Comfort letters can be a useful tool for providing an assurance of support from a parent to a subsidiary company. In some cases they help inform the decision of the board of a subsidiary and its continuing trade. It's possible for such letters to form binding obligations in law, if carefully considered and drafted.
The recent case of Simon Carves Limited sub nom Carillion Construction Ltd v (1) Zelf Hussain & Robert Jonathan Hunt (joint liquidators of Simon Caves Ltd) (2) Simon Carves Ltd (In liquidation)  EWHC 685 (Ch) serves as a useful reminder of the limitations of letters of support. In particular, the case confirmed that:
- where letters of support issued by the parent were addressed to directors of a subsidiary in the course of preparation of annual accounts, they were only relevant to enable the directors to consider whether it was appropriate for the financial statements for the year to be prepared on a going concern basis; and
- letters of comfort are subject to the normal rules of contractual construction. In order to be binding they must demonstrate offer, acceptance, consideration, certainty and an intention to create legal relations.
Facts of the case
In the Simon Carves case, Carillion Construction Limited (CCL) requested permission to make an application under section 423 of the Insolvency Act 1986 (the 1986 Act) against Simon Carves Limited (in liquidation) (SCL) and its ultimate parent company Punj Lloyd Limited (PLL).
CCL was an unsecured creditor of SCL at the time SCL went into administration. CCL was aware of the existence of three letters of support (given by PLL to SCL on 12 May 2008, 14 May 2009 and 31 March 2010) which had been referred to in the directors' report accompanying SCL's financial statements. When SCL went into administration, its business and assets were sold to a sister company by way of a pre-pack transaction. Unsecured creditors were to get a nominal dividend return.
CCL claimed that the letters of support constituted enforceable obligations. It also claimed that the dividend payable to unsecured creditors was only nominal because the value for the sale of the assets in administration was affected by the fact that SCL and PLL had agreed not to enforce the letters of support. The Court was asked to consider whether the letters of support constituted binding obligations on PLL, and whether the failure to enforce those obligations constituted a transaction defrauding creditors for the purposes of section 423 of the 1986 Act.
The letters of support
The relevant sections from the three letters of support are set out below:
- 12 May 2008: "we, Punj Lloyd Limited, confirm that we shall provide the necessary financial and business support to Simon Carves Limited to ensure that the Company continues as a going concern."
- 14 May 2009: "We are aware of the financial position of your company, its state of affairs and the results of its operations, and we hereby agree to provide sufficient funds to the company for these purposes, to enable it to continue operating and to meet its liabilities as and when they fall due for the period until 31 May 2010, to ensure that the Company continues as a going concern."
- 31 March 2010: we, Punj Lloyd Limited, confirm that we shall provide the necessary financial and business support to Simon Carves Limited for a period of not less than 12 months from the date of approval of the accounts to ensure that the Company continues as a going concern."
Each letter was addressed to SCL's board of directors at the time of preparation of its annual accounts, which were prepared on a going concern basis. The letters were referred to in the directors' statement accompanying the financial statements. In 2008, the report stated that the letter had been prepared "to ensure that the company continues as a going concern". In subsequent years the report stated that the letter was the main basis for the company continuing to operate as a going concern.
PLL withdrew support the day before SCL was put into Administration and its business and assets were sold by pre-pack.
Fundamental to the success of the application of CCL was the need to show that the obligations in each of the letters of support were binding on PLL. If they were not, then a claim under section 423 would fail.
The Court's view was that, whether or not comfort letters give rise to enforceable obligations is a question of construction and understanding about what the letters mean and what the parties intend by them, having regard to the specific terms of the letters and the circumstances in which they are given. Letters of support are also subject to the normal rules of contractual construction. In order to be binding they must demonstrate offer, acceptance, consideration, certainty and an intention to create legal relations.
The focus in the Simon Carves judgment was the context in which the letters were provided and their terms:
- The fact that the letters were addressed to the board of directors of SCL and not simply to SCL was deliberate. It was significant that they were provided in the course of the preparation of SCL's year end financial statements. They were to enable the directors, acting as directors, to decide whether it was appropriate for the year end accounts to be signed off on a going concern basis. There is no suggestion in the judgment that it was improper for the directors to rely on the letters for this purpose. The directors would no doubt have to consider such matters carefully, taking into account all relevant facts and circumstances in line with their duties as directors.
- The letters didn't purport to be a contract with SCL and they didn't indicate what consideration was passing from SCL or the board to PLL in return for the financial support. Even if SCL, separately to the directors, relied on the letters of support to continue trading, that would not have constituted valuable consideration to make the letters contractually binding. An obligation in the letters that SCL should continue to trade or be subject to other obligations may have addressed this.
- It was considered to be "extravagant" for the letters to be considered to commit PLL to meeting all of SCL's liabilities during the following 12 month period, thereby restoring SCL to balance sheet solvency (the balance sheet at 31 March 2010 showed SCL's current liabilities to stand at £271.5 million).
The transaction defrauding creditors
The court held that as the letters were not binding on PLL, there was no case to answer on the section 423 application. In any event, there was no evidence that SCL and PLL had agreed the letters to be binding but had gone on to agree that the letters of support would never be enforced.