Letters of support

Parent company guarantees provide protection in case a subsidiary fails in its contractual obligations. Sometimes as an alternative, a generally worded letter of support which confirms that a group’s policy to ensure its subsidiaries are able to meet their liabilities may be used. But how good is this alternative? It was recently tested in a case brought by a subcontractor, Carillion Construction.

Carillion invoiced its client Simon Carves Limited (SCL) for £12 million for work carried out under contract. SCL was suffering from financial difficulties and its parent company provided three letters of support to SCL’s directors, but three months later withdrew this support citing prevailing market conditions. SCL went into administration. Carillion applied to the court for a declaration that the letters constituted binding obligations upon the parent company to financially support SCL.

The Judge held that there was nothing in the letters of support to make them legally binding. They did not purport to be contracts and there was no provision for them to be accepted by SCL’s directors, as would be expected in the case of a binding letter of support. The fact that SCL may have relied upon the letters to continue trading did not amount to a contractual undertaking. Their true purpose was nothing more than to provide evidence that SCL’s accounts should be signed off as a going concern.

For a letter of support to be legally binding, the usual contractual requirements all need to be satisfied - namely offer and acceptance, consideration, certainty as to terms, and intention to create legal relations. Recipients need to look behind the letter of support to ascertain whether the parent company is likely to continue to provide support and they should probably also obtain a qualified audit report to back this up.

The wording used in PLL’s letters of support was stronger than usual, which may have given the impression that they were binding. However, the Judge’s decision implies that the only way to be confident that the security is legally binding is to enter into a properly drafted parent company guarantee or bond.