Recently, the Hon’ble National Company Law Tribunal, New Delhi (“NCLT”) in the matter of Shapoorji Pallonji and Company Pvt. Ltd. v. ASF Insignia SEZ Pvt. Ltd., has held that ‘an entity which has issued a ‘Letter of Comfort’ cannot be treated as corporate debtor/ corporate guarantor within the framework of law’.
In the present matter, a contract was executed between Shapoorji Pallonji and Company Pvt. Ltd. (“SPC”) and Black Canyon SEZ Private Limited (“Black Canyon”), in terms whereof SPC was required to deliver duly certified works to Black Canyon, for a consideration/ payment payable by Black Canyon. For the purpose of ensuring prompt payment by Black Canyon, ASF Insignia SEZ Pvt. Ltd. (“AIS”) had issued a letter of comfort in terms whereof AIS had undertaken that in the event Black Canyon fails to make payment with regards to the works by SPC, then AIS shall intervene and ensure prompt payment of such dues. The relevant excerpt of the subject comfort letter is extracted herein below:
“We, AISPL, undertake that if BCSPL does not make payment with regard to duly certified works delivered by SPCPL, under the contract, then AISPL shall intervene and ensure prompt payment of such dues”.
As a result of failure by Black Canyon to fulfil its payment obligation towards SPC, a demand notice under Section 8 of the Insolvency and Bankruptcy Code, 2016 (“IBC”) was issued by SPC to AIS, to which AIS responded by stating that AIS did not assume any repayment obligations towards SPC, not even in the capacity of a guarantor in terms of the comfort letter. AIS merely indicated its intention to get involved and ensure that Black Canyon complies with its payment obligation in the event of default, without assuming any repayment obligation upon itself and therefore, the contents of the comfort letter cannot be considered in a manner to impose any guarantee obligation upon AIS.
Furthermore, AIS in its response to the demand notice also referred to Section 126 of the Indian Contract Act, 1872 to assert that a contract of guarantee is a separate independent contract by itself whereby the surety consciously agrees and accepts the repayment obligations and hence, the comfort letter cannot be equated with a contract of guarantee.
Thereafter, an application under Section 9 of the IBC was filed by SPC for the purpose of initiating corporate insolvency resolution process against AIS. Upon assessment of the facts and circumstances before the NCLT, the NCLT rejected the Section 9 application of SPC as not being maintainable and held that AIS can neither be treated as a ‘corporate guarantor’ under Section 5(5A) of the IBC and neither the present nature of the debt can be regarded as an operational debt under Section 5(21) of the IBC.
In normal parlance, a letter of comfort is a letter/ document issued by the holding company or a controlling entity or promoter, for the sole purpose of providing some comfort to the entity in whose favour such comfort letter is issued, so as to ensure that the obligations and covenants involved in the transaction are fulfilled by the entity/ person bound to perform. However, it has also been witnessed in the recent past that such letters of comfort have been argued by the lenders as ‘contract of guarantee’.
Though, there is very limited jurisprudence available in relation to the enforceability of the comfort letters, however, this is not the first time that a judicial forum has opined on the enforceability of the letters of comfort. The Hon’ble Karnataka High Court in the matter of ‘United Breweries (Holding) Ltd. v. Karnataka State Industrial Investment and Development Corporation Limited and Ors. (2011 SCC OnLine Kar 4012)’ too had opined on a similar issue, wherein a comfort letter was issued by United Breweries (Holding) Limited (“UBHL”) in favour of Karnataka State Industrial Investment and Development Corporation Limited (“KSIIDCL”), for a loan availed by Dominion Chemical Industries Ltd. (“DCIL”) and upon default by DCIL in fulfilling its payment obligation, KSIIDCL had sought enforcement of the comfort letter and also a direction from the high court to the effect that UBHL shall along with the other respondents pay the debt outstanding along with the interest, jointly and severally.
Dealing with the issue of enforceability of comfort letter in the United Breweries (Supra.), the Karnataka High Court inter alia observed that the comfort letter in the present case merely states that the debtor company will meet the financial and contractual obligations and that UBHL shall take all reasonable steps to ensure that the debtor company conducts its operations efficiently to meet its obligations in the usual course of business. Hence, the comfort letter is more in the nature of recommendatory letter. The High Court further observed that if a person has not stood as guarantor or surety, he cannot be treated a guarantor or surety without there being a specific undertaking by him that he would discharge the liability of the third person, in case of his default. Relying on its observation as set out above, the Karnataka High Court held that comfort letter merely indicates UBHL’s assurance that the debtor company would comply with the terms of the financial transaction without guaranteeing performance in the event of default.
By way of this present order the Hon’ble NCLT has cleared certain level of ambiguity involving the enforceability of letter of comfort and the liability of the entity issuing such comfort letters. However, such precedent may not be used by the judicial forums to interpret the letters of comfort as not being guarantee contracts, as the difference between a contract of guarantee and the letter of comfort depends more on the facts of case, the intention of the parties and the terms set out in such document. If in a comfort letter, the issuer of the letter undertook or guaranteed the payment, then such a comfort letter can be akin to a corporate guarantee, irrespective of the nomenclature of the document. Hence, while interpreting the terms of the letter of comfort to opine the aspect of enforceability of such document, it would be required to examine and assess the intention of the parties and the actual terms set out thereunder.