Analysis of the enforceability of “letters of comfort” under IBC

The following is a brief introduction to the topic

Shapoorji Pallonji and Company Pvt. Ltd. v. ASF Insignia SEZ Pvt. Ltd., the Hon’ble National Company Law Tribunal, New Delhi (“NCLT”) recently ruled that “an entity who has given a ‘Letter of Comfort’ (LoC) cannot be viewed as a corporate debtor or a corporate guarantor within the framework of the law.” The adjudicating authority was of the view that a letter of comfort could not be equated with a contract of guarantee as given under The letter is usually regarded as non-binding and is viewed as a moral obligation to perform financial duties. In commercial transactions, they are used to provide comfort to lenders and to secure lending facilities for borrowers.

In this case, Shapoorji Pallonji and Company Pvt. Ltd. (“SPC”) and Black Canyon SEZ Private Limited (Black Canyon) entered into a contractual agreement under which SPC agreed that Black Canyon could receive duly certified works for an amount or payment to be paid by Black Canyon. ASF Insignia SEZ Pvt. Ltd. (“AIS”) provided a letter confirming that if Black Canyon did not pay for the work performed by SPC, then AIS would step in and ensure prompt payment.

SPC received a demand letter from SPC under Section 8 of the Insolvency and Bankruptcy Code (2016 (“IBC”) due to Black Canyon’s inability to pay its obligations to SPC. AIS responded by stating that it had not assumed any responsibility to repay SPC, even under the comfort letters.

The letter stated that if Black Canyon defaulted on its obligations, it would take action to ensure that Black Canyon met those obligations.

SPC then submitted a request under section 9 of IBC to resolve corporate insolvency against AIS. The NCLT, after evaluating all relevant facts and circumstances, deemed SPC’s Section 9 Application as unmaintainable. It also determined that AIS could not be regarded as a corporate guarantor under Section 5.5.1A of the IBC.

It is essential to consider the legal liability of those who issue letters of credit and their enforceability in light of the case.

Differentiate between a letter of comfort and a letter of guarantee.

Many people mistakenly believe that “Letters of Comfort” are similar to “Contracts of Guarantee,” but there is a big difference between them regarding their nature, enforceability, and liabilities.

Section 126 of the Indian Contract Act defines a Contract of Guarantee as requiring three parties to be present: the principal debtor, the surety, and the creditor. A CoG is a contract that exists independently, in which the surety agrees to be bound by the repayment obligations.

LoC is not legally enforceable if the surety defaults; there can be a claim against him. Unlike CoG, defined by Section 126 of the Indian Contract Act 1872 and governed under Sections 372A, 295, etc., LoCs do not have any such statutory or legal framework. LoCs are not governed by the Companies Act of 2013.

As has been found in many cases, their applicability and enforceability heavily depend on the parties’ words and intentions. This includes India.

LoC in foreign jurisdictions

The English Court of Appeal first addressed the issue of whether LoCs are enforceable by nature in Kleinwort Benson Ltd. V. Malaysia Mining Corp. Bhd. ((1989) 5 BCC 337). In this case, the plaintiff’s bank issued a PS5m line of credit to the subsidiary of the defendant instead of an LoC. This stated that “it is our policy” to ensure the subsidiary’s business can meet its obligations to you at all times under the above agreements.

The bank then sued the defendant to recover compensation for the breach of this LoC. The Court rejected this claim, holding that an LoC is not a contract promise but merely a representation or current practice of the parent company.

This judgment has been criticized because the Court relied heavily on the words used in the LoC, not the parties’ intent. The Supreme Court of New South Wales, in Banque Brussels Lambert SA [(1989)] 21 NSWLR 502, criticized the above interpretation for being unnecessarily commercially unrealistic and too technical. It seemed the LoC to be a promise as the requisite intent of the parties was to engage in contractual obligations, and the instrument’s language created a binding obligation.

The Court laid out certain principles for determining whether a LoC is a contractual obligation. First, the Court stated that ordinary rules of interpretation and construction relating to contracts would apply. It said that the parties’ intent would be determined by documents and events surrounding the contract’s inception in light of industry practices.

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