Legal Status of Comfort Letters in South Africa - Essay Example

 A comfort letter is generally defined as a document issued by a parent company which is primarily aimed to encourage a lending institution to issue credit to another company which is usually a subsidiary of the maker or issuer (Block, et. al, 2004). In the case of Kleinworth Benson v. Malaysia Mining Corporation Berhad 1 WLR 379 at 391 (1989), the court held that “letters of comfort denotes a document under which comfort is given to the leader by the assumption not of legal responsibility but of moral responsibility only”. As such, comfort letters generally are not indented to be legally binding. The use of comfort letters is becoming widespread in the commercial lending world. It is now commonly used in countries like the United States of America, the United Kingdom, and Australia. However, these countries do not have specific statutory law/s pertaining to the formation and the enforceability of comfort letters but they rely on the universally accepted general principles of obligations and contracts and of the common laws. It is hereby submitted that the answer to the question of when do comfort letters create an enforceable obligation to the maker or issuer depends on the factors or circumstances surrounding the creation, the contents, and the conditions of the acceptance of the comfort letter as will be discussed in this work. The legal status of comfort letters in other countries like South Africa is still a relatively new subject of legal research and there is not an abundance of case law in commercial lending pertaining to the use of comfort letters in that country. In the absence of abundant common and statutory laws that will hold the legal status of comfort letters in South Africa, it is presumed that South Africa also follows the universally accepted general principles of obligations and contracts and the common laws in dealing with comfort letters, South Africa being a part of international community that recognizes these principles. The essence of comfort letters is to encourage a lending institution (i.e. potential creditor) to enter into a legally binding transaction with the subsidiary company (i.e. potential debtor) while attempting to avoid liability should the subsidiary fails to perform (Block, et. al, 2004, quoting from the case of LaSalle Bank National Association v. Citicorp Real Estate [2003] WL 21671812). With this context, courts generally view comfort letters unenforceable and the maker or issuer assumes no obligation as comfort letters are not intended to be legally binding obligations (Block, et. al, 2004). The enforceability of comfort letters depends upon the factors established in the following decided cases: 1) Kleinwort Benson Limited v. Malaysia Mining Corporation Berhad 1 WLR 379 at 391 (1989); 2) Banque Brussels Lambert SA v. Australian National Industries Limited 21 NSWLR 502 (1989); and 3) Gate Gourmet Australia Pty Limited (in liq) ACN 089 374 562 v. Gate Gourmet Holding AG and Ors NSWSC 149 (2004). In the Kleinworth Benson case, the court said that in order to determine whether the comfort letter created an enforceable obligation on the part of the maker or issuer, legal construction of the words or language used in the comfort letter should be made. If the words or language strongly suggest that the comfort letter is promissory in nature which is evident on the face of the letter itself, the maker or issuer is obliged to perform an obligation under the comfort letter. In this case, the court held that the comfort letter is not enforceable because the terms only represented it was the “practice” of the company to provide financial support and with no indication in the letter that the policy would continue in the future (Gurney, et. al). The Banque Brussels’ decision took a more liberal approach by saying that in addition to the terms of the letter, one must consider the factual matrix surrounding the creation of the comfort letter (Gurney, et. al). Simply stated, if the maker or issuer does not intend to be binded by the comfort letter, he or she must include a disclaimer or a clear statement on the face of the letter that he or she does not intend to give rise to any legal obligation whatsoever. Otherwise, in the absence of the disclaimer, the comfort letter is intended to be legally enforceable. This view somehow was utilized by a court in deciding a case in 2002 when it held that the plaintiffs’ reliance on the comfort letters was unjustifiable because the disclaimer language expressly stated that they were ‘not to be used, circulated, quoted, or otherwise referred to for any purpose, including but not limited of the purchase or sale of securities” (Block, et. al, 2004, quoting from the case of Rotterdam Ventures, Inc. v. Ernst Young, [2002] 752 N.Y.S. 2d 746). However, the case of Gate Gourmet Australia Pty Limited decided in 2002 is a recent judgment of the Supreme Court of NSW in which the parties found themselves in court testing the validity of such letters against the propositions outlined by the leading authorities. For the first time since Banque Brussels cases, a letter of comfort was found to have given rise to enforceable obligation. In this case, the auditors of Gate Gourmet Holdings Pty Limited requested the Swiss parent company to provide a letter of support to the Australian Gate Gourmet group given its nominal capitalization and the fully drawn nature of its external facilities. Evidence suggested that the directors of Gate Gourmet Holdings Pty Limited were seeking support in order to be satisfied that the Gate Gourmet Australia was not trading while insolvent. The court held that the comfort letter was in nature promissory and binding based on the language used, “to meet the respective commitments as and when they fall due” that indicated an obligation of a recurrent and continuing kind. In short, it was found out that the primary purpose of the comfort letter was to induce other business persons to enter into a business transaction. Comfort letters by that nature, always contain promissory language (in the absence of a disclaimer), otherwise directors or subsidiaries would not be able to place any reliance on them. In that decision, Clayton Utz acted for the liquidator of a company which had the benefit of such a letter of comfort. In that case, the Supreme Court of NSW held that a letter of comfort that came into existence created a binding contract between, among others, the Australian trading arm of the foreign-owned Gate Gourmet Group (“Trading Company”) and the Swiss based parent company (Gurney, et. al). To summarize the stated facts, a comfort letter can give rise to a contractual obligation only if it is itself a contract. An agreement will be a contract only if it is concluded with the intentions of creating an obligation or obligations. It is the existence of this intention to create obligations which distinguishes a contract from any other agreement. Therefore, a comfort letter will be a contract only if it is proven that there was a common intention to create obligations. There are various pointers or factors which may be utilized to determine if a comfort letter is an enforceable contract. Some of these are: 1) the language of the comfort letter itself; 2) the sophistication of the parties; 3) oral representations; 4) the parties’ prior dealings; 5) whether or not the instrument is customarily viewed as enforceable in the particular trade or profession at issue; 6) The parties reason for using the letter of comfort; and 7) the role the letter of comfort played in the agreement (Block, et. al, 2004). The issue of the legal status of letters of comfort does not hold a definitive legal definition is South Africa. Similar to other jurisdictions, the formation and the enforceability of comfort letters in this country follow the bases of other countries as provided in this work. Works Cited AICPA Professional Liability Insurance Program, (2009). “CPA Comfort Letter to Lenders”. Retrieved April 8, 2009 from AICPA.org Block, et. al. (2004). “Comfort Letters: Casual Drafting Can Turn Into a Guarantee”. New York Law Journal. (Online). Retrieved on May 5, 2009 from Comfort Letter. (2009). In Investopedia ULC [Web]. Retrieved on April 7, 2009 from Gordon, K. (2006). “The Legal Status of letters of comfort in the South African Law”. Retrieved on April 7, 2009 from Goldman Judin Maisels Inc. (2009). Letters of Comfort [Brochure]. Johannesburg, South Africa: Gurney, et. al.“The Twilight Zone revisited – intragroup letters of comfort”. Clayton Utz. Retrieved on May 5, 2009 from NLB InterFinanz. (2000). “Legal Issues: What comfort are guarantees?”. Retrieved on May 5, 2009 from The Free Library. “Revival of the Letter of Comfort”. Retrieved on May 5, 2009 from Read More