A Letter of Comfort [LoC] is a financial instrument that is usually given by the parent company or the promoter, attesting to the financial soundness and solvency of the obligor (the company receiving the credit from the lenders). A lot of debate has already taken place with regard to the enforceability of such an instrument that could not be put under the strict definition of a guarantee.
But the similarities between the two instruments cannot be ignored. A typical contract of guarantee also has three parties where a third person (the parent company or the promoter, in this case) acts as a surety for the principal debtor (obligor or the company taking the loan) to the lender. A contract of guarantee has its own rules of enforcement given under the Indian Contract Act, 1872. However, the position of LoC as being covered under the Act has been a contentious issue.
In Lucent Technologies v. ICICI Bank, the Delhi High Court had stated that whether such a Letter would be treated as guarantee or not depends on the intention and the wordings of the LoC. In that case specifically, there was no manifest intention to make that letter enforceable as a guarantee as derived from the literal interpretation of the phrases used and therefore it was held to be unenforceable. This decision had specifically referred to pre-decided principles of common law.
In United Breweries Ltd. v. Karnataka State Industrial Investment and Development Corporation, the Karnataka High Court had held that the value of such a letter is merely recommendatory and not enforceable per se unless the obligations have been specifically undertaken by the issuer. The court relied upon the definition given by P Ramanatha Aiyar in his book on advanced contracts, which can be stated thus: “Letter of Comfort—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.”
On the other hand, in Intesa Sanpaolo v. Videocon, the Bombay High Court had looked at the interconnectedness of the terms of LoC with the decision of the lender to grant any credit or loan. In the said LoC, the decision to grant the loan was contingent on execution of such LoC and in such cases, the nature of LoC assumes the form of guarantee irrespective of the form in which it is given. It is important to bring in the principles of the Contract Act as they rely only on the intention of the parties executing the contract and do not provide for any straight-jacket formula of drawing up a contract that might be enforceable under the law.
Recently, this issue was again interpreted in Yes Bank Limited v. Zee Entertainment by the Bombay High Court. The court looked at whether the terms of the letter amounted to guarantee under Section 126 of the Indian Contract Act (which defines a contract of guarantee). The court also referred to Banque Brussels Lambert SA v. Australian National Industries on which a heavy reliance was placed by Yes Bank wherein it has been held: “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. …
If these statements are appropriately promissory in character, courts should enforce them when they are uttered in the course of business, and there is no clear indication that they are not intended to be legally enforceable.” But the fact of reliance was found to be misguided because the action that was proposed to be taken was that of damages and not enforcement of guarantee or specific performance of the obligations. For this, the court heavily relied on the communications subsequent to the issuance of LoC where Yes Bank neither filed a suit for loan recovery or sought enforcement of put option agreement. Furthermore, the obligations being prayed to be enforced and undertaken by the LoC are different.
Thus, it can be seen through the series of judgments that the nature of the LoC in most cases has been held to be unenforceable unless it states the undertaking of liability on default in unequivocal terms. Such an instrument that is based on the trust of the parties creating binding relations between them should be formulated in those terms. A question may be asked as to why then should LoC be treated as a security anyway. The answer to this lies in the construction of the agreement and the intention of the parties. The lender especially should be cautious of the wordings of the letter being issued. Otherwise, this will result in commercial uncertainty of the transaction and will frustrate the purpose of the security so issued.
Kavya Lalchandani (lalchandani.kavya@gmail.com)
Legal scholar based out of Delhi