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How risky are ‘Letters of Comfort’?

 

A letter of comfort is usually a written document whether in digital or paper format that provides an assurance by the parent company that the subsidiary will meet its loan obligations to the lender. As example, lets say Widget Pty Ltd is the parent company to Fixme Pty Ltd, and Fixme obtains a loan from Aussie Bank. Widget then provides a letter to Aussie Bank giving an assurance that the loan to Fixme will be paid in full. 

 

Parent companies usually offer a letter of comfort to a lender when they are not willing to ‘technically’ guarantee the loan of a subsidiary company that it will be paid back in full. This type of letter usually demonstrates that the parent company is aware of the finances of the subsidiary company, and that they will maintain control and ownership over that company until the debt is paid. 

 

The issue with letters of comfort, is whether the parent company in the wording of the letter, created a legal commitment by the parent to the lender. This legal commitment would be based on the content of the letter and what was promised. In other words if the parent company promised that a loan would be settled, and the wording of the letter creates that legal commitment, then that parent company will be held liable to settle that loan. 

 

In the English case of Kleinwort Benson Ltd v Malaysia Mining Corp Bid [1989] this was a litigated case concerning the effect of a letter of comfort. In this case the lender agreed with the parent company to extend a loan to a subsidiary company, on the basis of the letter of comfort provided to the lender by the parent company. The letter of comfort used the following words: 

 

It is our policy to ensure that the business of (the subsidiary) is at all times in a position to meet its liabilities to you under the loan facility arrangements. 

 

The subsidiary company went into liquidation and the lender made a claim against the parent company based on the letter of comfort issued. The lender argued that the letter of comfort was a guarantee by the parent company. The court on appeal said the letter did not have any contractual effect as it was a position statement of the parent company’s intention. The letter was not held to be a future conduct promise, and no legal responsibility applied. 

 

Whether a letter of comfort creates a legal obligation on the party that issues the letter, will be subject to the wording of the document. In determining whether a letter of comfort creates a legal obligation, this will be subject to the ordinary rules of construction of legal contracts. 

 

As example in Banque Brussels Lambert SA v Australian National Industries Limited (1989) the defendant company applied for a line of credit, and the bank required a reassurance from the principal shareholder of the company. The principal shareholder then responded with a letter to the bank:

 

We confirm that we are aware of the eurocurrency facility of US$5m which your bank has guaranteed to (the company) which is wholly owned subsidiary of (another company). 

 

We acknowledge that the terms and conditions of the arrangement have been accepted with our knowledge and consent and state that it would not be our intention to reduce our shareholding in (the company) from the current level of 45% during the currency of this facility. We would, however, provide your bank with 90 days notice of any subsequent decisions taken by us to dispose of the shareholding, and furthermore we acknowledge that, should any such notice be served on your bank, you reserve the right to call for the repayment of all outstanding loans within 30 days. We take this opportunity to confirm that it is our practice to ensure that our affiliate (the company) will at all times be in a position to meet its financial obligations as they fall due. These financial obligations include payment of loans made by your bank under the arrangements mentioned in this letter. 

 

The subsidiary company defaulted on its loan and the bank brought proceedings against the parent company on the basis of the letter of comfort from the principal shareholder. 

 

The court held in this circumstance the letter of comfort from the shareholder contained an undertaking of a contractual obligation that could be enforced by the bank. The court emphasised that the letters purpose, was mainly to induce the bank to extend the line of credit to the subsidiary company. 

 

In Australia the use of certain language in a letter of comfort may be viewed as being consistent with the promissory intent of being bound by that document. 

 

In Gate Gourmet Australia Pty Ltd (in liq) v Gate Gourmet Holding AG [2004] the letter of comfort said: 

 

This is to confirm that (the parent entity) will provide the financial support that may be necessary to enable (the subsidiary) and its controlled entities to meet its financial commitments as and when they fall due. 

 

This Letter of Support will not be withdrawn before (the subsidiary) and its controlled entities have sufficient means to meet their obligations without the support of the parent company. 

 

The court held the letter of comfort through the use of its language created a legal commitment through the promissory intent to be bound. 

 

Issuing letters of support, intent or comfort, require careful consideration for the actual intended purpose of the document. While letters may not contain words of a true guarantee, there may be enforceable undertakings made that create liability for the party that issues the letter. To avoid a letter having a negative consequence, that wording should be unambiguous, and when statements are made that could pass as a legal obligation, it needs to be clearly spelt out that it is not the case. 

 

Letters may contain serious legal consequences when careful drafting is not applied. The prudent solution is to have an external party draft the letter who is not associated in anyway whatsoever with the party requiring the correspondence, as that will provide clear and precise independence on the content of the document where no colouring can be applied. Taking that extra step is important, so call me, to get that legal advice to protect your legal rights and interests. 

 

The comments in the aforementioned do not constitute legal advice and are general in nature, and if legal advice is required please contact: John Melis at Legal AU Pty Ltd (03) 9999 7799 www.legalau.com 

 

Legal AU Pty Ltd Lawyers are “Liability limited by a Scheme approved under Professional Standards Legislation.”