Letter of Indemnity VS Letter of Guarantee

Published February 19, 2020

The Malaysia Court of Appeal (“COA”) recently delivered its decision on 3.2.2020 in the case of Bank Pembangunan Malaysia Berhad v Spring Hill Bioventures Sdn Bhd [2020] 1 LNS 74.

In essence, the COA held as follows: -

(a) Under Section 77 of Contracts Act 1950 (“CA 1950”), a “contract of indemnity” is a contract by which one party promises to save the other from loss caused to him by the conduct of the promisor himself, or by the conduct of any other person;

(b) Under Section 70, a “contract of guarantee” is an undertaking to guarantee the obligations of a named principal and it is a collateral contract by which a guarantor/surety undertakes to answer for the default of the principal debtor/borrower who is to be primarily liable to the creditor;

(c) The main difference between a guanratee and an indemnity is that in the case of a guarantee, there must be three parties involved whereas in the case of an indemnity, two parties may be sufficient;

(d) In the construction of a document on whether it is a guarantee or an indemnity, the court is not bound by the label affixed onto the particular document. The duty of the court is to construe the document as a whole and to determine from its language and any other admissible evidence its true nature and purport;

(e) There is no requirement for an express agreement or contract between the principal debtor and the guarantor for it to constitute a contract of guanratee and suffice that the principal debtor’s request may be derived by inference;

(f) The letters of guarantee in this case do not impose an obligation on a creditor to give such notice to the surety on the debtor’s default and the fact that no notices were given is not fatal and it is sufficient that a demand is just made to the debtor;

(g) There is a difference between sections 86 and 88 of the CA 1950 whereby section 86 discharges the guarantor partly and section 88 discharges the guarantor completely;

(h) In the absence of a waiver provision (waiver of the surety’s rights under the CA 1950) in the contract of guarantee, any variation without the guarantor’s consent will discharge the guarantor; and

(i) In order to attract section 88 of CA 1950 to discharge the remaining of a guarantor/surety’s remaining liability, it has to be shown that the guarantor/surety’s position is altered to his detriment without his assent and the giving of time or indulgence alone by the Creditor (to extend time for the principal repayment by the Debtor) alone does not attract section 88 of CA 1950.

Salient Facts

The Appellant, Bank Pembangunan Malaysia Berhad (the creditor in this case) gave 2 term loan facilities to the borrower Alfa Biologics and the Respondent, Spring Hill Bioventures Sdn Bhd (the surety in this case) gave 2 letters of undertaking (‘impugned letters’) to the Appellant for the 2 terms loan facilities taken by Alpha Biologics.

The 1st Impugned Letter for the 1st Term Loan Facility in the amount of RM20 million provides as follows:

“In consideration of your granting or continuing to make available the Term Loan Facility of Ringgit Malaysia Twenty Million (RM20,000,000.00) only (“the Term Loan”) or any other accommodation for so long as you may think fit to Alpha Biologics Sdn Bhd (Company No.606545-H) of Suite 3.02, Level 3, Wisma E & C, No.2, Lorong Dungun Kiri, Damansara Heights 50490 Kuala Lumpur (“the Borrower”), we, hereby declare, confirm and undetake that we shall upon demand by you, cover any shortfall in the obligations of the Borrower during the tenure of the Term Loan and to meet all repayments under the Term Loan in the even the Borrower is unable to meet its debt obligations under the Loan Agreement executed or to be executed between the Borrower and you.

”The 2nd Impugned Letter for the 2nd Term Loan Facility in the amount of RM10 million contains the terms of which are identical to the 1st impugned letter saved for the amount of the facility granted.

Both Term Loan Facilities had been varied via letters dated 23.10.2009 and 26.7.2010 respectively and it is not disputed that both variations were done without the consent of the Respondent.

The Appellant had via 3 letters dated 3.6.2011, 8.9.2011 and 25.10.2012 to Alpha Biologics demanded for repayment of total sum due under the 1st and 2nd Term Loan Facilities. These 3 letters were not addressed nor copied to the Respondent.

On or about 31.7.2014, the Appellant terminated the 2 term loan agreements and recalled the 1st and 2nd Term Loan Facilities and further demanded payment of the outstanding amount of RM31,908,811.70 as at 16.7.2014 from Alpha Biologics. Even though this letter of termination was copied to the Respondent, no demand was made against the Respondent for the outstanding amount.

On 6.6.2016, the Appellant’s solicitors by a letter dated the same issued a letter of demand to the Respondent under the two Term Loan Facilities pursuant to the 2 letters of undetaking/impugned letters. On 14.6.2016, a 2ndLetter of Demand was issued to the Respondent again demanding for the same.

On 30.8.2016, the Appellant initiated this suit to claim for RM35,741,572.65 for the 1st Term Loan Facility and RM1,940,567.86 for the 2nd Term Loan Facility against Alpha Biologics and the Respondent. As Alpha Biologics was already wound up and did not defend the claim, the suit proceeded against the Respondent premised on the 2 letters of undetaking/impugned letters.

High Court’s Decision

The High Court made the following findings: -

(a) the two letters of undertaking are in effect contracts of guarantee under section 79 of CA 1950;

(b) the Appellant was obliged to notify the Respondent that Alpha Biologics had defaulted and demand for payment within the tenure of the 1st and 2nd Term Loan Facilities;

(c) the Respondent had been completely discharged of its obligation under the 1st Letter of Undertaking as a result of variation to the letter of offer by virtue of Section 88 of the CA 1950; and

(d) the Respondent had been discharged of its liability under the 2nd Letter of Undertaking as a result of variation to the letter of offer for all transactions subsequent to the variation by virtue of Section 86 of the CA 1950.

Contract of Indemnity and Contract of Guarantee

Section 77 of the CA 1950 defnies a contract of indemnity while section 79 defines a contract of guarantee as follows: -

"Contract of indemnity"

77. A contract by which one party promises to save the other from loss caused to him by the conduct of the promisor himself, or by the conduct of any other person, is called “contract of indemnity”.

“Contract of guarantee”, “surety”, “principal debtor” and “creditor”

“79. A “contract of guarantee” is a contract to perform the promise, or discharge the liability, of a third person in case of his default. The person who gives the guarantee is called the “surety”; the person in respect of which default the guarantee is given is called the “principal debtor”, and the person to whom the guarantee is given is called the “creditor”. A guarantee may be either oral or written.”

The COA summarizes that a contract of idemnity (2 parties are sufficient to form it) is to be nothing more than “a contract by one party to keep the other harmless against loss” and that the obligation has no reference in law to the debt of another. On the other hand, a contract of guarantee (3 parties must be involved i.e. the surety, the borrower and the creditor) is an undertaking to guarantee the obligations of the borrower and the guarantor therefore only owes a secondary obligation to the creditor to make good the particular defaults of the debtor.

The COA also affirmed the principles stated in the case of Woo Yew Chee v Yong Yong Hoo [1979] 1 MLJ 131, Addiscombe Garden Estates Ltd v Crabbe [1958] 1 QB 513 and Supreme Court case of Malayan Banking Bhd v PK Rajamani [1994[ 1 MLJ 405 on the need to always look beyond the terminology of an agreement to the actual facts of the situation in the construction of a document and an objective appraoch has be adopted by the judge whereby subjective intention of the parties should not be concerned by the Court and what in fact is relevant is the parties’ imputed intention.

Is there a requirement for an express agreement or contract between the principal debtor and the guarantor for it to constitute a contract of guarantee?

The COA referred to the following 3 Indian cases on section 126 of the Indian Contracts Act (pari materia to section 79 of CA 1950): -

(a) Ramchandra B. Loyalka v Shapurji N Bhownagree AIR [1940] Bom 315;

(b) K.V. Periyamianna Marakkayar & Ors v Banians And Co. AIR [1926] Mad 544; and

and held that these 3 cases do not propound that the request must be express and request can be implied too.

The COA further referred to the Indian case of Nagpur Nagarik Sahakari Bank Ltd v Union of India 1881 SCC OnLine AP 19, which stated: -

“…A Contract of guarantee is no doubt tripartite in nature but it is not necessary or essential that the principal debtor must expressly be a party to that document. It is adequate if his obligation is established by implication…”and concluded that there is no requirement for an express agreement or contract between the debtor and the guarantor for it to constitute a contract of guarantee.

Sections 86 and 88 of CA 1950

The COA emphasises that there is a difference between Sections 86 and 88 of CA 1950 in that Section 86 discharges the guarantor partly while section 88 discharges the guarantor completely.

“Section 86. Discharge of surety by variance in terms of contract

Any variance, made without the surety’s consent, in the terms of the contract between the principal debtor and the creditor, discharges the surety as to transactions subsequent to the variance.”

“Section 88. Discharge of surety when creditor compounds with, gives time to, or agress not to sue principal debtor.

A contract between the creditor and the principal debtor, by which the creditor makes a composition with, or promises to give time to, or not to sue, the principal debtor, discharges the surety, unless the surety assents to such contract.

”The COA relied on the Federal Court’s case of Citibank N.A. v Ooi Boon Leong & Ors [1981] 1 MLJ 282 and held that in the absence of a waiver provision in the contract of the guarantee, any variation without the guarantor’s consent will discharge the guarantor.

On whether the action by the Appellant creditor to extend the grace or moratorium period and extended time for the principal repayment would attract section 88 of CA 1950, the COA referred to the case of Bouse v Bradford Banking Co [1894] 2 Ch 32 at p 75 as follows:

“It has long since been established that, if a creditor contracts with a principal debtor and a surety, and afterwards by a binding contract with the principal debtor he gives time to him without the consent and knowledge of the surety and without reserving his rights against the surety, the surety is discharged.

Different reasons, given by different Judges, for this will be found in the books; but I apprehend that the main reason is that the surety is entitled at any time to require the creditor to call upon the principal debtor to pay off the debt, or himself to pay off the debt, and when he has paid it off he is at once entitled in the creditor’s name to sue the principal debtor; and if the creditor has bound himself to give time to the principal debtor, the surety cannot do either the one or the other of these things until the time so given has elapsed, and it is said that by reason of this the surety’s position is altered to his detriment without his assent.

”In concluding this issue, the COA held that the variation of the 1st Term Loan Agreement (extension of grace or moratorium period and extended time for the principal repayment) has NO IMPACT on the Respondent’s right to sue under the 1st Term Loan Facility and what happened is just that the right to sue has been deferred to later date and in such circumstances, the more suitable provision to invoke is section 86 of CA 1950.

Conclusion

I personally find this COA’s decision significant as it further clarifies on the law and principle on contract of indemnity and guarantee as well as the relevant provisions under the CA 1950 including Sections 86 and 88 of the CA 1950.

This may also prove to be useful for financial institutions and practitioners out there in drafting any indemnity and guarantee agreements for instance: whether to insert a clause of waiver provision in the contract of the guarantee so as not to get the guarantor’s consent in any variation/alteration of the contract of the guarantee and therefore avoiding the applicability of Sections 86 and 88 of the CA 1950?

Published by Chuar Kia Lin
Partner of Pierre Chuah & Associates

Case Update: Letter of Indemnity VS Letter of Guarantee: Differences and Relevant Law and Principle