Letter of Comfort: Definition, Uses, Vs. Guarantee

What Is a Letter of Comfort?

A letter of comfort—also known as a letter of intent or a solvency opinion—is a written document that provides a level of assurance that an obligation will ultimately be met. In its traditional context, a letter of comfort is given to organizations or persons of interest by external auditors regarding statutory audits, statements, and reports used in a prospectus. The letter of comfort will be attached to the preliminary statements as assurance that it will not be materially different from the final version.

Understanding a Letter of Comfort

In practical uses, letters of comfort are often issued by auditors to lenders as solvency opinions on whether a borrower can meet the payment obligations of a loan. They are opinions, not guarantees, that the underlying company will remain solvent.

Letters of comfort can also be issued to underwriters as an obligation to carry out "reasonable investigation" into offerings of securities. These letters of comfort will ensure that the reports conform to generally accepted accounting principles (GAAP). This helps the underwriter better understand aspects of the financial data that might not otherwise be reported, such as changes to financial statements and unaudited financial reports.

Yet another broad category of letter of comfort application is the parent company to a subsidiary entity. Whereby a parent company can issue a letter of comfort (also known as a keepwell agreement) on behalf of a subsidiary that needs to borrow from a bank in its locale or provide a letter to a supplier of a subsidiary that wishes to transact a large purchase order of raw materials.

Benefits of a Letter of Comfort

Two parties in a business deal can use a letter of comfort to put in writing the outline of the terms of their deal. Most major business transactions require a lot of time on management's part to perform due diligence before they can finalize a deal. A letter of comfort can summarize the steps each party agrees to take to ensure the successful completion of the transaction. A well-written letter of comfort can assure each party that the time spent on completing these tasks will be well worth the effort.

Although the letter of comfort is not binding between the two parties, it may have binding provisions. The letter of comfort provides an opportunity for the two parties to clearly spell out these binding provisions. For example, a binding provision might state that one party owes the other party a sum of money should it decide to pull out of the deal. This sum of money might be equal to the costs incurred by the party who has not left the deal.

A letter of comfort might also include binding provisions regarding confidentiality stipulating what the parties may or may not divulge to outside parties regarding the transaction. A letter of comfort can have a wide range of binding provisions, including ones regarding non-competition or the hiring of certain executive employees should the deal go through.

A letter of comfort can also enhance a company's ability to obtain much-needed funding. If a reliable, third-party attests to the company's capacity to repay a loan, the company can present this statement to the lending institution as evidence of its creditworthiness. While the lending institution will consider many factors in its decision, a persuasive letter of comfort can be a critical factor on the company's behalf.

Special Considerations

A letter of comfort is typically couched in vague wording, in order to prevent the issuer from being saddled with a legally enforceable obligation. In many cases, a letter of comfort creates a moral obligation for the issuer rather than a legal one.

Companies generally do not furnish letters of comfort unless absolutely necessary. This is because in the worst-case scenario the company may be on the hook financially should an unexpected situation occur. For example, if a subsidiary is unable to repay a debt, the parent company may either be liable for the full amount if the letter of comfort was poorly worded, or may have to incur expensive legal fees to prove that its letter of comfort was not a tacit guarantee of its subsidiary's payment obligation.