Letter of comfort: How does it differ from a guarantee?

By Vikramaditya Kapoor and Tania Khullar, SNG & Partners
29 April 2017

Aletter of comfort (LoC) is a letter given by a third party (usually the parent company or promoter flagship), to help secure lending facilities for the borrower. Ordinarily, a letter of comfort is assumed as a moral obligation or passive reassurance by the third party issuing such a letter in support of the borrower.

A letter of comfort is understood to be inherently non-binding in nature depending on the language used and there being no tangible recourse against the letter of comfort provider. The letter of comfort is widely used in commercial transactions and is a mere reassurance of performance. The distinction in obligations under a LoC and a guarantee is evaluated below.

Vikramaditya Kapoor Associate SNG & Partners
Vikramaditya Kapoor
SNG & Partners

In United Breweries (Holdings) Ltd v Karnataka Industrial Investment and Development Corporation Ltd, a letter of comfort had been given on behalf of an associate company stating “that it is our normal practice to see that all our associate companies meet their financial and contractual obligations and [to] this end we will undertake all reasonable steps to ensure that … conducts its operations efficiently to meet its obligations in the usual course of business”.

The court held that the letter was not a guarantee and that it was worded in the vein of a letter of recommendation. The court defined letter of comfort as “a document that indicates one party’s intention to try to ensure that another party complies with the terms of a financial transaction without guaranteeing performance in the event of default”.

Similarly, in Lucent Technologies Inc v ICICI Bank Limited & Ors, a company relied on a letter of comfort from its parent company to obtain a loan. The LoC 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 referred to passages from The Law of Contract (Butterworths Common Law Series), which said that “there is no absolute rule as to whether a letter of comfort can or cannot create a legal relationship”, “the effect of such a letter will depend on the precise form of wording used”, and “no statutory definition of this expression and document is available”. The court focused on whether the words were promissory and not whether the party wanted to create legal relations and held that the letter of comfort “contained no warranty to the future but merely a statement of the defendant’s present policy”.

In contrast, in Tiong Woon Project and Contracting Pte Ltd v Naftogaz India Pvt Ltd and Ors, a payment from the principal contractor was owed to the secondary contractor. The principal contractor’s guarantor wrote “we hereby, assure and agree to release an amount of … on first priority basis from the certified bills/invoices”. The court held the guarantor had a legal obligation to make the payment since it was on the assurance and guarantee of guarantor that the secondary contractor continued to work beyond the date agreed in the contract.

Tania Khullar Associate SNG & Partners
Tania Khullar
SNG & Partners

It is clear that whether a letter of comfort effectively creates a legal obligation or merely a moral obligation depends on the language used. For example, in Commonwealth Bank of Australia v TLI Management Pty Limited, terms such as “we agree”, “we undertake” and “we promise” were held to be legally binding but “we confirm that we will” was found to be ambiguous. In Banque Brussels Lambert SA v Australian National Industries, the court observed that in disputes a “finely tuned linguistic fork” should be used to determine the binding value.

In view of the above arguments, what must be discerned is whether a letter of comfort would need to be stamped, especially when there is a legal obligation to repay debt on behalf of the borrower. The question then becomes whether a stamp duty obligation should be applicable on all LoCs or only when they are construed to create a legal obligation on the guarantor.

The key question is whether a guarantee is actually required and whether a letter of comfort could be a convenient substitute. This suggestion aligns clearly with the well settled principle of substance taking precedence over form. The potential guarantor may or may not assume a legal obligation and yet allow its relationship with the borrower to inject faith in the efficiency of the borrower’s operations and provide reassurance to the lender. The guarantor then only plays a supervisory or friendly role, without undertaking any legal obligation but only a moral obligation.

SNG & Partners has offices in Delhi, Mumbai, Singapore and Doha. Vikramaditya Kapoor and Tania Khullar are associates.