A letter of comfort (also known as a letter of intent or letter of awareness) is typically a statement in which the issuer/signor declares to support the debtor’s obligations vis-à-vis the creditor.
A letter of comfort is often used instead of a contract of guarantee or as a substitute for a contract of guarantee in the situation where the issuer wishes to avoid/ease its liability. A general example thereof is a parent company providing a letter of comfort as security for a subsidiary’s obligations vis-à-vis a bank or another creditor/lender.
RECENT JUDGMENT FROM THE COURT OF NÆSTVED
A judgment delivered by the Court of Næstved mid-2019 concerned the football club FC Vestsjælland, which was declared bankrupt in December 2015.
Prior to the bankruptcy, the club wished to apply for a DBU club licence for the coming season, but the club’s budget put an end to this as it appeared from the budget that the club needed additional capital of DKK 13 million. DBU made it a condition for granting the licence that a guarantee was made in relation to the additional capital, and as this was not provided, DBU turned down the club’s application.
FC Vestsjælland complained about the decision and attached a letter of comfort to DBU signed by two of the club’s owners. The letter of comfort read as follows: "[Owner 1] unconditionally undertakes to cover [club]'s need for liquidity of up to DKK 13,000,000, see the club’s budget of 10 March 2015, either as a subordinate loan or a capital increase. The purpose is to support [club] financially to the extent required for [club] to pay its creditors and to have the finances required to maintain the DBU licence required from time to time until the expiry of the licence period 2015/2016."
The letter of comfort contained a similar statement from Owner 2; however, Owner 2’s liability was limited to DKK 1.4 million.
The two owners then paid a total of DKK 5,888,200 to FC Vestsjælland, but the club was subsequently declared bankrupt. The question was then whether the two owners were bound by the letter of comfort, and in that case whether that obligation could be invoked by the bankruptcy estate to cover the creditors’ loss.
Based on the wording of the letter of comfort, the Court of Næstved concluded on 10 May 2019 that the owners had given an unambiguous and unconditional promise. The Court ruled that, due to the promise and its wording, the owners had a general obligation to the club, even though the letter of comfort had been given to DBU in a specific context.
The owners had only paid a part of DKK 13 million, even though the bankruptcy estate had a need for liquidity which clearly exceeded the remaining sum of DKK 7,111,800. Consequently, the owners had materially breached their obligation towards the club. They were therefore ordered to pay total compensation of DKK 7,111,800; however, one owner’s share was limited to DKK 1,4 million.
WEAK OR STRONG LETTER OF COMFORT
A distinction is made between weak and strong letters of comfort. A weak letter of comfort contains factual information which is not legally binding on the issuer, e.g.:
“We support our subsidiaries’ business policies”.
However, a strong letter of comfort contains a promise to the recipient which is binding on the issuer, e.g.: “We undertake to provide sufficient funds in relation to ....”
In 1994 and 1998, the Supreme Court ruled in two cases concerning construction of letters of comfort. In both cases, a parent company had provided a letter of comfort to the subsidiary’s bank.
In 1994, the Supreme Court ruled that the parent company’s letter of comfort stating that “if necessary, we will invest sufficient capital for the company to be able to fulfil its obligations to the bank at any time” was an unambiguous and unconditional promise to the bank obligating the parent company to cover the bank’s loss. It was therefore a strong letter of comfort.
However, the Supreme Court ruled in the case from 1998 that a letter of comfort stating “... to support G A/S financially so that the company will be able to fulfil its obligations to the bank” was not a sufficiently unambiguous and unconditional promise to the bank. The Supreme Court assessed that this was only a weak letter of comfort which did not obligate the parent company to cover the bank’s loss.
LETTER OF COMFORT IS NOT A GUARANTEE OBLIGATION
A letter of comfort is not to be considered a guarantee obligation because the issuer of the letter of comfort does not undertake an actual payment obligation, but only undertakes an obligation to ensure that the debtor will fulfil its obligations.
In a Supreme Court case in 1999, the court assessed the below statement from a bank to the seller’s lawyer in connection with a business transfer: “With reference to the present correspondence ... we (bank) hereby confirm that the agreed cash purchase price of a total of DKK 800,000 is made available to the purchaser. The amount may be transferred as soon as the contracts have been duly reviewed by .... and the purchaser and signed by the purchaser ...”.
A majority of the High Court judges found that the bank had warranted that it would pay DKK 800,000 as the statement had been prepared under circumstances where it ought to have been clear to the bank that security for payment of the purchase price was sought. In addition, the majority of the High Court judges noted that, already based on the wording, the statement was to be considered a warranty for payment from the bank, and the bank was therefore ordered to pay.
However, an unanimous Supreme Court found that the wording of the statement was not to be considered a warranty that the purchase price was going to be paid, and the Supreme Court ruled in favour of the bank. The case shows that the wording of the statement is unclear compared to the issuer’s intention.
WORDING IS DECISIVE - OTHER CIRCUMSTANCES ARE OF SECONDARY IMPORTANCE
There may be many circumstances in connection with the preparation of a letter of comfort which say something about the issuer’s intention with the letter of comfort. But in the end, the wording carries most weight, which was emphasised by the Supreme Court ruling in 2011: “It appears from the Supreme Court’s case law concerning letters of comfort that, first of all, the content of the specific letter of comfort determines the extent to which the issuer becomes obligated vis-á-vis the recipient.”
The Supreme Court statement may be considered a criticism of the High Court’s grounds as the High Court first reviewed the other circumstances in relation to the preparation of the letter of comfort and then decided on the actual wording.
A LETTER OF COMFORT DOES NOT UNDERTAKE LIABILITY TO THE WORLD AT LARGE
In 2009, the Supreme Court ruled that the wording of a letter of comfort must be subject to a strict interpretation in relation to whom the obligation applies.
In this case, the letter of comfort was issued by a company’s owners and stated the following: “The company’s board of directors and owners will ensure the necessary capital to the company’s continued operation and future development” and “will provide liquidity by way of loans so that the company is expected to have the necessary liquidity to carry out the budgeted activities next year.”
The company then went bankrupt, and several creditors brought legal action against the owners claiming fulfilment of the owners’ obligations under the letter of comfort.
It was decisive to the Supreme Court that the statements were general and made to an undefined group of persons and was not a guarantee for fulfilment of the company’s obligations to the creditors. The Supreme Court therefore ruled in favour of the owners.
WORDING OF LETTERS OF COMFORT IS OF GREAT IMPORTANCE TO THE LEGAL EFFECT
The wording of a letter of comfort is decisive in relation to the subsequent legal effect, and the wording may have consequences in several respects - is the letter of comfort binding at all, and to whom is the issuer obligated? It is therefore important for banks, parent companies and other issuers to be careful when wording and receiving a letter of comfort as it may be construed contrary to the issuer’s intention if the wording is sufficiently ambiguous. If the issuer has any doubt, he should seek professional assistance.