Video

Wragge & Co experts take a look at topical issues in contract law. Covering everything from competition law and boilerplate, to trends in liability law and how to terminate a contract, they outline the main issues in-house lawyers should consider.

Parent Company Guarantees

Amanda Grace: What is a parent company guarantee?

Kirsty Barnes: Parent company guarantees are used increasingly in commercial situations. They are exactly as they sound, a guarantee from generally a parent company of an organisation and they are used increasingly often in today's society and are there to guarantee the performance of the underlying company entering into a contract with a third party.

Amanda Grace: How many types of guarantees are there and what form do they take?

Kirsty Barnes: Now that is the question of all questions! There is an awful lot of different types of guarantees. There are three main types: on-demand bonds, a true guarantee and an indemnity. They have different characteristics and that's why it's very important to understand the type of guarantee that you are entering into.

Amanda Grace: When would a parent company guarantee typically be needed?

Kirsty Barnes: Parent companies tend to give guarantees to bolster the financial credibility of their subsidiary companies. If one of its subsidiaries has entered into a commercial contract with a third party, that third party may want to insure the performance of the contract and look to other companies within the same group to give a financial or a performance guarantee in respect of those obligations. It gives an extra level of comfort in respect of the obligations which are being contracted with, with that subsidiary company.

Amanda Grace: What are primary and secondary obligations?

Kirsty Barnes: Primary obligations are those created by an indemnity or an on-demand bond. They create a primary, a separate, an independent obligation for the guarantor to pay without reference back to the underlying contract and without the need to sue under that contract for a breach. A secondary obligation, by contrast, is linked to the underlying contract. There must be a breach of the underlying contract and that must be proved before the guarantee can be enforced.

Amanda Grace: Tell me about amendments and variations.

Kirsty Barnes: Amendments and variations actually relate to the underlying contract and it is really important to understand the type of guarantee that's been put in place. Is it an on-demand bond or is it a guarantee? That will then dictate what amendments and variations, if any, to the underlying contract that can be made.

If you have a guarantee, a true guarantee, then it's of primary importance to understand that you can't actually vary or amend the underlying contract without the consent of the guarantor. If you do, the underlying principle is that the guarantee will fall away, it will be invalid. If, however you have an on-demand bond or an indemnity in respect of the underlying contract, you can make any amendments and variations as you wish without affecting the validity of that bond or indemnity.

Amanda Grace: What is a letter of comfort and when would that be used?

Kirsty Barnes: A letter of comfort is very distinct from a guarantee or bond. It is exactly what it says it is, it's a letter of comfort. It is not as formal and not designed to be as binding or as financially binding as a parent company guarantee as we have just been talking about. It's completely separate and it doesn't create a contingent liability as such that needs to be recorded in the company's accounts.

Amanda Grace: What are the main things an in-house lawyer should know or do when working with parent company guarantees?

Kirsty Barnes: There are three main things that any in-house lawyer should really consider when looking at parent company guarantees.

The first is to understand exactly what the obligation is that's being entered into. Is it a bond? Is it a guarantee? Does it create a primary or a secondary obligation?

The second thing is to understand what kind of liabilities that will create for the group as a whole. Is it a primary liability? Is it a conditional liability? Is it going to be something that needs to be recorded within the company's accounts and that the FD will need to know about?

The final consideration is the type of guarantee that's being given or received. For the grantor of the guarantee, it's important to understand that from a financial perspective. If it's a pure letter of comfort, it doesn't need to be noted in the company's accounts but entering into a guarantee will have a financial affect on the company and it's something to flag with the FD to make sure that it's dealt with appropriately.

Amanda Grace: Thank you Kirsty.

This video may contain information of general interest about current legal issues, but does not give legal advice.