I. Liability after issuing a hard external letter of comfort

Letters of comfort have been popular means of securing for a long time, especially in the context of group financing. Depending on whether a legally enforceable liability of the patron for the liabilities of the beneficiary company should be established or not, a distinction is made between hard and soft letters of comfort.
The hard letter of comfort establishes a contractual commitment of the patron towards the addressee of the letter. By the letter the patron assumes, either in the internal relationship with the beneficiary company (so-called internal letter of comfort) or in the external relationship with the company’s creditors (so-called external letter of comfort), the obligation to provide the beneficiary company – which is usually an affiliate of the patron – with sufficient means to always fulfill its financial obligations.
The hard external letter of comfort is a means of security comparable to sureties or guarantee bonds. The advantage of this letter over the sureties or guarantee bonds is the fact that outside insolvency the patron may freely decide in which way it will fulfill its obligation. In the case of insolvency the patron’s obligation for providing financial means to the beneficiary company becomes an obligation to direct payment to the addressee of the letter of comfort. The legal basis for this direct claim is a claim for damages of the beneficiary creditor against the patron, which is based on the patron not having fulfilled its obligation to provide financial means for the affiliate accepted under the letter of comfort (as otherwise the affiliate would not have become insolvent).

II. Risk of double claims; decision by the BGH as of 12 January 2017

In the case of a hard letter of comfort the patron bears the risk that funds provided by it to the affiliate are for whatever reason not used by the affiliate to settle the beneficiary creditor’s claims. If the affiliate does not use the provided funds to meet the beneficiary creditor’s claims or if other creditors seize the provided means, the beneficiary creditor may continue to raise claims against the patron.
The same holds – as recently decided by the BGH (decision as of 12 January 2017 – XI ZR 95/16, ZIP 2017, 337 seq.) – if the affiliate uses the provided funds as intended to meet the beneficiary creditor’s claims, but the affiliate becomes insolvent at a later stage and the creditor has to pay back the payments received by the affiliate into the insolvency assets after a successful challenge by the insolvency administrator.
In the case decided by the BGH the creditor of one of the defendant’s affiliates, a gas supplier, demanded the fulfillment of the affiliate’s payment duties by the parent company. The parent company had declared to the gas supplier on 12 June 2007 that it obliged itself to provide its affiliate “with the financial means required to fulfill the affiliate’s contractual obligations according to the agreed payment plan”. As agreed, the obligation period was limited until 15 August 2007. The parent company duly fulfilled its commitment under the letter of comfort within the agreed term. As the affiliate only partially fulfilled its payment duties towards the gas supplier in the time following, the supplier stopped its deliveries to the affiliate on 18 September 2009 and, finally, the affiliate became insolvent. Some of the payments made by the affiliate to the gas supplier were successfully challenged by the insolvency administrator so that the gas supplier had to pay back these payments into the insolvency assets.
The gas supplier filed a suit in which it demanded the payments from the parent company based on the letter of comfort and was successful. The BGH interpreted the declaration of the parent company as a hard letter of comfort. The gas supplier was therefore entitled to demand direct payment from the parent company after the affiliate had become insolvent. The fact that the parent company had duly fulfilled its duties within the term of the letter of comfort did not work in favor of the parent company from the BGH’s perspective. According to the BGH, the patron’s obligation to provide its affiliate with the financial means required to fulfill its contractual obligations cannot be deemed complied with if the payments made by the affiliate using the funds provided by the patron are successfully challenged by the insolvency administrator. The parent company would then be liable for damages as the gas supplier’s receivables had become uncollectable within the scope of the successful challenge. The BGH also dismissed the defendant parent company’s point that it could no longer be charged at the time of the suit on the basis of the letter of comfort due to its limitation: the limitation agreed upon could not be interpreted in that manner that the patron would only have to fulfill its obligation during the period of the letter of comfort. Instead, the patron would also after the expiry of the agreed term have to be fully liable for the liabilities established in the period covered by the letter of comfort.
As a result the parent made the payment twice: once for its affiliate via means of internal provision and once to the gas supplier in order to fulfill its liability for damages.

III. Conclusions for the application in practice

This result, which obviously turned out unfortunately for the parent company, could have been avoided if the parent company had been properly advised on issuing the letter of comfort and on fulfilling its obligations arising from that letter. It is possible to issue a letter of comfort that rules out any liabilities of the patron after the termination of the limited period – even for liabilities established during the period covered by the letter of comfort. Of course, in most cases creditors will not agree to these limitations. In such a case it should then at least be secured that the patron makes the required payments directly to the creditor instead of providing the required funds to the affiliate. Direct payments by the patron may be made even without an according provision in the letter of comfort, even though it is advised that an according provision is included as a precaution. In order to reduce any risks which may cause a challenge (and any insolvency application arising from that) it is advised that as a precaution the patron waives the right of recourse against the beneficiary affiliate which results from the direct payment.