Contract Law

Letter of Comfort

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.

What is the meaning of “indebted” under the law?

The meaning and the scope of the word “indebted” used in s.9(1)(b) of the Companies Act, 1965 with particular reference to credit card, housing loan and HP facilities with companies which are related companies of audit client are as follows:

S.9(1)(b) of the Companies Act, 1965 states as follow:

(1)  A person shall not knowingly consent to be appointed, and shall not knowingly act, as auditor for any company and shall not prepare, for or on behalf of a company, any report required by this Act to be prepared by an approved company auditor –

(b)  if he is indebted to the company or to a corporation that is deemed to be related to that company by virtue of section 6 in an amount not exceeding two thousand five hundred ringgit.

Hereinafter, this provision will be referred to as “the said provision”.

According to The New Shorter Oxford English Dictionary, the word “indebted” carries the meaning “involve in debt”. Besides that, The New Shorter Oxford English Dictionary also stated that “indebted” would mean:

  • Under obligation to another on account of some liability incurred or claim unsatisfied; liable for some omission of duty, or in other word, “bound”.
  • Under obligation on account of money borrowed; owing money, in debt (to).
  • Under obligation for favours received; owing gratitude to (someone or something) for a benefit.

Stroud’s Judicial Dictionary of Words and Phrases (Sixth Edition) provides that “indebted” has a similar meaning to “due”, i.e. presently payable, as in Re Stockton Malleable Iron Company [Chancery Division] 2 Ch D 101, where the Court gave judgment that the word “due” meant due and payable, and the word “indebted” had a similar signification. In this case, it was said that “moneys due” may mean either owing or payable, and what it means is determined by the context.

In Words and Phrases Legally Defined (Third Edition), the word “indebted” is stated to have the same meaning as “owing”, and that the word “indebted” describes the condition of a person when there is a present debt, whether it be payable in present or future, and that the words “all debts owing or accruing” mean the same thing. They describe all debt in present, whether solvent in future, or solvent in present. Future possible debts are not included in this definition. This was adopted from Webb v Stenton and others [1881 – 1885] All ER 312.

In Webb v Stenton and others [1881 – 1885] All ER 312, the word “is indebted” and the words “debts owing or accruing” refer to the same subject matter. There must be an actual present debt, either equitable or legal. The requirements of the rules are satisfied by a present debt, whether payable now or in the future, and that the words include all such debts.

The meaning of a present debt, whether payable in the present or in the future would also require the Court to look into the present situation of their case at hand. In this case, since there was clearly no debt payable in the present from the trustees, hence it is in question whether there is going to be debt payable in the future. Fry LJ was of the opinion that in this case, trustees are not equitable debtors until they have money in hand which they are bound to pay over, or until they are made liable for breach of trust, or for default in the performance of their duties as trustees. Since they were under no liability to pay money now, there may be no question of debt in the future as well.

 Conclusion

Therefore, in our present context, the words “if he is indebted to the company” would mean if there is an obligation on the auditor to pay debt that is already due, or debt that is presently owing and accruing to the company.

Debt that is not currently due is not included in the meaning of the word “indebted”. Hence, debt that is only going to be owing and accruing in the future would not be included in this context.

Thus, an auditor who is a credit card holder of companies which are related companies of audit clients would not fall within the meaning and scope of the word “indebted” used in the said provision unless there is a debt due and payable by the auditor to the company.

If an auditor has acquired housing loan from the company, and the loan is not yet accruing, then he is not prohibited to act as the auditor of the company.

Similarly, if an auditor is under an obligation to make payment to the company in the form of installments in HP facilities, it is not a prohibition to him to act as the company auditor as well, unless the payment is already due and accruing.