The development of trade has introduced a new atypical means of providing security currently widely used within the Mozambican legal system.
Vasco Soares da Veiga defines the comfort letter as “simple solemn affirmation, undertaken by a certain company before a Bank, in which the subscriber of that letter introduces a certain client, normally an affiliate company or a company in which the subscriber of the letter holds significant or even dominant shares or quotas, aiming at granting a credit to that subsidiary company“. Vasco Soares da Veiga, 1997 “Direito Bancário” (2ª edição revista e actualizada), Coimbra, Livraria Almedina.
Comfort letters are considered ‘atypical security’ because the Mozambican legal system does not regard them as security in line with mortgages, pledges, assignment of receivables, guarantees or suretyship. Nevertheless, they are allowed within the scope of the autonomy of the will of the parties as set out by article 405 of the Civil Code; whereby parties can conclude other contracts not provided for by law. Comfort letters are classified as personal security as opposed to real guarantees or the provision of collateral.
Provision of comfort letters have been preferred by parent companies as a means of providing security for obligations undertaken by their affiliates as their provision does not imply that such engagement is reflected on the company’s balance sheet or necessarily result in taxation implications. In some countries the issuance of comfort letters, unlike with the granting of other securities, is tax free.
There are three types of comfort letters based on level of commitment:-
- Weak Comfort Letters = are letters that contain statements stipulating the parent company’s knowledge of the credit, the company’s shareholding in the affiliated company, the solvency of the affiliated company and an explanation of the policy of the economic group within which the guaranteed/secured company falls. These letters do not include any promises from the parent company.
- Medium Comfort Letters = these letters contain a commitment from the parent company, qualified under an obligation based on means and not on results, undertaking to closely monitor the business of the secured company, ensuring affiliates continue to carry on normal business and endeavour to ensure compliance with obligations under the facility agreement. These letters can also include an obligation by the parent company to keep its shareholding in the affiliate company.
- Strong Comfort Letters = these letters contain a real obligation to pay. The parent company has to comply with the payment obligation in the event the debtor fails to do so. Since this establishes a payment obligation, it is also viewed as a suretyship.
Weak and medium comfort letters are not true personal guarantees of obligation as in the case of strong comfort letters where the parent company has to provide accurate information and comply with obligations undertaken. In weak and medium comfort letters debtor insolvency is a risk. Strong comfort letters are regarded as real guarantees of obligation because they amount to an obligation to pay; if a debtor defaults, the parent company can be held liable.
Article compiled by Célia Francisco, lawyer at CGA Advogados, LEX Africa member for Mozambique