English High Court decides that a letter of comfort creates legal relations

Non-binding letters of comfort are sometimes used in finance transactions if the provider of the letter is unable or unwilling to provide a guarantee in relation to a loan facility but where, nonetheless, a level of assurance is sought in relation to the borrower. This case highlights that immense care must be taken when drafting these documents as, depending on the language used, they may be construed as creating legally binding obligations on the provider of the letter, with the consequence that the provider is liable for substantial sums.

In this case, the wording of the letter of comfort pointed very much towards construing the document as a guarantee and indemnity, but other cases may not be as clear cut. Wording which unambiguously conveys the intention of the parties is therefore paramount.

Background

IDBI Bank Limited (“the Bank”), an Indian bank which operates via a branch in the Dubai International Financial Centre, entered into a Credit Facilities Agreement (“CFA”) with Axcel Sunshine Limited (“Axcel”), a BVI company, under which Axcel borrowed USD 67 million from the Bank.

The USD 67 million borrowed by Axcel was transferred to Siva Industries and Holdings Limited (“Siva”), an Indian company, which used the funds to discharge previous liabilities owed by Siva group companies to the Bank, which Siva had guaranteed.

Axcel defaulted on the CFA. The outstanding liability under the CFA, including accrued interest, stood at approximately USD 143.7 million. The Bank brought proceedings to recover this amount from Siva under what was expressed to be a “letter of comfort” (“the LoC”) which Siva had provided to the Bank in relation to Axcel, on which the Bank relied as a legally binding guarantee and/or indemnity.

The LoC

The LoC was governed by English Law. Siva gave the following express assurances in the LoC in relation to Axcel (who was defined as the “Borrower” in the LoC):

Clause 3: “we do hereby irrevocably and unconditionally agree, confirm and undertake to IDBI Bank…that

(a) we shall ensure that the Borrower shall duly and punctually observe and perform all its obligations under and shall comply with all the terms and conditions of the Finance Documents… …

(c) we shall ensure repayment/payment by the Borrower of the said Facility together with interest, further interest, liquidated damages, fees, costs, charges, expenses and other monies…In the event that the Borrower has insufficient funds to meet any such obligations, we shall provide assistance to the Borrower, subject to necessary statutory approvals, to enable it to fulfill [sic] its obligations towards IDBI Bank. …”

Clause 6: “…This Letter of Comfort is irrevocable and constitutes legal and binding obligation(s) upon us, our successors and permitted assigns, and shall continue to be in full force and effect until such time as the said Facility is repaid…”

Clause 7: “…We represent, warrant, and confirm:…(ii) that we have obtained all… authorizations and taken all other actions required by law to facilitate due execution of this Letter of Comfort…”

Clause 11: “…We shall keep you indemnified against any loss or damage caused or suffered by you on account of disbursement of the said Facility to the Borrower by you, placing reliance on this Letter of Comfort and subsequent non-observance or non-adherence thereto by us…”

Siva’s defence

Siva resisted the Bank’s claim on, predominantly, two bases:

• First, it contended that the Bank had represented that the LoC was only a paper exercise (on the basis that the Bank required it solely as “an optic”, in order to fulfil a procedural requirement) and would never be used by, or relied upon, by the Bank.
• Secondly, it relied on the principle laid down by Ralli Bros v Compania Naviera Sotay Aznar (“Ralli”)². This is an exception to the general legal principle that the enforceability of a contract governed by English law is determined without reference to illegality under any other law except where contractual performance requires an act to be done in a place where it would be unlawful to carry it out. Siva contended that the case fell within this exception on the basis that performance of the LoC would contravene Indian law, namely Regulation 3 of the Foreign Exchange Management (Guarantees) Regulations 2000 (the “FEMA Regulations”) which prohibit persons resident in India from guaranteeing the debts of persons resident outside India unless the Reserve Bank of India (“RBI”) gives permission.

Decision

The case was heard before Lionel Persey KC, sitting as judge of the High Court. The judge held as follows:

(1) Was the LoC a mere paper exercise?

On the evidence before the court relating to the negotiations between the parties over the wording of the LoC, the judge held that there was nothing to suggest that the LoC was intended by the parties to be a purely paper exercise. On the contrary, he considered that the parties’ belief in the binding nature of the LoC was clear, and the LoC itself expressly stated that its contents were legal and binding (Clause 6).

As to the effect of the LoC, the judge held that it constituted both a guarantee and an indemnity. In coming to this conclusion, he had regard to previous case law, notably the case of Associated British Ports v Ferryways³, which established that the label, “letter of comfort”, is not determinative but that the effect of the document is a matter of construction of the document as a whole. Considering the wording of the LoC, he observed that it used promissory language, and that it provided for a classic “see to it obligation” which is characteristic of a guarantee (Clause 3) and that it also contained a clear promise of indemnity (Clause 11).

(2) Did the Ralli principle apply?

The judge was satisfied that the Ralli principle did not apply to this case as performance of the LoC in India would not necessarily be illegal. His decision was based on the following findings:

• Although the LoC came within the ambit of Regulation 3 on the basis that it was a guarantee, its performance was not necessarily illegal under Regulation 3 due to the lack of RBI permission because Siva could ask the RBI for retrospective permission.
• In the similar case of Ultrabulk v Jagatramka⁴ Mr Justice Teare confirmed that the FEMA Regulations do not require RBI permission before entering into a guarantee. The Gujarat High Court held that Teare J’s judgment was enforceable in India.
• The Ralli principle was recently considered by the Court of Appeal in Celestial Aviation Services v UniCredit Bank⁵ in which Lord Justice Falk confirmed that a party who can apply for a licence to allow payment under a guarantee must do so, or prove that such an application would have been in vain. Here, Siva could not show that it had attempted to obtain RBI approval or that RBI approval would necessarily be refused.
• The FEMA Regulations did not apply to indemnities.
• Moreover, under the CFA, Axcel, a BVI company, was obliged to repay the loan to an account in Dubai - and, under the LoC, Siva guaranteed this obligation. Hence, the place for performance of the LoC was not even necessarily India.

The Bank’s alternative arguments

Given the judge found in favour of the Bank on the basis of its primary arguments (as set out above), he dealt with certain alternative arguments advanced by the Bank very briefly. He held as follows:

• Breach of warranty: The LoC expressly placed responsibility for obtaining all relevant authorisations on Siva, and its failure to do so amounted to a breach of warranty.
• Misrepresentation: Siva had expressly represented to the Bank that it had obtained all authorisations required by law (Clause 7). Under section 2(1) of the Misrepresentation Act 1967, a person is guilty of misrepresentation unless they can prove that they had reasonable grounds to believe, and did believe, that the facts represented were true. Siva did not adduce any evidence as to what it believed at the time. Given that the Bank entered into the LoC on the basis that the representations made by Siva were true - and given that, but for the LoC, the Bank would not have advanced the loan to Axcel - the elements for a claim in misrepresentation were made out.
• Subrogation and unjust enrichment: If the LoC had not been enforceable, the Bank would have been entitled to resurrect previous guarantees provided by Siva in respect of company debts discharged by sums advanced under the CFA by way of subrogation. Alternatively, Siva had been unjustly enriched on the basis that the disbursement of funds by the Bank under the CFA enriched Siva by virtue of the discharge of its liability for certain debts and that, as Siva had guaranteed each of those debts, the discharge of the debts therefore reduced Siva’s obligations. Further, the package of securities for which the Bank contracted included the LoC and, if the LoC was unenforceable, then the absence of that crucial component would leave Siva substantially enriched (and the Bank out of pocket).

Conclusion

The judge awarded the Bank judgment for the sum it was claiming under the LoC, plus contractual interest up to a certain date, and statutory interest thereafter.

A version of this article first appeared in Butterworths Journal of International Banking and Financial Law in June 2025.

Authored by Daniela Vella and Alex Sciannaca.