Letter Of Comfort Meaning Sample Example In Banking

Letter Of Comfort Meaning

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Obtaining the letter helps individuals or businesses gain trust and prove creditworthiness in the eyes of parties with whom they are dealing and obligated. The letter includes a declaration of holding and awareness, a disclaimer, and credit service details. Even though it confirms the individual’s or firm’s financial stability before entering into a transaction, it does not guarantee payments or repayments.

Key Takeaways

A letter of comfort (LoC) is a document issued by a third party that certifies the borrower’s ability to meet its financial or contractual commitments against the lender. External auditors, such as accountants, underwriters, corporations, banks, and governments, can provide lenders with LoC. The letter, also known as a keepwell agreement, assists individuals and enterprises in obtaining trust and demonstrating trustworthiness in the eyes of those with whom they are working and obligated. A comfort letter is more of one party’s moral duty than a legally binding vow and generally includes terms for non-competition, secrecy, or compensation.

Letter Of Comfort Explained

A letter of comfort (LoC) ensures that the obligations of a party will be ultimately fulfilled under a contract. It typically includes non-competition, secrecy, or compensation if one party quits the deal. However, it does not have an expiry date. Its origin dates back to the 1980s, giving lenders some reassurance about the borrower’s financial position.

External auditors Auditors An auditor is a professional appointed by an enterprise for an independent analysis of their accounting records and financial statements. An auditor issues a report about the accuracy and reliability of financial statements based on the country’s local operating laws.read morecan issue LoC to lenders, such as accountantsAccountantsAn accountant is a finance professional responsible for recording business transactions on behalf of a firm, reporting the firm’s performance and issuing financial statements. Thus, an accountant plays an important role whether it is a small domestic entity or a large multinational company.read more, underwriters, corporations, banks, and governments. Also known as a keepwell agreement, it can be a part of the initial public offeringInitial Public OfferingAn initial public offering (IPO) occurs when a private company makes its shares available to the general public for the first time. IPO is a means of raising capital for companies by allowing them to trade their shares on the stock exchange.read more, loans, or mortgages. It can be treated as a letter of intentLetter Of IntentA letter of intent, also known as LOI, is a preliminary contract containing key terms of a prospective business deal between two or more parties. It is common in business transactions, for example, the sale, purchase, merger, or formation of a joint venture. read more in some cases or as a solvencySolvencySolvency of a company means its ability to meet the long term financial commitments, continue its operation in the foreseeable future and achieve long term growth. It indicates that the entity will conduct its business with ease.read more opinion in a few. However, it does not guarantee that the company will remain viable or the party will make the payment.

#1 – In Business

When a company needs to start a project but does not have enough cash on hand, a comfort letter can help. The letter confirms the company’s trustworthiness to the lending institution in repaying a loan. Furthermore, it is usually a financial document establishing a parent company’s commitment to providing its subsidiary with the resources it needs to meet its financial obligations or get credit.

#2 – In Banking

In the case of banks, LoC refers to a written document that assures the lender that its client is financially capable enough to meet its financial obligations. It also confirms that the client has access to short-term financing to complete the transaction. LoC guarantees the financial stability of an individual or firm. However, it does not serve as an assurance for payment. It only ensures that a person or firm can pay its share of obligation financially.

#3 – In Accountant

An accounting firm may also give underwriters a LoC to research new securities offerings. A certified public accountant issues the letter to certify that the financial statementsFinancial StatementsFinancial statements are written reports prepared by a company’s management to present the company’s financial affairs over a given period (quarter, six monthly or yearly). These statements, which include the Balance Sheet, Income Statement, Cash Flows, and Shareholders Equity Statement, must be prepared in accordance with prescribed and standardized accounting standards to ensure uniformity in reporting at all levels.read more do not contain misleading or inaccurate information. It also assures that the financial statements comply with widely accepted accounting principlesAccounting PrinciplesAccounting principles are the set guidelines and rules issued by accounting standards like GAAP and IFRS for the companies to follow while recording and presenting the financial information in the books of accounts.read more (GAAPGAAPGAAP (Generally Accepted Accounting Principles) are standardized guidelines for accounting and financial reporting.read more).

Features

The comfort letter is not a legally binding commitment. Instead, it is a third-party assurance of one party’s financial ability to meet its financial obligations to another. It, thus, is a moral rather than a legal obligation for the borrower.LoC assists individuals and businesses in gaining trust and demonstrating trustworthiness in the eyes of those with whom they are dealing and obligated.It lays down the contract conditions and steps to complete the transaction successfully.

Types Of Comfort Letter

The entities that issue comfort letters are divided into the following categories:

#1 – Banks

The bank issues the LoC to the supplier, confirming that their client is financially secure enough to participate in and maintain the trade. However, the letter of comfort in banking does not guarantee the payment but only assures the capability of the borrower to pay the lender for their services. It often includes a purchase orderPurchase OrderA Purchase Order (PO) serves as a legal document between buyer and seller, wherein, the buyer sends this contract that details the goods and services, date of delivery, payment terms as per the contract etc.read more or sales and purchase agreement.

#2 – Accountants

An accountant provides the required financial statement to confirm a borrowers’ financial stability to be consistent enough to meet their financial obligations. In addition, the accountant offers extensive updates on the financial situation of the concerned person and comments on the amount that is subject to change or requires professional attention.

#3 – Companies

Companies issue LoC when it is difficult for them to assume an obligation. In short, it acts as a guarantee on behalf of businesses, ensuring that they will be able to meet whatever obligations they may have.

Assume that the agreed-upon deadline for meeting the obligation indicated in the comfort letter has passed, and the company involved has failed to reimburse. The bank has the right to demand payment from the guarantor in this scenario.

#4 – Underwriters

An underwriterUnderwriterAn underwriter is an individual or an institution who is involved in the act of underwriting the issue of securities of a company for a fee.read more ensures the accuracy of the information provided in the LoC. It also ensures that misstatements and financial mistakes do not result in liabilities for insurers. In addition, it confirms that accurate information and comprehensive research are provided, resulting in no failures or errors.

#5 – Governments

In the federal government’s case, an LoC assures the lender, usually a public enterprise, that the obligation will be met on time.

Example

Let us consider the following letter of comfort example to understand the concept better:

Supplier A required confirmation of company C’s financial viability before signing the sales and purchase agreement. It ensured that there would be no late payments in compensation for the services provided. As a result, the bank issued a comfort letter as an assurance document, ensuring the company’s financial stability to pursue the new agreement.

Template

Below is a letter of comfort sample, indicating the format followed to prepare the LoC:

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