In a ruling issued in January 2017, the German Federal Court of Justice (“Bundesgerichtshof, BGH“) has once again extended the scope of liability for a so-called “hard” letters of comfort.
The plaintiff supplied the subsequent insolvency debtor, a subsidiary of the defendant, in the context of a continuous contractual obligation with gas. In order to secure the payments, the defendant gave the claimant a statement, inter alia. with the following content:
“We, the sole shareholder of [the subsequent insolvency debtor], hereby undertake to provide the [subsequent liquidator] with the necessary financial resources to comply with the contractual obligations in accordance with the payment plan agreed with your home. The present letter of comfort is limited in time until 15.08.2007. ”
After submission of this statement, the plaintiff continued to provide and was – at least partially – also paid by the later insolvency debtor. However, after the commencement of insolvency proceedings, the insolvency administrator successfully avoided these payments. The plaintiff then re-claimed respective amounts from the defendant under the conditions of the letter of comfort.
The BGH initially viewed the statement of the defendant as a so-called “hard” letter of comfort.
Depending on whether the patron either wants to indeed be legally bound with regard to the ability of the debtor to perform or the statement bears only a non-binding character, it is called a “hard” or “soft” letter of comfort. “Soft” letters of comfort are given, for example, to demonstrate the support of the parent company for certain (future) projects. However, such letters shall not create a legal obligation to provide the subsidiary accordingly; they are pure declarations of “goodwill”.
On the other hand, a “hard” letter of comfort as construed here by the BGH stipulates that the patron has a legal duty to the addressee of the declaration. The patron undertakes, either internally or in relation to its subsidiary, or externally vis-à-vis its creditors, to provide the subsidiary with the appropriate means to constantly meet its financial obligations.
According to the BGH, the obligation to provide the subsidiary in such a way that it always meets its financial obligations is actually not met if the means transferred through the subsidiary within a cash-flow system and paid to the addressee prove to be voidable in later insolvency proceedings. Then, the defendant is liable for damages because the claim of the addressee proves to be irrecoverable to the extent it is voidable. Therefore, the external letter of comfort granted by the parent company to the creditor of its subsidiary turns into a direct payment obligation to the subsidiary following the insolvency of the subsidiary.
Referring to the terminability of a letter of comfort explained in a judgment rendered in 2010, the BGH further points out that a limitation of the letter of comfort is in principle admissible. However, the patron cannot escape the requirement to provide the subsidiary with sufficient liquidity for the period of the effectiveness of the letter of comfort by the limitation or termination of the letter of comfort. Rather, he has to pay for all liabilities incurred during the term of his declaration, even subsequently.
Advice for the practice
The BGH’s decision clarifies the potential risk of double payment for the patron: if, in addition to the letter of comfort, he also provides the subsidiary with direct funds to settle the invoices, he bears the risk of having to pay again if the insolvency administrator successfully challenges the forwarded payment.
Although not all avoidance risks may be excluded, at least in the constellation described here, the parent company may be offer a direct payment of the liabilities of the subsidiary to the addressee. The resolution also underlines the need for a comprehensive restructuring plan – even if only to minimize the risks of avoidance in the event of a failed turnaround.