A comfort letter, also known as a letter of comfort or a letter of support, is a document issued by a third party, usually a parent company, bank, or financial institution, to provide assurance or support to another party, typically a lender or investor, regarding the creditworthiness, performance, or financial obligations of a borrower or subsidiary company.
Comfort letters are often used in business transactions, such as debt or equity offerings, bank loans, or mergers and acquisitions, to mitigate the perceived risk associated with the borrower or subsidiary company. While a comfort letter provides a degree of confidence, it does not constitute a legally binding guarantee or commitment to fulfill the obligations of the borrower or subsidiary.
The content and format of a comfort letter can vary depending on the specific circumstances and the parties involved. However, common elements in a comfort letter may include:
- Confirmation of the relationship between the third party (e.g., parent company or bank) and the borrower or subsidiary company.
- A statement expressing support or confidence in the borrower or subsidiary company’s ability to meet its financial obligations or perform under the terms of the transaction.
- Information about the financial position, creditworthiness, or operating performance of the borrower or subsidiary company.
- Acknowledgment of the transaction details, such as the loan amount, interest rate, or securities offering.
While comfort letters do not offer the same level of assurance as a guarantee or a legally binding commitment, they can still provide a measure of confidence to lenders, investors, or other stakeholders, and may help facilitate business transactions or secure financing.
Example of a Comfort Letter
Let’s consider a hypothetical example to illustrate the concept of a comfort letter.
Imagine there is a company called XYZ Corp, which is a subsidiary of a larger parent company called ABC Group. XYZ Corp wants to issue bonds to raise capital for a new project. However, due to its limited operating history and relatively weaker financial position, potential investors are hesitant to purchase the bonds.
To alleviate investors’ concerns and facilitate the bond issuance, ABC Group, as the parent company, decides to provide a comfort letter in support of XYZ Corp. The comfort letter may contain the following information:
- Confirmation that XYZ Corp is a subsidiary of ABC Group and a description of their relationship.
- A statement expressing ABC Group’s confidence in XYZ Corp’s ability to meet its financial obligations related to the bond issuance.
- Information about XYZ Corp’s financial position, creditworthiness, or operating performance, as well as the financial strength and backing of the parent company, ABC Group.
- Acknowledgment of the bond issuance details, such as the bond amount, interest rate, and maturity date.
While the comfort letter does not constitute a legally binding guarantee that ABC Group will cover XYZ Corp’s obligations if it fails to repay the bonds, it provides a degree of assurance to investors that the parent company stands behind its subsidiary. As a result, investors may feel more comfortable purchasing the bonds, allowing XYZ Corp to successfully raise the capital needed for its new project.
This example demonstrates how a comfort letter can help mitigate concerns and facilitate business transactions, even in cases where one party may have a weaker financial position or limited track record.