for breach (expectation/reliance damages, remoteness, mitigation), equitable relief (specific performance, injunction), and agreed damages vs penalties.

Test Your Knowledge

Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.

1. Which of the following statements concerning guarantees is INCORRECT?
   1. A guarantee creates a secondary obligation.
   2. A guarantee must generally be evidenced in writing to be enforceable.
   3. The guarantor becomes immediately liable upon the creation of the principal debt.
   4. The guarantor's liability is dependent on the principal debtor defaulting.
2. Identify the method of discharge where a contract ends due to an unforeseen event making performance impossible or radically different.
   1. Performance
   2. Agreement
   3. Breach
   4. Frustration
3. Primary liability is characteristic of which type of contractual arrangement?
   1. Guarantee
   2. Indemnity
   3. Novation
   4. Assignment

Introduction

A contract creates legally binding obligations. The 'discharge' of a contract refers to the process by which these obligations come to an end. Parties can be released from their contractual duties in several ways: through complete performance, by mutual agreement, as a consequence of a serious breach, or due to frustration where external events make performance impossible or radically different. Understanding how contracts are discharged is fundamental to advising clients on their rights and liabilities.

This article also examines two important related concepts often encountered in commercial and financial contexts: guarantees and indemnities. Both involve undertakings regarding the obligations of another party (the principal debtor), but they differ significantly in the nature of the liability assumed. Distinguishing between them is essential for determining enforceability and advising on potential remedies. In practice, documents often combine a guarantee with an indemnity to provide a creditor with both secondary and primary recourse; you must be able to identify which promise is engaged on the facts and the consequences for enforcement.

Discharge of Contractual Obligations

Contractual obligations do not last forever. They are discharged (brought to an end) in one of four main ways:

• Performance: This is the most common method. The contract ends when both parties fully perform their obligations exactly as agreed under the contract terms. Issues arise where performance is defective or incomplete. Depending on the terms and seriousness, defective performance may be a breach entitling the innocent party to damages, and possibly termination if the breach is repudiatory. In some cases, substantial performance may allow recovery of the price subject to a deduction for defects, while trivial defects may only sound in damages.

• Agreement: Parties can mutually agree to end the contract. This might be through a new agreement (accord and satisfaction), replacing the old contract entirely (novation), or simply releasing each other from outstanding obligations (release). Consideration is generally required for the discharge agreement unless it is made by deed. Where a contract is discharged by novation, a third party may take over obligations; careful analysis is required to determine the impact on any associated guarantee: a novation substituting a new principal obligation will normally discharge a guarantor unless the guarantor consents to guaranteeing the novated obligation or the guarantee expressly extends to variations and replacements.

• Breach: A failure by one party to perform their obligations without lawful excuse constitutes a breach. A sufficiently serious breach (a repudiatory breach, often a breach of a condition or a serious breach of an innominate term) gives the innocent party the election to terminate or affirm while claiming damages. An anticipatory breach occurs when one party indicates, before performance is due, that they will not perform; the innocent party may accept the repudiation and sue immediately. Damages for breach are usually assessed on the expectation basis (difference in value or cost of cure, where reasonable), subject to limitations: causation, remoteness (loss in reasonable contemplation at the time of contracting), and mitigation (reasonable steps to reduce loss). Liquidated damages clauses are enforceable if they protect a legitimate interest and are not penal; if penal, they are unenforceable. Equitable remedies (specific performance and injunction) may be available where damages are inadequate, e.g., unique goods or land, or to restrain a threatened breach.

• Frustration: A contract may be automatically discharged by frustration if, after the contract is formed, an unforeseen event occurs without the fault of either party, making performance impossible, illegal, or radically different from what was contemplated. Examples include destruction of the subject matter or supervening illegality. Money paid before the frustrating event is recoverable, and sums due cease to be payable, subject to the court’s discretion to allow a just sum for expenses or benefits conferred under the Law Reform (Frustrated Contracts) Act 1943. Where a principal contract is frustrated, a secondary guarantee linked to that obligation generally falls away because liability under a guarantee is contingent upon default under a primary obligation that no longer exists. By contrast, a freestanding indemnity is a primary obligation and may be drafted to survive frustration or unenforceability of the principal contract.

Key Term: Guarantee
A contractual promise by one person (guarantor) to answer for the debt, default, or miscarriage of another (principal debtor).

Key Term: Secondary Obligation
An obligation that only arises if there is a failure in the performance of a primary obligation by another party.

Key Term: Guarantor
The party who provides the guarantee, promising to meet the debtor's obligation if the debtor defaults.

Key Term: Creditor
The party to whom the debt or obligation is owed.

Key Term: Principal Debtor
The party whose debt or obligation is being guaranteed.

Guarantees and Indemnities

Guarantees and indemnities are commonly used arrangements where one party provides security or assurance regarding the debt or obligation of another. Although often confused, they create distinct legal liabilities.

Guarantees

A guarantee is a promise made by one party (the guarantor) to a creditor, undertaking to be responsible for the debt or default of another party (the principal debtor) if the debtor fails to meet their obligations. The guarantor’s liability is normally co‑extensive with the principal debtor’s liability: the guarantor cannot be liable for more than the principal debtor owes (subject to any express cap) and can generally rely on any defences available to the principal debtor, save for personal defences unique to the principal debtor that do not touch the principal debt.

Key Term: Co‑extensive Liability
The principle that a guarantor’s liability mirrors the principal debtor’s liability to the creditor, unless the guarantee provides otherwise.

Due to its nature, a guarantee must generally be evidenced in writing to be enforceable under the Statute of Frauds 1677. A note or memorandum of the agreement signed by the guarantor (or an authorised agent) will suffice; multiple documents or modern electronic communications can together satisfy this requirement if they record the material terms and are authenticated as a signature. If a guarantee is not evidenced in writing, it will not be enforceable, and equitable doctrines (such as estoppel) cannot usually be used to circumvent the statutory bar. The guarantee must also be supported by consideration, unless executed as a deed. Consideration is often found where the creditor advances money or grants facilities at the guarantor’s request; if the guarantee is given after the loan has already been advanced, fresh consideration (for example, an agreed extension of time or forbearance) is required.

Key Term: Statute of Frauds (Guarantees – Writing Requirement)
A statutory requirement that a contract of guarantee (a promise to answer for another’s debt or default) be evidenced in writing and signed by the party to be charged (or their authorised agent).

Key Term: Consideration (Guarantee Context)
Something of value given in exchange for the guarantor’s promise (e.g., the creditor advancing funds or granting time); not needed if the guarantee is executed as a deed.

Guarantees are strictly secondary: liability is triggered by the principal’s default. Some guarantees are “continuing guarantees,” which cover a series of transactions or a fluctuating account (for example, “all monies” guarantees). A continuing guarantee can usually be revoked by notice for future transactions, but the guarantor remains liable for obligations already incurred at the time of revocation. Death of a guarantor will ordinarily revoke a continuing guarantee for future advances if the creditor has notice of the death, again without affecting liability for accrued indebtedness.

Key Term: Continuing Guarantee
A guarantee intended to cover a series of transactions or a fluctuating balance until revoked, typically by notice.

The construction of guarantees is important. Wording indicating “if the principal debtor fails to pay, the guarantor will pay” is characteristic of a secondary obligation. If the obligation is framed as an independent promise to pay on demand irrespective of the principal debtor’s default, it is more likely an indemnity or an on‑demand bond. Labels are not determinative; the court examines substance and effect.

Indemnities

An indemnity is a promise by one party (the indemnifier) to compensate another party (the indemnitee) for loss suffered as a result of a specific event. It creates a primary obligation, independent of any default by a third party. Because it is primary, it is not dependent on the enforceability of the principal obligation and does not need to be evidenced in writing to be enforceable (though it often is in practice). Indemnities are common in commercial contracts to allocate risk and provide a direct route to compensation without the limitations associated with guarantees.

Key Term: Indemnity
A contractual promise by one party to accept responsibility for loss or damage suffered by another party.

Key Term: Primary Obligation
An obligation that exists independently and is not conditional on the default of another party.

In finance and construction, documents sometimes bundle both instruments: a guarantee (secondary) plus an indemnity (primary). The indemnity acts as a back‑stop so that, even if the guarantee fails (for example, the principal obligation is set aside or tainted by a defect), the indemnity may still be enforceable. This is a key practical distinction when analysing enforceability and the creditor’s choice of remedy.

Key Term: Surety
Another term for a guarantor, i.e., a person who undertakes to answer for the debt or default of another.

Worked Example 1.1

Alpha Ltd needs a loan from Beta Bank. Gamma, a director of Alpha Ltd, tells Beta Bank, "If Alpha Ltd doesn't repay the loan, I will." Beta Bank grants the loan, but Alpha Ltd defaults. Is Gamma liable to Beta Bank, and what type of obligation has Gamma undertaken?

Answer:
Gamma has likely provided a guarantee. Gamma's promise is to pay only if Alpha Ltd defaults. This creates a secondary obligation. For the promise to be enforceable by Beta Bank, it must generally be evidenced in writing. Gamma is liable only because Alpha Ltd has defaulted.

Worked Example 1.2

Delta Construction contracts with Echo plc to build a factory. The contract includes a clause where Delta agrees to "indemnify Echo plc against any claims or losses arising from damage to adjacent properties caused by the construction works." During construction, Delta's negligence causes damage to a neighbouring property, and the owner successfully sues Echo plc. Can Echo plc recover the amount paid from Delta?

Answer:
Yes, Echo plc can recover the amount from Delta based on the indemnity clause. Delta's obligation to pay Echo plc arises directly from the loss suffered by Echo plc (being sued due to damage caused by Delta's works). This is a primary obligation, and Echo plc does not need to prove any default by another party before claiming against Delta under the indemnity.

Worked Example 1.3

Omega Bank agrees to lend funds to Zeta Ltd. After the loan is advanced, Zeta’s shareholder, Y, emails the bank: “I will stand behind Zeta’s debt to you.” No fresh facility is granted. The bank later sues Y on the email. Is the promise enforceable?

Answer:
The promise is likely unenforceable as a guarantee. There is no fresh consideration (the loan was already advanced) and the promise is not executed as a deed. Even if consideration could be shown, a guarantee must be evidenced in writing signed by Y (or an authorised agent). An email can satisfy the writing and signature requirements if it records material terms and is authenticated, but here the absence of fresh consideration is fatal unless the bank provided something new (e.g., agreed time) in exchange.

Worked Example 1.4

Supplier S takes out an “all monies” continuing guarantee from Individual I covering “all sums now or in the future due from Buyer B.” Years later, I gives written notice revoking the guarantee. B already owes £50,000 and continues buying on credit, accruing another £30,000 after revocation. What is I’s liability?

Answer:
Revocation does not affect liability for sums already due when notice was given. I remains liable for the £50,000 accrued before revocation, but not for the £30,000 incurred afterwards.

Exam Warning

Incorrectly identifying an arrangement as a guarantee when it is an indemnity (or vice versa) can lead to wrong conclusions about enforceability (especially regarding the writing requirement) and the trigger for liability. Pay close attention to whether the obligation is conditional on another's default (guarantee) or arises directly from a specified event or loss (indemnity).

A further pitfall is attempting to bypass the Statute of Frauds writing requirement for guarantees using equitable arguments. Courts are slow to allow estoppel or similar doctrines to undermine the statute. Ensure there is compliant written evidence (which can be pieced from emails) and valid consideration or a deed.

Discharge of a Guarantor

A guarantor's secondary liability can be discharged (brought to an end) in several circumstances, meaning the guarantor is no longer liable even if the principal debtor defaults. Key situations include:

• Variation of the Principal Contract: If the original contract between the creditor and the principal debtor is materially altered without the guarantor's consent, the guarantor is generally discharged (often entirely). The rationale is that the guarantor agreed to guarantee a defined risk, and significant changes increase or alter that risk. Trivial or beneficial variations may not discharge the guarantor; materiality is assessed objectively. Many modern guarantees include “consent in advance” clauses allowing the creditor to vary terms (e.g., change interest rates, grant time) without affecting the guarantor’s liability—these clauses are effective if clearly drafted.

• Giving Time or Composition with the Debtor: A binding agreement by the creditor to give time for payment, or to accept a composition or release, will usually discharge the guarantor unless rights are expressly reserved against the guarantor. Mere forbearance to sue (i.e., a unilateral decision by the creditor not to pursue immediate enforcement) typically does not discharge the guarantor.

• Release of the Principal Debtor: If the creditor releases the principal debtor from their obligation, the guarantor is discharged. A covenant not to sue may have similar effect unless the creditor expressly reserves rights against the guarantor.

• Creditor's Actions Prejudicing the Guarantor: If the creditor acts in a way that prejudices the guarantor's rights—such as releasing or failing to perfect security which the guarantor would have been entitled to on payment, or impairing recourse against the principal—the guarantor may be discharged fully or to the extent of the prejudice. This links to the guarantor’s equitable right of subrogation: on paying the debt, the guarantor steps into the creditor’s shoes as regards securities and remedies.

• Invalidity or Unenforceability of the Principal Obligation: Because a guarantee is secondary, if the principal obligation is void, unenforceable, discharged by frustration, or otherwise set aside, the guarantee typically falls with it (unless the guarantor’s obligations are separately framed as a primary indemnity). This can be critical where, for instance, the principal contract is avoided for misrepresentation or illegality.

• Misrepresentation, Undue Influence, or Non‑Disclosure: If the guarantor’s consent was obtained by a misrepresentation attributable to the creditor or if the creditor had notice of undue influence exerted by the principal debtor (e.g., spousal guarantees), the guarantee may be set aside. Creditors (especially banks) must take reasonable steps to ensure the guarantor receives independent advice where there is a risk of undue influence. While there is no general duty of disclosure to a surety, suppression of unusual facts materially increasing the risk, if known to the creditor and unknown to the guarantor, can in some cases support rescission.

• Revocation of a Continuing Guarantee: A continuing guarantee can be revoked by notice (and by death, if the creditor has notice) as to future transactions, but liability for sums already accrued remains.

• Payment and Performance: Once the principal debt has been paid or performed, the guarantee is naturally discharged.

Key Term: Subrogation
On satisfying the debt, a guarantor is entitled to the benefit of all rights and securities the creditor had against the principal debtor.

Key Term: Contribution (Co‑sureties)
Where multiple guarantors are liable for the same debt, a guarantor who pays more than their fair share can recover the excess from co‑sureties.

Key Term: Co‑surety
A person who, together with others, guarantees the same debt or obligation.

After payment, a guarantor acquires powerful equitable rights. Subrogation allows the guarantor to enforce (or be assigned) the creditor’s securities; any impairment of these rights by the creditor can discharge the guarantor to that extent. The guarantor also has an implied right to be indemnified by the principal debtor for sums paid under the guarantee. Where there are co‑sureties, the paying guarantor may claim contribution so that the burden is shared fairly, typically on a pro rata basis unless the guarantee instruments provide otherwise.

Worked Example 1.5

Creditor C and Debtor D agree to double the credit limit and extend the repayment term without consulting Guarantor G. The change increases D’s risk profile. D then defaults. Is G still liable?

Answer:
Likely not. A material variation of the principal contract without the guarantor’s consent typically discharges the guarantor because it increases or alters the risk guaranteed. If the guarantee instrument contained a clear clause consenting to such variations in advance, the position could be different.

Worked Example 1.6

Bank B takes a standard‑form guarantee from H to support her spouse’s business borrowings. H signed at home after pressure from the spouse. B knew the funds were for the spouse’s business and that H derived no direct benefit. B did not ensure H had independent legal advice. H seeks to set the guarantee aside. Is she likely to succeed?

Answer:
She has a strong case. Where a creditor is on inquiry that a guarantor may be subject to undue influence (common in spousal guarantees for business debts), it must take reasonable steps—typically ensuring the guarantor receives independent legal advice—to avoid being fixed with notice. Failure to do so can render the guarantee unenforceable against the guarantor.

Worked Example 1.7

Two directors, A and B, guarantee their company’s overdraft up to £60,000 each. The company defaults. A pays £60,000; B pays nothing. What are A’s rights?

Answer:
A can claim contribution from B. As co‑sureties for the same debt, they should bear the liability fairly (usually equally absent contrary agreement). A may also exercise subrogation to the bank’s securities to recoup sums paid.

Key Term: Variation (of Principal Contract)
A change to the terms of the creditor–debtor contract. Material variations made without the guarantor’s consent can discharge the guarantor.

Key Term: Release
A binding agreement by the creditor to discharge the principal debtor from liability. Unless rights are reserved, releasing the debtor typically releases the guarantor.

Key Term: Forbearance
A creditor’s unilateral decision not to enforce immediately. Mere forbearance typically does not discharge a guarantor; a binding agreement to give time can.

Exam​ Warning

The secondary nature of the guarantor’s obligation means that if the agreement that contains the primary obligation with the debtor is held to be unenforceable, or is otherwise set aside, then the guarantee will also be unenforceable or set aside. The opposite is true in the case of an indemnity: because it is a primary obligation, the indemnifier can remain liable even if the debtor’s agreement is set aside. Many commercial forms combine both obligations to avoid this risk.

Remedies Context: Damages, Agreed Sums, and Equitable Relief

Although guarantees and indemnities focus on who must answer for loss, the measure of recovery still follows general contract principles:

• Expectation damages aim to put the innocent party in the position as if the contract had been performed. This may be measured by difference in value or by cost of cure if reasonable and proportionate to the benefit. If reinstatement is out of all proportion to the benefit, courts may refuse cost of cure and award a modest sum for loss of amenity where appropriate.

• Reliance (wasted expenditure) damages may be available where expectation loss is too uncertain. However, claimants cannot use reliance to escape a bad bargain.

• Loss must be caused by the breach, not too remote (in reasonable contemplation at formation), and reasonably mitigated. Reasonable mitigation steps that increase loss can still be recovered if sensible in the circumstances.

• Agreed damages (liquidated damages) are enforceable if they protect a legitimate interest and are not out of all proportion to that interest; if penal, they are unenforceable. Guarantees often extend to “all losses, costs, and expenses” including agreed damages and enforcement costs, subject to construction.

• Equitable remedies are discretionary where damages are inadequate. Specific performance is common for unique goods or land; prohibitory injunctions can restrain breaches where appropriate (e.g., where supply is irreplaceable). While such remedies target primary obligors, guarantees and indemnities often include express covenants to pay sums due on demand, enabling quick monetary recovery.

Key Term: On‑Demand Bond (Performance Bond)
A primary undertaking to pay on demand, typically without proof of default. Distinguished from a “see‑to‑it” guarantee because liability arises upon compliant demand, not contingent default.

While on‑demand instruments are common in international commerce, in domestic transactions a carefully drafted indemnity often achieves similar functional protection (primary liability without many suretyship defences) and avoids the Statute of Frauds writing requirement.

Key Point Checklist

This article has covered the following key knowledge points:

• Contracts can be discharged by performance, agreement, breach, or frustration.
• Expectation, reliance, remoteness, causation, and mitigation govern damages; agreed damages are enforceable if not penal; equitable relief may be granted where damages are inadequate.
• A guarantee creates a secondary obligation, conditional on the principal debtor's default; the guarantor’s liability is usually co‑extensive with the principal debtor’s.
• Guarantees generally require written evidence to be enforceable (Statute of Frauds 1677) and must be supported by consideration unless executed as a deed.
• An indemnity creates a primary obligation, independent of any third‑party default, and does not require written evidence for enforceability.
• The distinction between primary and secondary liability is essential for determining enforceability, available defences, and remedies.
• A guarantor may be discharged by material variation without consent, release of the principal debtor (absent reservation), prejudicial conduct regarding securities, binding agreements to give time, revocation of a continuing guarantee for future advances, or invalidity of the principal obligation.
• Creditors can preserve guarantor liability through clear drafting (e.g., advance consent to variations, reservation of rights) and by combining guarantees with indemnities.
• Guarantors have potent post‑payment rights: subrogation to securities, an implied right of indemnity against the principal debtor, and contribution from co‑sureties.
• In spousal or similar guarantees, creditors must take reasonable steps (such as ensuring independent advice) to guard against undue influence; failure can render guarantees unenforceable.

Key Terms and Concepts

• Guarantee
• Secondary Obligation
• Guarantor
• Creditor
• Principal Debtor
• Indemnity
• Primary Obligation
• Surety
• Co‑extensive Liability
• Statute of Frauds (Guarantees – Writing Requirement)
• Consideration (Guarantee Context)
• Continuing Guarantee
• Subrogation
• Contribution (Co‑sureties)
• Co‑surety
• Variation (of Principal Contract)
• Release
• Forbearance
• On‑Demand Bond (Performance Bond)