You might be wondering why businessmen bother to make an agreement if it has no legal effect—is it worth the paper it is written on? [mine] In banking practice ‘comfort letters’ are used literally; they provide comfort to a lender that he will get his money back. A borrower’s parent company (i.e. its main shareholder) will usually be saying something along the lines of ‘we will try to be a really good parent company and make sure that our subsidiary pays all your money back’. The bank does not expect to be able to sue on this agreement, and should insist on receiving a guarantee if it wants to have legally enforceable rights against the parent company.
In Kleinwort Benson Ltd v Malaysia Mining Corp. (1989) the following wording in a comfort letter was held not to contain an intention to create legal relations: ‘It is our policy to ensure that the business of [our subsidiary] is at all times in a position to meet its liabilities to you under the above arrangements.’ Companies must be careful not to promise to ‘guarantee’ or ‘undertake’ to do anything as this is more likely to be interpreted as a binding agreement.
It may seem as though comfort letters have the potential to be absolutely useless in certain circumstances. The question begs as to why a creditor would accept a comfort letter from a guarantor that refuses to give a guarantee when the letter cannot be enforced at law. The commercial reality is that when a business fails to meet its obligations, whether as a matter of law or honour, it reflects poorly on that business. A bad reputation can be much worse for a company than having to repay a loan. While this may not seem like an appropriately harsh punishment for one who fails to honour a non-contractual version of a guarantee, it should be remembered that, unfailingly, the author of a comfort letter will have been asked for a guarantee first, and the author refused.
In addition to this weak punishment, it is entirely possible, and in fact probable, that some comfort letters will be interpreted as binding legal obligations in the future. All it would take is for the wording of a letter to indicate promissory intent (perhaps by using the future tense), and the letter would be held to create legally binding obligations.
I'm asking just about comfort letters that aren't legally enforceable. Viz. disregard last para above.
If I were the lending officer at a rich bank, I'd distrust any borrower or its parent company that can't guarantee! I wouldn't lend it. After all, I can just lend to someone else who does guarantee, though I may have to sweeten my offer.
The emboldened quote doesn't feel true to me. Any examples? To the lender, "a bad reputation" won't get her his money back, and feels useless.
Are there other reasons?