Comfort Letters Unenforceable, But May Give Rise to Damages

Comfort Letters Unenforceable, But May Give Rise to Damages

Contributed by Gárdos, Füredi, Mosonyi, Tomori

September 25 2009

The Arbitration Court of the Chamber of Commerce and Industry has recently issued an ambiguous decision about the legal nature of comfort letters.

Comfort letters, although not regulated by Hungarian law, are often used in financial transactions, sometimes even by the state or its agencies. Banks often rely on comfort letters in the absence of more tangible security, particularly where the debtor's parent company is considered more creditworthy than the debtor itself. International practice distinguishes between so-called 'hard' and 'soft' comfort letters on the basis of the definiteness of the undertaking. However, soft comfort letters, whereby the issuer refrains from giving express assurances regarding its intentions, are uncommon in the market. In general, financial institutions in Hungary expect a subsidiary's parent company to make a commitment to use its best efforts to ensure that the subsidiary performs the obligations arising from the underlying credit agreement. The issuer may undertake more specific obligations in exceptional cases.

The court examined the legal nature and effects of comfort letters. It found no uniform, Europe-wide interpretation of the legal nature of comfort letters - some cases imply that undertakings in comfort letters are legally binding, whereas in others the courts have stated that comfort letters give rise merely to a moral responsibility.

The arbitration court ruled that comfort letters in the form of unilateral undertakings are unenforceable because the Civil Code states that the performance of a unilateral undertaking can be enforced only in cases expressly provided for by law, in which case the laws of contract apply. As a letter of comfort is not a regulated legal instrument, it cannot be enforced.

However, the court went on to examine whether an issuer of a comfort letter may be liable in tort. Considering the present case, it stated that as the issuer owned the debtor, it had a direct interest in its successful operation. The issuer was aware that credit was a precondition of such successful operation and it had precise information about the debtor's creditworthiness. The court concluded that issuing a letter of credit in such circumstances may give rise to damages. Furthermore, it found the issuer liable for failing to comply with its obligations in the comfort letter. In reaching this view, the court attached great importance to a provision in the comfort letter whereby the issuer submitted any dispute arising from the letter to arbitration.

The effect of the judgment is difficult to assess. Parties are usually aware that comfort letters do not create enforceable obligations and the reasoning underlying the ruling is correct – on a literal analysis – in referring to the fact that performance of such unilateral undertakings cannot be required. However, the reasoning in resect of the issuer's liability is harder to understand. The court stated that the issuer was tortiously (ie, noncontractually) liable, but the reasoning was based on the fact that the issuer breached the obligations in the comfort letter. Therefore, it is unclear whether the comfort letter created an undertaking and whether the issuer's liability was based on breach of contract or in tort.

There are strong grounds to believe that soft comfort letters indicate merely a moral undertaking by the issuer, which does not create enforceable obligations and may give rise to tortious liability only in exceptional cases.

For further information on this topic please contact Péter Gárdos at Gárdos, Füredi, Mosonyi, Tomori by telephone (+36 1 327 7560), fax (+36 1 327 7561) or email (gardos.peter@gfmt.hu).

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