Letters of comfort have been floating in the banking sector for quite some time now and are increasingly becoming part of the security package for many lenders. As a distant cousin of the traditional guarantee, letters of comfort (“LOCs”) provide a middle ground for the borrower and lender in terms of affirming and assuring the financial soundness of the borrower to repay its debt(s).
Although prima facie both guarantee and letter of comforts are intended as a reassuring instrument, it depends on the circumstances of the case and the wording of such instrument to ascertain as to what rights and obligations stem from such instrument. It is very common to often confuse or mix up letters of comfort with guarantees and the most recent case of the same is Yes Bank Ltd vs Zee Entertainment Enterprises Ltd & Ors1. In the present article, we analyze this case and set out the principles laid down by the Hon’ble Bombay High Court.
FACTS OF THE CASE
Living Entertainment Limited (“LEL”), ATL Media Ltd (“ATL”), Veria International Ltd (“VIL”) were wholly owned subsidiaries of Zee Entertainment Enterprises Ltd (“Zee”). LEL and ATL had a separate put option arrangement between them under a put option agreement dated 20th January 2016 pursuant to which LEL could compel ATL to take up LEL’s holdings in VIL thereby infusing flow of funds into LEL. Yes Bank Limited (“YBL”) granted a loan of USD 50 Million to LEL under a Facility Letter dated 30th March 2016 and Facility Agreement dated 8th June 2016. As part of its security package, the put option agreement was assigned to YBL thereby entitling YBL to exercise the put option (upon occurrence of any event of default) against ATL to buy out LEL’s equity holding in VIL, thereby putting funds in LEL with which it would repay YBL.
Additionally, YBL obtained a letter of comfort dated 31st May 2016 (“Zee LOC”) from Zee wherein Zee prima facie undertook to support ATL by infusing equity / debt for enabling it to inter alia meet all its working capital requirements, debt requirements, business expansion plans, put options etc.
Thereafter, LEL defaulted in payments and some other defaults such as dilution in promoter holding, insufficient DSRA etc., were also committed under the said facility agreement. Accordingly, YBL sent enforcement notices at different intervals demanding repayment of the debt amounts and invoking the put
option. YBL also issued 3 (three) letters (November 2019, January 2020 and March 2020) to Zee asking Zee to honour its obligations under the Zee LOC. YBL stated that the Zee LOC was akin to an absolute, irrevocable and unconditional guarantee and that Zee had a direct pecuniary liability under the same. In its reply, Zee disputed its liability as an alleged guarantor. It further said that there was no privity of contract ipso facto between Zee and YBL and that the Zee LOC was signed merely to keep ATL in liquidity.
Whether the Zee LOC can be fairly read to be a ‘guarantee’ furnished by Zee to repay facility extended by YBL to LEL?
The Hon’ble Bombay High Court vide its order dated 19th August 2020 (“said Order”) dismissed YBL’s interim application that sought enforcement of the Zee LOC as a guarantee basis the following reasons:
- As per Section 126 of Indian Contract Act, 1872 a contract of guarantee is a contract to perform the promise, or discharge the liability, of a third person in case of his default. A guarantee creates a very specific type of obligation. The Zee LOC did not in any way on the face of it, result in Zee assuming, assuring or guaranteeing the repayment of YBL’s loan to LEL. Instead, it provided for a means to facilitate the enforcement of security that YBL took. It was just a ‘confirmation’ by Zee that it will ‘support’ ATL, if needed.
- It is true that a document has to be read for its intent and construed as a whole in context of related documents but at the same time an impressionistic broad approach, especially where the terms are pretty much clear and unambiguous, is equally impermissible. There is absolutely no scope for adding or subtracting words just for a convenient outcome.
- The Court relied on United Breweries (Holding) Ltd. Vs. State Industrial Investment & Development Corporation Ltd. wherein the Karnataka High Court relied upon the definition of ‘Letter of Comfort’ under P Ramanatha Aiyar’s Advanced Law Lexicon which states that a Letter of Comfort means a document that indicates one party’s intention to try to ensure that another party complies with the terms of a financial transaction without guaranteeing performance in the event of default.
- A guarantor is liable only to the extent of his guarantee and not beyond. He cannot be made liable for more than what he has undertaken. Under the Zee LOC, Zee might have the liability to put ATL in sufficient funds for the put option to work but that is not the same as LEL’s debt to YBL. The two obligations are entirely different in nature and scope.
The saga of LOCs and guarantees has once again been settled in the present case. Although a fairly common practice, lenders should not mistake LOCs as a replacement of guarantees. A guarantee under Indian law requires a commitment or the assumption of obligation to pay off the debt of another upon default. The guarantor stands surety for the repayment of the debt. If the debtor fails to repay, the creditor need not look any further than the surety or guarantor.
Few points that should be kept in mind while undertaking financial transactions as per the said Order when dealing with LOCs vis-à-vis guarantees have been summarized below:
- A letter of comfort may indeed amount to a guarantee in some cases, however not every letter of comfort is ipso facto a guarantee. The nomenclature is unimportant. In such cases, the substance prevails over the form. Whether the document in question is a guarantee or not depends upon the exact terms to which the guarantor binds himself. In law, no guarantor is liable for more than what the guarantor has undertaken.
- The ordinary rules of construction and interpretation relating to contracts apply to LOCs.
- A document is to be construed as a whole in a reasonable commercial sense and in context of events and other associated documents but ultimately to be treated as a ‘guarantee’, it must conform to the provisions of Section 126 of the Indian Contract Act 1872.
- Where the terms of a written contract are unambiguous and clear, they cannot be altered by addition or subtraction. The terms of a written guarantee cannot be so altered to foist on a party a liability beyond that which the party has undertaken. The contract cannot be rewritten at the instance of one party.
- The conduct of the parties is a relevant factor in assessing the construction of any contract. However, broad allegations of commercial infidelity, immorality or amorality do not have much role to play in the construction of commercial contracts.
1 LD-VC-IA NO. 01 OF 2020 IN LD-VC- SUIT NO. 120 OF 2020
Originally published by Dhaval Vussonji & Associates, September 2020
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.