What is a Letter of Comfort?
It is a written assurance, often issued by the seller’s parent company or bank, which is intended to offer “comfort” to the buyer as to the seller’s ability or willingness to perform its obligations. Commercially, they may also be used to supplement or clarify the loan documents. Generally, comfort letters are not intended to be legally binding obligations but is usually a statement of moral responsibility. Comfort letters are issued because the seller is unable or unwilling to provide a bond or guarantee of performance.
Purpose of a Letter of Comfort
A comfort letter is used by the parent company to encourage a lending institution to issue a credit to a subsidiary. The purpose of having a comfort letter is to encourage the lending institution to enter into a legally binding transaction with the subsidiary company while attempting to avoid liability if the subsidiary fails to perform. Reasons for using a comfort letter are:
- seller’s guarantee facility may have been reached and it may be unable to procure further guarantees.
- seller is not empowered to obtain a guarantee because of financial constrains or its constitution or borrowing facilities
- issuer of the comfort letter may be unwilling to undertake a binding legal obligation on behalf of the seller.
- if the seller’s parent is to issue the letter, the parent may wish to preserve its own credit ratings and gearing
- unlike guarantees, on demand bonds and standby letter of credit, comfort letter are not required to be noted in a company’s accounts as contingent liabilities.
Is a Letter of Comfort legally binding?
Comfort letters are usually not meant to be legally binding. However, this may depend on the party’s intention and how the letter is drafted. Thus, the effect of the letter may vary from non-binding statement of present intention (usually the case) to a legally binding contractual obligation. It is thought that because of how a letter of comfort is drafting, it may lead to subsequent involvement of the drafting party in the agreement itself. If so, this may just cause the letter of comfort to be part of the implied contract and assume the drafter to be the guarantor.
When is it legally binding?
It is legally binding if the party’s intended it to be so. Overall context of the transaction in which the comfort letter was written, the language of the letter may lead the court to to find the letter as part of an implied contract. If a parent company of a subsidiary which later became insolvent had a letter which contained a statement such as
“It is our policy to ensure that the business of (the subsidiary) is at all times in position to meet its liabilities to you under (the facility).”
This may not amount to a contractual promise as it was merely a statement of present fact. If the statement was inaccurate when given, the the buyer could have brought an action against the issuer in deceit or misrepresentation (refer to Benson Limited v Malaysian Mining Corporation Bhd (1989) 1 WLR 379).
Other examples of statements which may not be legally binding:
- “We are confident that our subsidiary will be able to meet its obligations to you”
- “We will not take any action which would prevent our subsidiary from fulfilling its obligations to you”
However, a comfort letter may sometimes contain express wording to the effect that it does not intend to be legally bound to reinforce the non-binding effect of the letter. This does not mean that it will not be bound. If it still contains the essential elements of a contract such as offer, acceptance, consideration, intention to create legal relations, it will inevitably lead to it being a legally binding contract. It would not matter if “comfort letter” is expressly stated on the letter because it constitutes a binding undertaking. However, if it is found to be a legally binding contract, resulting loss and damage may be difficult to prove.