What is a Comfort Letter?
A comfort letter is a document of assurance issued by a parent company or an accounting firm to reassure a subsidiary company of its willingness to provide financial support. It is an affirmation letter, not a confirmation letter, that offers backups where a customer requires a loan or a company needs financial help. The federal government may also issue a comfort letter to a borrower or supplier of a public entity to reaffirm support when obligations are not met on time.
A comfort letter is also issued by an auditor together with the preliminary prospectus, after the review of the financial statement of a company, to reassure the viability of the report before the auditing process is completed. It confirms that the information/report given is correct and that even after the review of the whole financial statement no changes are seen.
The beneficiary of the comfort letter must be entitled to a “due diligence” defense under the Security Act of 1933. The issuer should prepare and submit a registration statement and ensure that the supplier receives necessary current information for them to make a decision.
A comfort letter may be issued differently by an organization depending on its applicability to meet various needs. It may also be issued by industries, underwriters, regulated and state-controlled entities, as well as governments.
Features of a Comfort Letter
A comfort letter should be structured in a way that no unplanned legal formalities and unnecessary risks are added, and that all the statements made by the bank or organization should be valid and bear relevant facts and opinions. It should not create unplanned tax liabilities; it should always include a disclaimer, a well-detailed user of credit service, and an outline of the credit service. In addition, the comfort letter should contain a statement of awareness from the bank issuing the credit to affirm their knowledge in all the set-out obligations.
The comfort letter should state the services intended to be achieved. In such a case, the issuer should not indicate that the letter is provided as a condition precedent, but as a credit facility to be issued. Another feature is that the comfort letter does not include an expiry date but expires after the provision of the stated services. In case of continuation or where a new service is to be rendered, an original comfort letter is issued. A statement of holding is another crucial item to be considered in a comfort letter. The statement of holding should be as at the period of issuance of the letter.
Types of Comfort Letters
Comforts letters come in several types, including:
Bank Comfort Letter (BCL)
A Bank Comfort Letter is a document issued by the bank on behalf of its client(buyer) to the supplier, to assure the supplier of the financial ability and legality of the buyer in maintaining consistent trade. It is important to note that the BCL does not affirm payment, but it guarantees the seller of the stability of the buyer to fulfill their promise in conducting business. Banks issue the BCL to the supplier as an affirmation of the capability of the buyer, and it is accompanied by a signed Purchase Order or a Sales and Purchase Agreement.
A BCL creates an assurance from their client (borrower) to the lender in the purchase of large commodities or merchandise or a loan. In case the credit lending facility fails to offer a BCL on behalf of their client in the initial stage of purchasing the merchandise/mortgage, the supplier/lender will perceive the inability of the buyer/borrower to meet all the financial requirements. In such a case, the supplier/lender may reconsider getting into an agreement with the buyer/borrower.
Company’s Comfort Letter
The company issuing the letter of comfort may at times feel it difficult to accept the obligation. It is difficult for small businesses to issue guarantees. Guarantees are essential in the backup, and their services are terminated after its expiry of the agreed period. The period given enables the bank to ask for its debt payment, and if it is not paid, the bank will demand payment from the guarantee. When a company guarantees the obligations of a subsidiary’s foreign business, there is a potential of change of taxes of the parent company. Where there are liabilities incurred, the lender is not entitled as an option for the settlement of the debt.
A lot of administrative burdens are incurred in the process of issuance and control especially where the group to be issued is large. A company should ensure that the information given satisfies the bank or supplier to avoid possible risks. Clarity on the liability should be emphasized by the issuing affiliate because, at times, the letter may be misinterpreted as a promise to the lender.
Underwriter’s Comfort Letter
An underwriter ensures that the information in the letter of comfort is right. Through the help of an underwriter, liabilities to be incurred by the insurer from misstatements and financial omission can be avoided. They provide an affirmation that no failures or mistakes were made in the time the letter and investigation were being done. They give a written evidence that formal research was carried out and the information provided is accurate.
Accountant’s Comfort Letter
The accountant gives a relevant financial statement and confirms that the borrower is financially stable in comparison to the financial statement provided. An accountant provides detailed and updated financials and often, comments on the amount that may change or be subjected to a higher level of professional service. He should be satisfied with the information given in that there are no matters that would lead to change in the numbers considered in the comfort letter.
Thank you for reading CFI’s guide to comfort letters. To further your financial education regarding formal documents, we suggest the following resources will be helpful.