How Much Comfort Does a Letter of Comfort Provide?

A comfort letter is a representation by one party that assures the other about its ability to carry out a task. Comfort letters have proved to be a hypocritical instrument used in commercial transactions, given the nature of words generally used in such letters. While some letters do not have any legal enforceability, others may constitute a valid and binding contract. Courts in different jurisdictions have mostly relied on the language of the letter, the surrounding circumstances and the conduct and intention of the parties while determining the contours of such comfort letters.

Comfort letters have no strict legal backing.  They can either be construed as a guarantee under the Indian Contract Act, 1872 or enforced under specific performance or remain unenforceable against the issuer depending on the peculiarities of the words used. Usually guarantees create an independent financial obligation on the guarantor and such obligation may or may not arise in case of a letter of comfort.

In the above context, we have analyzed the treatment of a letter of comfort in various jurisdictions.

United Kingdom

The enforceability of a letter of comfort was first considered by a UK Court in the case of Kleinwort Benson v Malaysia Mining[1]. In this case, the words used in the letter issued to the lender for a loan made to the subsidiary were, ‘it is the policy of the parent company to ensure that its subsidiary is at all times in a position to meet its liabilities'.  

It was held that by use of such words in the letter, the issuer was merely making a statement regarding the present fact and not the company’s future conduct. The letter only gave an understanding that now and at all times in the future, so long as the subsidiary was under any liability to the lenders under the facility arrangements, it shall be the company's policy to ensure that the subsidiary remains in a position to meet its liabilities, and as such the letter did not constitute any contractual promise by the company to make it liable for its subsidiary’s inability to pay the loan.

Singapore

In HSBC v. Jurong Engineering Ltd.[2], no distinction was drawn between a ‘letter of comfort’ and a ‘letter of awareness’. The question before the Court was whether the letter of awareness created a legal obligation on the issuer to compensate the other party for the losses sustained by them due to non- repayment of loan extended to the issuer’s subsidiary.  The letter in question provided:

“If the borrower is unable for any reason to meet its obligations, we will endeavour to either: (a) make funds available to the borrower sufficient to meet its obligations, or (b) have funds made available to the borrower by others in amounts sufficient to enable the borrower to meet its obligations.”

It was held that the words ‘will endeavour’ indicated that the issuer was only stating that it would try to carry out what was in the letter and as such the letter was nothing more than an acknowledgement of its moral obligation.

Canada

The Canadian Courts determined the implications of issuing a letter of comfort in the case of Toronto-Dominion Bank v. Leigh Instruments Ltd.[3] (Trustee of). In this case, five comfort letters were issued,  of which four provided:

“It is our policy that our wholly owned subsidiaries, including Leigh.., be managed in such a way as to be always in a position to meet their financial obligations including repayment of all amounts due under the above facility.”  

However, the fifth letter provided that the comfort letters issued earlier shall not constitute a legally binding obligation. The Court held that the language used in the fifth letter clearly indicated that the intent was for the letters to not have any legal obligation. The Court further observed that without the said statement, the issuer of such letter would be under no legal obligation given the circumstances of the case and as such, the lender’s internal policy considered comfort letters as mere documentation and not security.  

India

Letter of Comfort is defined in Ramanatha Aiyar’s Advanced Law Lexicon as follows:

“A document that indicates one party’s intention to try to ensure that the other party complies with the terms of the financial transaction without guaranteeing performance in the event of default.”

In United Breweries Holdings Limited v. Karnataka State Industrial Investment and Development Corporation Limited and Others[4],  the Karnataka High Court ruled that a letter of comfort is more in nature of a recommendatory letter when the issuer uses the words “will undertake all reasonable steps to ensure..” and the issuer cannot be made liable for more than what he has undertaken.

In Tiong Woon Project and Contracting Pte Ltd v Naftogaz India Pvt Ltd and Ors[5],the words used in the comfort letter were “we hereby, assure and agree…”. The Delhi High Court held that the defendant had guaranteed the payment due to the plaintiff under the plaintiff’s contract to the extent indicated in the said letter and could not retract from its responsibility later.

In Lucent Technologies Inc v ICICI Bank Limited & Ors[6], a company obtained a loan based on the letter of comfort from its parent company. The letter stated that “it was the [parent company’s] policy to ensure that the business of the subsidiary is at all times in a position to meet its liabilities … under the loan agreement”. The court held that such words “contained no warranty to the future but merely a statement of the defendant’s present policy” and as such could not be construed to be a promise.

Conclusion

Merely using the term ‘letter of comfort’ is not sufficiently indicative of the fact that the issuer guarantees and can be held liable for non- performance of the act contemplated between the parties. The words used in such letters of comfort must clearly spell out such liability of the issuer.

Although one view could be that there is no purpose of issuing such letter when one does not guarantee the act contemplated therein. In Edwards v. Skyways[7], it was held that where an agreement is reached in the course of business affairs and not in the domestic or social context, the presumption is that parties have intended to create legal obligations. The onus is on the party rebutting this presumption to show that they expressly intended to create a mere moral obligation and not a legal obligation.

No problem arises when the law or precedents themselves make a distinction between binding and non- binding comfort letters. In a few jurisdictions like Austria, there are two types of letter of comfort - the unrestricted comfort letter and the restricted comfort letter. While the unrestricted comfort letter imposes a mandatory obligation on the issuer to provide funds to the borrower to ensure repayment to the lender, the restricted letter of comfort does not impose any legal obligation but is more in nature of assurance that the debt will be repaid by the borrower and that the issuer will look after the debtor’s financial standing.

In the absence of any such clear distinction under Indian laws, a letter of comfort needs to be drafted carefully so that it is easier to determine whether the issuer is making some real commitments or is just acknowledging the existence of a debt or an event and is making non-binding statements. The words used in the letter must match the intention of both the parties - the one issuing it and the one relying on it.

The views and opinions expressed in this article belong solely to the author and do not reflect the position of Tatva Legal Hyderabad.

[1] [1989] 1 All ER 785

[2] [(2000) 2 SLR 54]

[3] 1999 CanLII 3778 (ON CA)

[4] (2007) 9 VST 594 Karn

[5] CS(OS) 2850/2011

[6] 2010(5) R.A.J. 574

[7] [1969] 1 WLR 349