When buying property through a limited company with a mortgage, there are different ways to give a lender security or reassurance that the loan will be repaid.
The most common method is a director guarantee, so that the mortgage will be secured against the director’s assets. Independent legal advice should always be sought when considering a director guarantee. However, in some cases, it is not possible to get a guarantee and the lender requires an alternative.
The alternative: comfort letters
This is a letter that gives ‘comfort’ to a lender, reassuring them that the company will meet its financial obligations to the lender. A comfort letter is usually used by a holding or parent company in support of a subsidiary. However, it can also be used for a party that is not directly connected to the business. Companies can also provide guarantees, but they may be prevented from doing so by their constitution, contracts or governing law in their registered country of business.
Legally binding comfort letters
A comfort letter is not usually legally binding and is not intended to be so. According to Lexis Nexis, it is rare to come across one that is legally binding. However, if a lender requires a legally binding comfort letter, a solicitor will be able to advise on the requirements. If the company issuing the comfort letter is based overseas, then it may need to consider what the governing law should be and whether that will be acceptable to the lender.
Non-binding comfort letters
A non-binding letter means that the lender will have little legal recourse to the company providing the comfort letter if the mortgage is not repaid in the agreed time. The letter instead draws on the reputational and moral authority of the company to try to satisfy the lender that the debt will be repaid.
What does a non-binding letter say?
The letter will usually be quite general in its language. Typically, the letter will set out the ownership structure and financial arrangements between the parent/holding company and the subsidiary.
If the letter is in relation to an unconnected third party, the relationship will need to be explained in more detail because the lender will need to understand the financial benefit to the company by supporting the third party. Board meeting minutes may need to be supplied, or a shareholders’ ordinary written resolution.
The company issuing the letter should confirm it is aware of the debt. If writing on behalf of a subsidiary, it should also confirm that its policy is to manage the subsidiary’s finances so that it maintains adequate financial resources and will meet its obligations. In some cases, additional reassurance may be needed, such as setting out the company’s means to repay the loan to persuade the lender that the parent or holding company has sufficient resources to satisfy the mortgage on behalf of the subsidiary.
The letter should also confirm that the letter is not intended to create legal relations between the company and the lender.
Who writes the comfort letter?
A comfort letter is best drafted by a qualified solicitor, even if intended to be non-binding. This is because a solicitor will ensure the content of the letter does not inadvertently create a legal agreement.