Profit Guarantee Clauses: What You Need to Know

Profit guarantee clauses or agreements are nothing new. Uncommon, but certainly not new.

In essence, a profit guarantee clause or agreement as the name suggests, would guarantee a certain amount of return (profit) as part of the consideration for agreeing to enter into a particular contract or venture. For example, Ali who is an owner of a business promises Muthu that if Muthu invests in Ali’s business, Muthu will get a ten percent return (profit) on his investment within the first year of doing so. Unconditionally and with no questions asked.

Profit guarantee clauses are commonly seen in agreements or ventures involving a franchise business model, royalty payment agreements, share sale agreements or even in instances where a business owner seeks investors, and as part of the consideration, offers the investor a certain (definite) amount of return on the investment over a definite period of time.

Too good to be true? Not entirely. If it is not apparent by now, profit guarantee clauses create a dynamic favourable to the party who receives the guarantee and most of the time, is practiced by readily established businesses intending to expand their domain of influence or by businesses wishing to entice new investors or partners.

Is a Profit Guarantee Clause / Agreement Enforceable?

Yes, just because an agreement confers more advantage to one party over the other does not necessarily mean that it is not a valid agreement. As long as all the elements of a valid contract are met, an agreement or rather the clause, irrespective of how unfair it is, is undoubtedly enforceable. As the issues on the enforceability of contracts are separate matters, they would be best considered in a separate article.

Why should I consider a Profit Guarantee Clause?

Well, it would definitely be the answer for those seeking short-term guaranteed returns on their investments. Whether or not a person would agree to providing a profit guarantee would then be a commercial decision.

What should I look out for?

The key consideration in a profit guarantee would be how definite a particular clause or agreement is. The more definite and clearer, the better. For starters, these are the usual things that you need to be aware of: -

1. How much profit is guaranteed, and would it be based on a percentage (of a particular amount) or would it be a fixed sum?
2. Will you be paid the short fall of the promised profit or would you be paid a fixed amount if the profit guarantee is not met? and
3. What is the duration of the guarantee and when would you be entitled to the guaranteed sum?

The purpose of looking out for the above items is to ensure that the profit guarantee clause is in fact enforceable. To illustrate, if a guarantee is made for the payment of a certain percentage of the profits of a company to a shareholder of the same company by the end of every financial year, it would be important to determine:

1. if they are calculated on the gross or net profits of the company?
2. if they were in any way viewed as dividends?
3. what would happen if the company does not make any profit?

In situations like these (if you have agreed to the guarantee), the Courts would look at the circumstances surrounding the contract to determine the true meaning of the term in question. The Courts would intervene where there is a dispute as to whether a party had actually intended to guarantee profits in favour of another contracting party. This was addressed by the High Court in the case of Global Capital Limited v Dato’ Sri Chong Ket Pen [2020] MLJU 1447 where it was held that: -

“[41]  What may have remained merely general principles and guidelines within the body of the Agreement and not intended to be an obligation required to be performed by any party is an issue that would have to be resolved as a matter of interpretation. However, there is no reason why even if there exists such a provision or provisions within the Agreement, if any, such would per se extinguish the otherwise legally binding effect of the Agreement itself.”

On this note, whether or not a profit guarantee clause or agreement was intended to be enforceable would rest on the letter of the agreement itself. Naturally, if it was concluded that parties had entered into an agreement on a different understanding, the agreement would be void for uncertainty. 

Conclusion

Profit guarantee agreements need not be complex arrangements. What is important is that the agreement is kept simple and certain, enough to ensure that the rights of the parties are guaranteed (pun intended).