A Key Issue for the Courts When Deciding on the Legal Status of a Comfort Letter - Article Example

A key issue for the courts when deciding on the legal status of a "comfort letter" is whether or not the party proffering the comfort letter intendedto create legal relations. In order to determine whether the party proffering the comfort letter intended to create legal relations between themselves and the other party it is necessary to discuss the relevance of comfort letters. Comfort letters came into usage due to the difficulty in finding someone who was prepared to act as a guarantor for the contracting party. Although comfort letters are designed to act as a guarantee from the proffering party that they will be able to honour the agreement entered into between the parties, the legal obligation that would be imposed if the person was acting as a guarantor, is not present within the issue of a letter of comfort. Comfort letters are common in loan agreements, as an alternative from asking the lender to obtain a guarantor for the loan. In order for a claimant to be able to rely on the letter of comfort as a guarantee of payment, the claimant has to prove that the person issuing the letter intended to create legal relations between themselves and the claimant. According to Ellinger (1989) comfort letters can be identified into 3 specific types, and can include undertakings from a parent company to meet the financial commitments of the subsidiary company. Less stringent comfort letters identify that the parent company knows of the intention of the subsidiary company to enter into a contract with the other party, but makes no express guarantee to honour the agreement of the subsidiary or to actively intervene to ensure that the subsidiary company fulfils the contract. These letters can have legal effect despite the fact that they cannot be relied upon as a guarantee that the party will fulfil their part of the contract. One of the first cases to consider the effect of comfort letters was Banque Brussels Lambert S A v Australian National Industries Ltd1 in which the defendant averred that the letter should not be regarded as a binding contract. In this case, the bank insisted on a letter of comfort as a condition of the loan agreement between the parties. The bank had originally tried to force the defendant to guarantee the payments on the loan, which the defendant had refused to do. The claimant attempted to aver that the letter of comfort contained promissory paragraphs with regard to the conduct of the defendant and that the defendant had breached these promises. One such paragraph stated We take this opportunity to confirm that it is our practice to ensure that our affiliate [the borrower] will at all times be in a position to meet its financial obligations as they fall due. These financial obligations include repayment of all outstanding loans within thirty (30) days. It was the role of Rogers J to determine whether this paragraph met the requirement with regard to a promissory obligation and also to determine whether the issuing of the comfort letter was an intention on the part of the defendant to create a legal obligation between themselves and the claimant. This argument was raised on the basis of the decision given in Kleinwort Benson Ltd v Malaysia Corp Bhd [1989]2. In Kleinwort the claimant sought to rely on a paragraph contained in the comfort letter sent by the defendant, as evidence to suggest that the comfort letter equated to a guarantee3. At the initial hearing the court was of the opinion that the paragraph contained in the comfort letter amounted to a guarantee and that MMC should be held liable for the debts of the defendant. However, the appeal court overruled this decision and concluded that the paragraph was merely a representation in relation to the existing policy and not a guarantee in relation to future conduct. This case gave credence to the argument that letters of comfort should only be viewed as a moral obligation and should not impose legal obligations on the person or company issuing the letter, unless evidence could be adduced to show that the letter was promissory in nature. Chitty on Contracts (1983) concluded that the general principle with regard to determining whether there was an intention to create legal obligations should be as follows An agreement, even though it is supported by consideration, is not binding as a contract if it was made without any intention of creating legal relations. Of course, in the case of ordinary commercial transactions it is not normally necessary to prove that the parties in fact intended to create legal relations. The onus of proving that there was no such intention is on the party who asserts that no legal effect is intended, and the onus is a heavy one. In order to determine whether there was an intention to create legal obligations it is necessary to point out that any such presumption is rebuttable, however, the onus of proving that no such intention existed is placed on the person asserting the lack of legal obligation4. In Banque Brussels Lambert S A Rogers J concluded that There should be no room in the proper flow of commerce for some purgatory where statements made by businessmen, after hard bargaining and made to induce another business person to enter into a business transaction would, without any express statement to that effect, reside in a twilight zone of merely honourable engagement5. This was similar to the conclusion reached by Hirst J in Kleinwort6 who was of the opinion that the words would have to be clearly promissory in order to be able to apply the decision given in Edwards v Skyways Ltd [1964]7. However, Rogers J went on to determine that the paragraph Banque Brussels Lambert SA was clearly promissory, and that the claimant would not have entered into the agreement with the defendant had the paragraph not been inserted into the letter of comfort. On this basis, Rogers J, concluded that although there was no clear intention of the defendant to enter into legal relations with the claimant, the promissory paragraph was sufficient for the letter to have legal effect. Rogers J found that the defendants would have been aware that the claimant was relying on the letter of comfort as a guarantee that they would meet the financial obligations of the parent company. A letter of comfort was also regarded as a guarantee in Associated British Ports v Ferryways [2009]8. In this case the court held that the wording of the letter was such that the defendant was unable to vary the conditions of the original agreement. The letter contained an agreement by the defendant that ‘In consideration of…ABP entering into an agreement relating to the port of Ipswich of even date with the letter (the agreement), we assume full responsibility for ensuring (and so shall ensure) that, for seven years from the date of this letter, Ferryways (i) has and will at all times have sufficient funds and other resources to fulfil and meet all duties, commitments, and liabilities entered into and/or incurred by reason of the Agreement as and when they fall due and (ii) promptly fulfils and meets all duties, commitments and liabilities.’ As Ferryways was struggling to meet its obligations, ABP amended the agreement by a Time to Pay Agreement, so that Ferryways would have more time to pay the amount outstanding. Initially, the court ruled that this amounted to a variation of the terms, and as such the letter of comfort should not be binding. However, on appeal, the court ruled that the letter amounted to a guarantee, and that the variation offered by ABP did not effect their right to rely on the guarantee. The court held that the defendant would have been able to avid liability if the letter had contained a clause stating that any variation of the original agreement would nullify the effect of the letter of comfort. The court of appeal pointed out that in general terms a letter of comfort would not give rise to legal obligations unless the letter could be construed as a guarantee by the wording of the letter. In this case, the wording contained promissory elements upon which the claimant could rely. In Walford v Miles [1992]9 the defendant requested a letter of comfort from the banker’s of the plaintiff, stating a loan would be granted to the plaintiff if the defendant terminated any negotiations with other parties and refused to consider any alternative offers. Although the comfort letter was provided as requested by the defendant, the defendant withdrew from negotiations with the plaintiff and sold the business to another party. The plaintiff attempted to argue that the defendant should not be entitled to withdraw from negotiations as the letter of comfort had been provided as requested. Although the court accepted that the defendant had a duty to stop negotiations with any third parties, they concluded that the defendant could not be forced to negotiate positively with the plaintiff as this could mean that the defendant would be forced to accept an unreasonable offer for the premises. After consideration of the above, it would appear that letters of comfort are generally not legally enforceable. Those wishing to rely on letters of comfort as guarantees for the promises of another will have to show that there was either an intention to create legal obligations by the person issuing the letter of comfort, or that the wording of the letter is such that the defendant would be aware that the claimant would be relying on the letter as a guarantee. It should also be noted in the above, that the burden to prove that the letter was not intended to create legal obligations is placed on the issuer of the letter. The courts appear to have consistently determined the relevance of letters of comfort by examining the content in order to establish whether promises have been made by the person issuing the comfort letter. In Kleinwort, the court of appeal could not find any such promises contained within the letter, and therefore ruled that the claimant could not rely on the letter as a promise by the defendant to honour the agreement of the other contracting party. Conversely in Banque Brussels Lambert S A the court found that paragraphs of the letter did amount to promissory obligations, and the defendants were held liable for the debts of the subsidiary. It would appear that the legal status of a comfort letter is dependent on the construction and content of the letter. Where there is clear and unambiguous evidence of promises made by the author of the letter, upon which the claimant might rely in entering into the contract, it is likely that the court will hold that the comfort letter does create legal obligations for the issuer. It is therefore important for anyone issuing a letter of comfort to ensure that the wording does not contain wording upon which a claimant might rely if they wish to avoid legal obligation for the default of another. Bibliography Beale, HD, Bishop, WD, Furmston, MP, (1995), Contract Cases and Materials, 3rd Ed, Butterworths Bixby M.B., Beck-Dudley C., Cihon P.J. (2002), The Legal Environment of Business, Prentice Hall, New Jersey. Chitty on Contracts, (1983) 25th ed, London: Sweet & Maxwell Civil Litigation Study Manual, (2008), BPP Learning Media Dignam, A J., (2006), Company Law, 4th ed. Oxford University Press, London Ellinger, E P, (1989) “New Cases on the Bank as Constructive Trustee” Journal of Business Law Elliott, C and Quinn, F, (2005) Contract Law, 5th Ed, Pearson Longman Goode, R M, (2004), Commercial Law , 3rd Edition, London, Penguin. Keenan, D and Riches, S, (2005), Business Law, 7th Ed, Longman Rose, FD, (2000), Statutes on Contract, Tort & Restitution, 10th Ed, Blackstone’s Treitel, G H.(1999), Law of Contract, 10th Ed, Sweet & Maxwell Read More