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JC - Article - Letter of Comfort: Enforceable Guarantee or Moral Obligation?


29 Nov 2016

Letter of Comfort: Enforceable Guarantee or Moral Obligation?

Letters of Comfort (“LoC”) continue to hold a mystifying position in the financing spectrum. While some interpret it as an enforceable obligation on the issuer, some merely see it as an unenforceable representation of a fact. In common parlance, LoC is a letter issued by a parent company or other related party/affiliate which has a controlling stake or power (“Issuer”) over another entity (usually a borrower) (“Obligor”) to the lenders of the Obligor. LOCs are intended to provide some form of “comfort” to the lenders in relation to the obligations and performance of the Obligor. The level of “comfort” will be integrally linked to the nature of statements made by the issuer in the LoC. These statements generally relate to assurance of financial soundness of the Obligor to repay its debt and perform its obligations and also at times provide comfort as regards the Issuer itself.

Is it a guarantee?

The difference between LoC and guarantee lies in the terms of their enforceability. While guarantees create an independent financial obligation on the Issuer / guarantor in case of any default by the Obligor, this need not necessarily be the case with an LoC. The provisions of Contract Act 1872 or Companies Act 2013 define and regulate guarantees. LoCs are a derivative of commercial transactional parlance and do not have a strict legal backing, other than that of specific performance under Contract Act 1872. The applicability of contract law also depends significantly on the nature of LoC and therefore the language of the LoC becomes critical to determine the enforceability.

Indian Jurisprudence

The Delhi High Court considered a question relating to enforceability of LoC in Lucent Technologies Inc. vs. ICICI Bank Ltd. & Ors. [2009]. Relying on the principles laid down in various international judgments, the Hon’ble court was of a view that “the circumstances and documents do not indicate that the parties intended to create any legal relations. The very terms of the letter dated 13th September, 2000, the term sheet enclosed therewith and the response of the plaintiff as contained in letters of comfort dated 27th September, 2000 and 30th November, 2000 are a strong indicator in this regard. Both use phrases and concepts having clear technical legal significance and do not manifest any intent that a final and concluded contract had been entered into. In view of the above discussion, it, therefore, has to be held that the communications placed before this court do not contain the kind of assent required to make for a binding contract.” Therefore, the issuer was not under any financial obligation to pay any amount under the agreement between the borrower and the bank.

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