M Glenn Hamel-Smith

& Akeem Lopez

Many per­sons or com­pa­nies that have tak­en loans from a bank or fi­nan­cial in­sti­tu­tion would be fa­mil­iar with be­ing asked to have some­one else pro­vide a guar­an­tee. Some­times that guar­an­tor is a par­ent, or in the case of a com­pa­ny, a share­hold­er or par­ent com­pa­ny, and some­times oth­er re­lat­ed par­ties act as a guar­an­tor. Oc­ca­sion­al­ly, those guar­an­tees may in­clude an in­dem­ni­ty or there may be a sep­a­rate deed of in­dem­ni­ty.

Guar­an­tees and in­dem­ni­ties are two cat­e­gories of con­tracts that are col­lec­tive­ly re­ferred to con­tracts of sure­ty­ship, but each have dif­fer­ing le­gal im­pli­ca­tions. Such con­tracts usu­al­ly in­volve a third par­ty (called the sure­ty) un­der­tak­ing to ful­fil the oblig­a­tions of the prin­ci­pal debtor (or bor­row­er) owed to a cred­i­tor (or lender). But it is not al­ways clear whether a con­tract in­cludes a guar­an­tee or an in­dem­ni­ty, or both, even if it is re­ferred to as one or the oth­er in the doc­u­ment.

A con­tract of in­dem­ni­ty is one by which a par­ty agrees to keep an­oth­er harm­less (pro­tect­ed) against loss. A guar­an­tee, on the oth­er hand, is a promise by one par­ty (the guar­an­tor) to a cred­i­tor to be re­spon­si­ble for the per­for­mance of the oblig­a­tions of the prin­ci­pal debtor to the cred­i­tor if the prin­ci­pal debtor fails to per­form such oblig­a­tions when due.

In Natwest Mar­kets Nv and an­oth­er com­pa­ny v CMIS Ned­er­land BV and an­oth­er com­pa­ny [2025] EWHC 37 (Comm) (the Natwest-CMIS Case), the Com­mer­cial Court of the Eng­lish High Court was tasked with con­stru­ing whether nu­mer­ous agree­ments en­tered in­to in con­nec­tion with cer­tain fi­nan­cial trans­ac­tions (known as se­cu­ri­ti­sa­tions) were deeds of guar­an­tee or deeds of in­dem­ni­ty.

Be­low we pro­vide a sum­ma­ry of the de­ci­sion in the Natwest-CMIS Case and high­light the ap­proach tak­en by courts in con­stru­ing con­tracts of sure­ty­ship to help demon­strate the risks to par­ties to con­tracts which might be con­strued as ei­ther a guar­an­tee or an in­dem­ni­ty.

Back­ground to the Natwest-CMIS case

CMIS Ned­er­land BV’s and CMIS In­vest­ments BV’s (to­geth­er CMIS) main busi­ness ac­tiv­i­ty was the pro­vi­sion of mort­gages in Nether­lands and Ger­many. CMIS’ ac­tiv­i­ties were fund­ed by the mort­gage-backed se­cu­ri­ti­sa­tion mar­ket, which is a mar­ket for mort­gage-backed se­cu­ri­ties. A mort­gage-backed se­cu­ri­ty is an in­vest­ment backed by the in­come stream gen­er­at­ed from an un­der­ly­ing pool of mort­gages.

These in­vest­ments played a sig­nif­i­cant role in the 2007-2008 glob­al fi­nan­cial cri­sis as they were backed by high-risk sub­prime mort­gages (ie mort­gages is­sued to less than cred­it­wor­thy cus­tomers). Natwest Mar­kets nv and Natwest Mar­kets plc (to­geth­er Natwest) were part of an in­ter­na­tion­al bank­ing group which pro­vid­ed hedg­ing struc­tures for mort­gage-backed se­cu­ri­ti­sa­tions. Hedg­ing struc­tures are agree­ments which help to mit­i­gate against loss­es in an in­vest­ment, usu­al­ly in the form of swap agree­ments or swaps (Swaps).

The se­cu­ri­ti­sa­tions

CMIS es­tab­lished nu­mer­ous se­cu­ri­ti­sa­tion spe­cial pur­pose ve­hi­cles (SPVs) which are usu­al­ly lim­it­ed li­a­bil­i­ty com­pa­nies or cor­po­rate en­ti­ties formed for a sin­gle pur­pose, such as to hold par­tic­u­lar as­sets. The pur­pose of these SPVs was to pur­chase the mort­gage re­ceiv­ables orig­i­nat­ed by CMIS. The pur­chase of the mort­gage re­ceiv­ables was to be fund­ed by the SPVs of­fer­ing and is­su­ing cer­tain in­vest­ments to in­vestors in the form of notes, which are in­stru­ments ev­i­denc­ing an oblig­a­tion to re­pay a sum of mon­ey (usu­al­ly with in­ter­est).

No­tably, in­ter­est from the mort­gage re­ceiv­ables was fixed while in­ter­est payable by the SPVs to the rel­e­vant note­hold­ers was based on the Eu­ro In­ter­bank Of­fered Rate (EU­RI­BOR), which is an in­dexed float­ing rate of in­ter­est which changes from time to time. This meant that any po­ten­tial changes in EU­RI­BOR could re­sult in a mis­match be­tween in­ter­est re­ceived by the SPVs and in­ter­est payable by the SPVs to the note­hold­ers.

The po­ten­tial ex­po­sures cre­at­ed by the mis­match were hedged by swaps trans­ac­tions en­tered in­to by the SPVs and Natwest un­der mas­ter agree­ments for each se­cu­ri­ti­sa­tion.

The ‘deeds of in­dem­ni­ty’

Pay­ment to Natwest un­der the hedg­ing trans­ac­tions was sub­or­di­nat­ed to the oth­er pay­ment oblig­a­tions of the SPVs and there­fore did not rank very high­ly in the or­der of pay­ment pri­or­i­ties of the SPVs which con­se­quent­ly cre­at­ed a risk of non-pay­ment to Natwest.

To counter this risk of non-pay­ment, Natwest and CMIS en­tered in­to cer­tain con­tracts la­belled ‘Deeds of In­dem­ni­ty’ in re­spect of each se­cu­ri­ti­sa­tion. These Deeds of In­dem­ni­ty aimed to trans­fer the risk of a pay­ment short­fall by the SPVs from Natwest to CMIS. By each Deed of In­dem­ni­ty, CMIS covenant­ed with Natwest that, among oth­er things,

(i) it would, on de­mand by Natwest, pay cer­tain in­dem­nifi­able amounts as from the date they be­come due un­der the rel­e­vant mas­ter agree­ment and

(ii) CMIS would be­come a pri­ma­ry oblig­or for those in­dem­nifi­able amounts pro­vid­ed that it would have the same ben­e­fits, pro­tec­tions and de­fences at law as are avail­able to the SPVs as the par­ty that owed the un­der­ly­ing pay­ment oblig­a­tion. Natwest and CMIS fur­ther agreed that any pay­ments by CMIS of the in­dem­nifi­able amounts would dis­charge the SPVs’ oblig­a­tions to pay the cor­re­spond­ing amount un­der the rel­e­vant mas­ter agree­ment.

The dis­pute

CMIS was ex­pect­ed to pay the sums due to Natwest un­der the swaps when­ev­er the SPVs had in­suf­fi­cient funds to dis­charge their oblig­a­tions. Be­gin­ning in Jan­u­ary 2017, on the fail­ure of the SPVs to pay the rel­e­vant sums, CMIS re­fused to pay these sums to Natwest on the ba­sis that the SPVs’ oblig­a­tions to pay were de­ferred un­der the terms of the mas­ter agree­ment.

Natwest de­mand­ed im­me­di­ate pay­ment on the out­stand­ing sums but CMIS main­tained it had no oblig­a­tion to do so on a prop­er con­struc­tion of the deeds. Natwest’s main ar­gu­ment was that the sums it sought to re­cov­er from CMIS were in­dem­nifi­able amounts un­der the deeds which could not be re­cov­ered from the SPVs, and there­fore CMIS was li­able to pay. CMIS coun­tered that the deeds were guar­an­tees rather than true in­dem­ni­ties and there­fore sub­ject to the prin­ci­ple of co-ex­ten­sive­ness.

The prin­ci­ple of co-ex­ten­sive­ness dic­tates that a sure­ty’s li­a­bil­i­ty is no greater and no less­er than that of the prin­ci­pal debtor, in terms of amount, time for pay­ment and con­di­tions to li­a­bil­i­ty. In oth­er words, the guar­an­tor’s li­a­bil­i­ty is gen­er­al­ly co-ex­ten­sive with that of the prin­ci­pal debtor.

There­fore, since the oblig­a­tions of the SPVs were de­ferred pur­suant to the terms of the rel­e­vant mas­ter agree­ment, the in­dem­nifi­able amounts were not ‘due’ and ac­cord­ing­ly, CMIS was not li­able for same.

In­ter­pre­ta­tion prin­ci­ples

The court set out the fol­low­ing prin­ci­ples ap­plic­a­ble to the con­struc­tion of the deeds and oth­er doc­u­ments:

• The task is to as­cer­tain the ob­jec­tive mean­ing of the lan­guage used. The court will con­sid­er what a rea­son­able per­son (ie a per­son who has all the back­ground knowl­edge which would rea­son­ably have been avail­able to the con­tract­ing par­ties in the sit­u­a­tion at the time of the con­tract) would have un­der­stood the par­ties to mean;

• The court will con­sid­er the lan­guage used, rel­e­vant sur­round­ing cir­cum­stances and the com­mer­cial con­se­quences of ri­val con­struc­tions;

• The over­all scheme must be un­der­stood, and the rel­e­vant term must be read in the con­text of the over­all scheme;

Where there are two com­pet­ing con­struc­tions, a court would be en­ti­tled to pre­fer the con­struc­tion that is con­sis­tent with busi­ness com­mon sense and pro­duces a more com­mer­cial re­sult.

Guar­an­tee or In­dem­ni­ty?

In de­ter­min­ing whether the deeds in this case were guar­an­tees or in­dem­ni­ties, the court re­ferred to the fol­low­ing prin­ci­ples:

1) The la­bels used by the con­tract­ing par­ties must not be con­fused with the sub­stance of their oblig­a­tions;

2) The use of the words ‘guar­an­tee’ or ‘in­dem­ni­fy’ will mere­ly be in­dica­tive but not con­clu­sive;

3) The sub­stance of the oblig­a­tions must be iden­ti­fied in ac­cor­dance with the nor­mal prin­ci­ples of con­struc­tion and by look­ing at the in­stru­ment as a whole;

4) An in­dem­ni­ty oblig­a­tion im­posed a pri­ma­ry pay­ment oblig­a­tion on the giv­er of the in­dem­ni­ty;

5) A guar­an­tor’s oblig­a­tion, on the oth­er hand, is al­ways sec­ondary to the oblig­a­tion of the prin­ci­pal debtor. In oth­er words, there is no li­a­bil­i­ty on the guar­an­tor un­less and un­til the prin­ci­pal debtor fails to per­form its oblig­a­tions; and

6) The prin­ci­ple of co-ex­ten­sive­ness is an es­sen­tial char­ac­ter­is­tic of a guar­an­tee which dis­tin­guish­es it from a con­tract of in­dem­ni­ty. The prin­ci­ple of co-ex­ten­sive­ness is not, how­ev­er, a fixed rule and it is pos­si­ble for a guar­an­tor to re­main li­able even though the prin­ci­pal debtor’s oblig­a­tion to the cred­i­tor has been dis­charged (once this is pro­vid­ed for in the con­tract).

The court re­ject­ed CMIS’ ar­gu­ment and found that the deeds were to be prop­er­ly con­sid­ered as deeds of in­dem­ni­ty for the fol­low­ing rea­sons:

(i) Though not con­clu­sive, the doc­u­ments were ti­tled ‘Deeds of In­dem­ni­ty’ and used lan­guage of in­dem­ni­ty rather than guar­an­tee and

(ii) The deeds im­posed on and CMIS ac­cept­ed pri­ma­ry pay­ment oblig­a­tions for the in­dem­nifi­able amounts. The court fur­ther rea­soned that the com­mer­cial pur­pose of the deeds was to pro­tect Natwest in the event the se­cu­ri­ti­sa­tion ve­hi­cles failed to pay Natwest un­der the Swaps. CMIS was there­fore deemed to have ac­cept­ed the risk that it might be called up­on to pay.

Guar­an­tees and in­dem­ni­ties are fa­mil­iar means of ap­por­tion­ing risk in high stakes fi­nanc­ing trans­ac­tions. It is in­cum­bent up­on lenders, bor­row­ers and oblig­ors that such doc­u­ments are care­ful­ly craft­ed, us­ing clear and pre­cise lan­guage which is re­flec­tive of the true com­mer­cial in­ten­tion of the par­ties.

If faced with a dis­pute on whether a con­tract can prop­er­ly be con­sid­ered one or the oth­er, the court will have re­gard to the ob­jec­tive mean­ing of the words used in the con­tract, the over­all scheme, com­mer­cial pur­pose and sur­round­ing cir­cum­stances, the la­bel(s) as­cribed to the con­tract and the sub­stance of the rel­e­vant oblig­a­tions.

Dis­claimer: This col­umn con­tains gen­er­al in­for­ma­tion on le­gal top­ics and does not con­sti­tute le­gal ad­vice.