Withdrawal of comfort letters by parent not attackable as a transaction to defraud creditors

Kathy Stones looks at  what happens if a parent company gives a comfort letter to its subsidiary and if it can be attacked by a third party creditor if it is later withdrawn? This issues was considered in the case of  Simon Carves Ltd; Carillon Construction Ltd v Hussain [2013] EWHC 685 (Ch), [2013] All ER (D) 304 (Mar).

In this case, the claimant sought the court’s leave to bring proceedings to compel the ultimate parent company of a company in liquidation to honour a series of binding obligations which it had entered into by way of three separate letters of support. The Chancery Division, in refusing permission, decided the letters of support had not subjected the parent company to any enforceable obligation.

What did the case decide?

In summary, it confirmed that:

  1. whether or not a comfort letter is binding is a question of construction
  2. the burden of proof for establishing a transaction defrauding creditors under the Insolvency Act 1986, s 423 (IA 1986) is high.

The High Court’s decision is unsurprising and reaffirms the position that determining whether a comfort letter is legally binding involves understanding what the letter means and establishing whether the parties to it intended it to give rise to obligations binding in law. Each case must turn on its particular facts. In this case, there was no real expectation the parent company would bail out the subsidiary and meet all of the liabilities then due for payment (or falling due shortly), which totalled around £271.5m. It was significant that the comfort letters were addressed to the board of directors of the UK subsidiary and not to the subsidiary itself because the court found that their purpose was to enable the subsidiary’s directors to consider whether it was appropriate for the financial statements to be prepared on a going concern basis. In the court's view, the comfort letters did not subject the parent company to any enforceable obligation.

Here, the creditor alleged there was an agreement between the parent and subsidiary (which did have some common directors) to release the parent from all liability under the comfort letters and that this should be attacked under the IA 1986, s 423 as a transaction to defraud creditors. This allegation was unsupported by evidence and so the attack failed.

The IA 1986, s 423 is unusual in that this is one of the few transaction avoidance powers which is not limited to being only available to administrators/liquidators, but can also be exercised by a victim of the transaction (in this case the unsecured creditor).

The court found that in cases where the officeholder declines to bring proceedings to attack the transaction in question, it is not enough to simply show that the claimant is a victim, they must also demonstrate a realistic prospect of establishing that:

  1. the transaction falls within the IA 1986, s 423 and they are a victim, and
  2. there is a good reason why they should bring the proceedings even though the liquidator or administrator does not

How did the issue arise?

An Indian parent company issued three consecutive comfort letters to its UK subsidiary. The UK subsidiary had suffered multi-million pound losses for the last three years and had entered into a subcontract with the third party for installation works. In July 2011, the Indian parent withdrew its support and the UK subsidiary entered into administration, with the bulk of the business being sold under a pre-pack sale to a related company.

The claimant was an unsecured creditor of the UK subsidiary owed £12m for unpaid invoices and was encouraged to continue trading, despite the huge losses, by the existence of the comfort letters from the Indian parent.

Although the UK subsidiary’s administrators initially identified 30 potential bidders for the business, only one offer was actually made—which was later withdrawn resulting in the pre-pack sale to the related company.

The unsecured creditor made the application as a successful attack could have restored the position to what it would have been if there had been no transaction and so swell the estate available for creditors as a whole (here, unsecured creditors were otherwise unlikely to get more that 4p in the pound).

What does this mean in practice?

The decision is unsurprising and serves as a warning to creditors that they should not assume that they can rely on comfort letters from a parent company if their trading party (here, the UK subsidiary) subsequently enters liquidation or administration.

 

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