Crumb of comfort?

Alex Innes explains the complexities behind Letters of Comfort and why care should always be taken.

Letters of Comfort are often provided as part of a transaction, usually in relation to a matter that is often either not included in, or contrary to, the main documentation. However, such letters carry great risk unless both the issuer and recipient are clear as to whether the letter is binding or not; and if it is not binding, you need to consider how much comfort it actually provides.

In a recent case, a tenant entered into an agreement with a landlord to lease part of a development on the basis that the tenant would undertake the fit-out works, and then it would receive a capital contribution from the landlord. There was a concern over the creditworthiness of the landlord, and a bank issued a letter to the landlord confirming that it held monies on deposit to meet the landlord’s commitment to fit-out costs. The tenant was aware of the existence of the bank letter (which was referred to in the agreement between the landlord and the tenant), and arguably relied upon it.

The tenant completed the works, and claimed the monies from the landlord; but due to a default by the landlord, the bank refused to release the monies on deposit.

The tenant argued that the letter created a binding obligation on the bank to pay the monies and sought to obtain payment direct from the bank. The bank argued that the letter was merely a Letter of Comfort, which did not amount to an undertaking to pay, and therefore it had no liability to the tenant.

After considering complex legal arguments on the exact wording of the letter and the particular circumstances of the case, the Court decided that the bank letter was a Letter of Comfort that was not enforceable against the bank by the tenant. Among the factors that persuaded the Court was that the letter was not addressed to the tenant; and it was subject to the terms of the drawdown arrangements between the bank and the landlord, therefore not an irrevocable undertaking to pay. As well as the tenant not obtaining the capital contribution it was expecting, considerable costs and time were incurred in reaching this conclusion which could have been avoided with a better crafted letter.

Another example of the danger with side letters, was a letter issued by a bank to a borrower as part of a refinancing, confirming that it would grant a guarantee, but without making reference to the remainder of the refinancing. The bank did not proceed with the refinance, and the borrower raised an action against the bank to force it to grant the guarantee. Again, after a long debate, the Court decided that the bank did not intend to issue the guarantee other than as part of the refinancing, and so it was not obliged to issue the guarantee.

While these cases were determined on the specific circumstances, and the exact wording of the letters, the lesson to be taken is that you need to be very careful when issuing a letter as part of a transaction.

If the letter is not intended to be binding, this should be prominently stated in the letter. For example, “This letter is not intended to be contractual in its effect.” This should avoid the risk of the letter being inadvertently relied upon.

If it is intended to be binding then, where possible, the relevant provisions should be included in the transaction documents to avoid the risk of a conflict with the transaction documents; but if a stand-alone document is required, then it must be properly drafted.

In the event that you are a recipient of a Letter of Comfort, then the reverse applies. If you intend to rely on it, you should ensure that it is binding, and properly addressed to you; or else it may not actually provide any real comfort.

Semple Fraser LLP is one of Scotland’s leading commercial law specialists, offering advice of the highest quality across a range of areas. With lawyers qualified in both Scots and English law, we are able to deliver a full banking service throughout the UK. The Banking & Finance Group of Semple Fraser LLP has expertise in all areas of banking and property finance, and works closely with the other specialists areas of the firm to provide the complete service to clients.

For more information on these topics, please go to www.semplefraser.co.uk, or contact Alex Innes on 0131 273 3771 or alex.innes@semplefraser.co.uk

Alex Innes is Head of the Banking & Finance Group of Semple Fraser LLP.

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