Olswang Cover Letter

The High Court has decided that letters of support provided by a parent company did not have contractual force. The letters did no more than provide the directors of the subsidiary with evidence from which they could confirm that the subsidiary’s accounts should be prepared on a going concern basis.

The facts

The subsidiary had entered into two contracts with a subcontractor, which had carried out works under the contracts and submitted invoices to the subsidiary. The subsidiary went into administration without paying the invoices, and its business and assets were sold in a pre-pack to another group company. Unsecured creditors like the subcontractor received only a nominal amount.

Over the three years preceding the pre-pack the subsidiary’s parent company had provided three brief letters to the subsidiary’s directors confirming that the parent would provide the necessary financial and business support to the subsidiary to ensure that it continued as a going concern. The subsidiary’s accounts over that period had been prepared on a going concern basis, and for the last two years had stated that this was based principally on the letter of continuing financial support from the parent company. Each of the letters was addressed to “The Board of Directors, Simon Carves Limited”.

The subcontractor claimed that the three letters had created obligations that were enforceable by the subsidiary against the parent, and that the failure to enforce them was a transaction defrauding creditors.

Decision

The judge rejected the subcontractor’s claim and found that:

  • the fact that the letters were addressed to the board of directors, and not simply the subsidiary, was deliberate.
  • it was significant that the letters were provided in the course of the preparation of the subsidiary’s accounts. The obvious purpose of the letters was to enable the directors (and the auditors) to determine whether the financial statements could be prepared on a going concern basis.
  • it would be extravagant and improbable to conclude that the parent had committed itself so casually in the letters to restore the subsidiary to balance-sheet solvency. In one of the years this would have required the parent to discharge liabilities of the subsidiary amounting to £271.5 million.

On the question of whether there was a contract between the parent and the subsidiary - or even its directors - the judge could find no consideration passing from the subsidiary in return for the assurance of financial support. He said that the fact that the subsidiary may have relied on the letters to continue trading was not consideration.

Comment

For a letter of support to create a binding legal commitment, the normal contractual requirements of offer and acceptance, consideration, certainty as to terms and intention to create legal relations will need to be satisfied.

Whether or not a document does or does not contain a contractually-binding promise is a matter of interpretation. The wording of the letters was stronger than the formula often used in non-binding letters of comfort, which would usually go no further than saying that it is the parent company’s present policy to ensure that its subsidiary is in a position to meet its liabilities. It might be surprising to some directors that the letters were not enforceable by the subsidiary, and some might not have been comfortable to confirm a company’s going concern status based principally on a non-binding assurance. Expert evidence given in the case suggested that some auditors would have regarded the letters as binding.

Interestingly, the fact that the letters of support were addressed to the subsidiary’s directors was an important factor in the judge’s decision – despite the fact that it is common practice for letter agreements to be addressed to the directors as agents of the company and for the terms of such letter agreements to be accepted by a director on behalf of the company upon signature.

For more information, see Re Simon Carves Ltd sub nom Carillion Construction Ltd v Hussain and others

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