The following is not meant to be a law lecture, but provides an overview of how some important parts of contracts can affect everyday life. That could be for example involving the purchase of a house, the lease of a property, hiring business equipment and giving guarantees or entering a franchise agreement. In the end, they are all reviewed with the same set of rules by judges if matters go to Court. It is important that all contracts are reviewed and drawn carefully with the understanding of the object of the contract in mind when undertaken.
The use of the terms warranties, conditions, guarantees and indemnities are commonly used and misused in contracts. Each of these terms has a defined legal meaning and specific legal effect. Misuse of these terms can lead to:
Conditions - A condition is an essential term and the most important obligation in a contract. A condition is a stipulation going to the ‘root of the contract’ so that any breach of that term may be regarded by the innocent party as a fundamental breach. If a condition is breached it gives the innocent party a right to terminate the contract and make a claim for damages.
Warranties - A warranty is a non-essential term and a secondary obligation in a contract. A term will be classified as a warranty if it is collateral to the main purpose of the contract. If a warranty is breached it only gives the innocent party a right to claim for damages and not to terminate the contract.
Guarantees - A guarantee is a secondary liability which can only be given by a third party outside the main contract. A term will be classified as a guarantee if it is considered to be a binding promise of one person to be answerable for the debt or obligation of another party if that party breaches the contract.
Indemnities - An indemnity is a primary liability involving an undertaking by one party to keep the other party harmless against loss, and as such, does not involve default by a third party.
The classification of a contractual term as constituting a guarantee, warranty, or indemnity, requires an examination of the natural meaning and substantial character of the contract as well as the nature of the transaction between the parties.
Once difference is in contracts of sale- The terms ‘warranty’ and ‘guarantee’ are often used interchangeably to classify performance obligations. Within a contract of sale the terms ‘warranty’ and ‘guarantee’ have a completely different meanings and are taken to refer to an undertaking as to the title, quality or quantity of a thing sold under a contract. For example, a warranty can be given when a motor vehicle is purchased.
In Australia the High Court has adopted a test of essentiality to determine whether a term of a contract is essential, and thus a condition. This test of essentiality looks at the contract as a whole, and its individual terms, to determine whether a term is such that a party would not have entered into the contract unless he or she had been assured substantial performance of that undertaking. The quality of essentiality depends upon a close analysis of the importance the parties have attached to a provision, as evidenced by the contract as applied to the surrounding circumstances. This approach gives a right to terminate a contract where a breach substantially deprives a party of the benefit of the contract, regardless of whether or not that breach is of an essential term.