Letter of Comfort

It is seen that on many occasions Lenders accept Letters of Comfort from a larger Parent Company, a well-to-do subsidiary company or a substantial shareholder. Such Letters of Comfort usually undertake to ensure that for the entire life of the facilities provided to the borrower and until its full discharge, the borrower shall be couched in all aspects and provided with required support in such way it will be able at all times fully to meet its obligations arising in connection with the facilities extended.

 

A stage might come where the Principal borrower defaults in repayments on the Lending and the Lender needs to invoke all remedies available to recover its dues. On that day a question arises for consideration -

 

“Whether the letter of comfort can be construed by the Lender as a Guarantee and consequently whether the Entity issuing such Letter of Comfort would be held liable as a Guarantor to clear the outstanding dues of the Lender” ?

 

In order to understand the true import and intention of a Letter of Comfort, the language of the Letter of Comfort is to be read. However, as stated earlier, the Letter of Comfort invariably records the facility extended to the Principal Borrower and an undertaking is given ensuring that till the entire life of the aforesaid facility and until its full discharge, the Principal Borrower shall be vouched in all aspects and provided with required support in such a way it will be able at all times fully to meet its obligations arising in connection with the said facility.”

 

The Letter of Comfort only undertaken to ensure that the Principal Borrower the issuer of the Letter of Comfort shall take all reasonable care to provide support to the Principal Borrower to remain solvent.

 

Section 126 of the Indian Contract Act, 1872 defines a “contract of guarantee” as under: -

 

“A “contract of guarantee” is a contract to perform the promise, or discharge the liability, of a third person in case of his default.”

 

As understood from the Letter of Comfort, the Issuer neither contracts to perform the promise made by the Principal Borrower, nor does the Issuer agree to discharge the liability of the Principal Borrower in case of a default by the Principal Borrower. There are no separate Agreements of Guarantee or any other Agreements pertaining to the facilities extended to the Principal Borrower. The Issuer also refrains from creating any charge on its own properties in consideration of the facilities provided to the Principal Borrower.

 

In terms of Section 372 A of the Companies Act, 1956, a Guarantee can be given only if the same is sanctioned by a resolution passed at a meeting of the Board with the consent of all the directors present at the meeting and the prior approval of the public financial institution, if any term loan is subsisting. The said approval of a public financial institution shall not be required where the aggregate of the loans and investments so far made, the amounts for which guarantee or security so far provided to or in all other bodies corporate, alongwith the investments, loans, guarantee or security proposed to be made or given does not exceed the limit of 60 percent specified in sub-section (1), if there is no default in repayment of loan installments or payment of interest thereon as per the terms and conditions of such loan to the public financial institution.

 

If, however, the guarantee proposed to be given is likely to result in the aggregate of loans and investments so far made, the amounts for which guarantee or security so far provided to or in all other bodies corporate, along with the investment, loan, guarantee or security proposed to be made or given by the Board, exceeding the limits laid down in Sub-section (1) of Section 372A, in addition to the requirements laid down in the preceding paragraph, prior approval of the Company needs to be obtained. Such approval shall be obtained by means of a special resolution passed at the General meeting of the Company.

 

However. the Board may give guarantee, without, being previously authorized by a special resolution, if, -

 

(a) a resolution is passed in the meeting of the Board authorizing to give guarantee in accordance with the provisions of this section;

 

(b) there exist exceptional circumstances which prevent the company from obtaining the previous authorization by a special resolution passed in a general meeting for giving a guarantee; and

 

(c) the resolution of the Board under clause (a) is confirmed within twelve months, in a general meeting of the company or the annual general meeting held immediately after passing of the Board resolution, whichever is earlier;

 

Moreover the notice of such resolution must indicate the details of guarantee proposed to be given. Apart from this, the Company needs to comply with the provisions of Section 58A of the Companies Act, 1956. The Company is also required to maintain the register as prescribed under Sub-section (5) of Section 372A.

 

None of the above conditions are met nor are required to be met prior to issuing a Letter of Comfort. In the circumstances, such Letters of Comfort cannot be termed as Guarantees and are therefore not enforceable in a Court of Law by the Lender against the Issuer for recovering the outstanding dues of the Principal Borrower under the facilities granted to it by the Lender.