Alan L Tyree

Southern Comfort

Question: How comforting is a letter of comfort?

Answer: It depends.

When making a loan to one of a group of companies, the prudent course is to take a guarantee from the parent company and, if possible, from all the companies in the group. It is only in this way that the lender can be certain that assets of the group will be available to meet the obligations of the legal borrower.

Unfortunately, what is prudent for the lender is not always acceptable to the parent company. A variety of commercial reasons may make a guarantee unattractive. The parent company may not wish to incur legal liability or it may wish to avoid having a contingent liability showing on its balance sheets.

The compromise position is the letter of comfort. Ellinger has classified letters of comfort into three basic types.1 At the one extreme, the parent company may give an undertaking to maintain its shareholding or other financial commitment in the subsidiary. A second type of letter calls for the parent to use its influence to see that the subsidiary meets its obligation under the primary contract. The weakest form of the letter of comfort is a confirmation that the parent is aware of the contract with the subsidiary, but without any express indication that the parent will assume any responsibility for the primary obligation. Although Ellinger classifies "letters" it is clear that a single letter may contain paragraphs of the different types.

A letter of comfort may have legal effect even though it is not a guarantee. The liability of the guarantor for the primary debt arises by the default of the primary debtor. But there may be other contractual promises, the breach of which would have the effect of allowing the lender to recover damages equivalent to the debt. The question in each case is to determine the legal effect of the terms of the letter.

The Kleinwort Case

In Banque Brussels Lambert S A v Australian National Industries Ltd 2, Rogers J considered the effect of a letter of comfort that contained paragraphs of all three types. The defendant argued that the letter did not create a binding contract, basing its argument on the decision of the English Court of Appeal in Kleinwort Benson Ltd v Malaysia Mining Corp Bhd.3

The form of the contested paragraph in the English case was of the intermediate type. It read:4

It is our policy to ensure that the business of MMC Metals Limited is at all times in a position to meet its liabilities to you under the above arrangements.

MMC was a wholly owned subsidiary of the defendants and the letter of comfort was in relation to an acceptance credit and multi-currency cash loan facility to a limit of £5 million, later increased to £10m. The tin market collapsed in October of 1985 and MMC collapsed with it. The plaintiff called upon the defendant to repay the outstanding loan, but the defendant refused on the basis that the letter did not impose any binding obligation on the defendant to support MMC. The defendant noted that the circumstances had changed materially and that they had reviewed and changed their policy as a consequence.

The court at first instance held that the paragraph constituted a contractual promise and that the promise included an undertaking that the policy would not change during the lifetime of the loan agreement. The Court of Appeal could not agree with this conclusion, holding that the paragraph was merely a representation by the defendants about their existing policy and not a promise about future conduct.

The decision in Kleinwort Benson was the first in which a UK superior court considered the enforceability of a letter of comfort. It lent substance to the view, championed by borrowers and their parent companies, that a letter of comfort expressed only a moral obligation unless the terms of the letter were decidedly promissory. The Court did not address the issue of why commercial men and women would devote so much time and money to expressing unenforceable obligations.

The Banque Brussels Case

The basic facts of the Banque Brussels case were similar. The defendant held 45% of the issued capital of the holding company that owned 100% of the borrower. The bank required the letter of comfort, in a form satisfactory to it, as a condition of the loan. The defendant had previously refused to give a guarantee. The disputed letter of comfort was the negotiated compromise.

The letter contained three paragraphs. The first was a "confirmation of awareness" paragraph. It was agreed by both parties that the paragraph had no promissory effect.

Of the disputed second and third paragraphs, the second was itself in two parts. In the first part the defendant 'stated' that it would not be their intention to reduce their shareholding in the borrower and in the second that they 'would' provide the bank with 90 days notice of any decision to dispose of any shareholding.

The second disputed paragraph, the third paragraph of the letter, was in the following terms:5

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.

Rogers J noted that there were two closely related questions. Was there an intention to create legal obligations and, if so, were the terms of the letter of a sufficiently promissory nature to be held to be contractual?

Intention to create legal obligations

It seems accepted that there is a prima facie presumption that in commercial transactions there is an intention to create legal relations. This presumption is rebuttable, but there is a heavy onus of proving the absence of such an intention that rests on the party who asserts that no legal effect was intended.6

Counsel for the defendant attempted to discharge that onus by arguing that the document was not a guarantee. However, as noted above, the conclusion that legal relations were not intended simply does not follow.7 Nor can any conclusion be drawn merely from the lengthy negotiations. Although the plaintiff argued that these negotiations pointed to an intention to create legal relations, they might also be as an indication that the defendant wished to avoid such relations.8

In the event, Rogers J took a very robust view, saying:9

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 engagement.

This is very close to the analysis of Hirst J at first instance in the Kleinwort case.10 The Court of Appeal, however, held that the Skyways principle could not apply unless the words were clearly promissory.

Promissory/Representational

As already noted, the Court of Appeal in Kleinwort held that the words were not promissory. They reached their conclusion by "...subject[ing] the letters to minute textual analysis."11

Rogers J acknowledged that the words used are important, but thought that:12

...it is inimical to the effective administration of justice in commercial disputes that a court should use a finely tuned linguistic fork.

With this approach, it is not surprising that Rogers J found both the disputed paragraphs to be promissory. The clear aim of the second paragraph was to devise "a carefully crafted trigger to allow for recovery"13 and Rogers J was prepared to find at least the second part of the paragraph to be promissory. He also thought the first part to be promissory even though it was slightly weaker than the (non-disputed) paragraph in the Kleinwort letter.

Concerning the third paragraph, Rogers J found that it was promissory by the simple expedient of rewording it. If the paragraph is read as:

it is our practice to ensure that [the borrower] is at all times in a position to repay all loans made to it by your Bank

then it is more obviously promissory.14 His Honour even rewrote the paragraph further by noting that he could see no difference between his reading (above) and saying that "we promise to ensure that".15 This approach is about as far away from the "minute textual analysis" style of the English Court of Appeal as can be imagined.

Estoppel

The plaintiff also succeeded in claiming that the defendant was estopped from denying the truth of the statements in the letter of comfort and from asserting that the promises were not a binding legal obligation. Rogers J found that the evidence established that the defendants knew that the plaintiff regarded the obligations as binding. It was, in the circumstances, unconscionable for the defendant to fail to disabuse the plaintiff of the incorrect perception.

Summary

It would be possible to reconcile Kleinwort and Bank Brussels in the traditional manner by attributing the difference in outcome to differences in wording and pleadings. To do so would be to overlook the differences in approach used by the two courts. The Court of Appeal adopted a traditional analytical approach whereas Rogers J used a functional analysis.

The approach of Rogers J is much to be preferred. It is simply absurd to think that teams of lawyers and business people spend time and money drafting documents that express only moral obligations. It is even more absurd to suppose that they then act on these documents by entering into transactions worth millions of dollars.

Rogers J said it bluntly and accurately:16

Courts will become irrelevant in the resolution of commercial disputes if they allow [minute textual analysis] to dominate their consideration of commercial disputes.

Alan L Tyree
Landerer Professor of Information Technology and Law
University of Sydney

1 Ellinger, EP [1989] JBL 259.

2 Unreported, Supreme Court of New South Wales, Commercial Division, 12 December, 1989.

3 [1989] 1 All E R 785.

4 [1989] 1 All E R 785 at 786.

5 at p 2

6 at p 36, relying on Edwards v Skyways Ltd [1964] 1 WLR 349, 355.

7 see also Rogers J at p 38.

8 at p 39.

9 at p 39.

10 [1988] 1 All E R 714.

11 per Rogers J at p 41.

12 at p 42.

13 at p 44

14 at p 45

15 at p 45

16 at p 41.