Legal Definitions - comfort letter

A comfort letter is a document that provides a level of assurance or support, typically in one of two distinct legal and business contexts: either from an independent auditor regarding financial statements in a securities offering, or from a parent company expressing support for a subsidiary.

1. In the context of securities offerings, a comfort letter is a formal statement issued by an independent auditor to an underwriter. Its primary purpose is to provide assurance that the financial information presented by a company in its public offering documents (like a prospectus for an Initial Public Offering or a bond offering) is accurate and complies with relevant accounting standards. Underwriters typically request these letters to establish a "due diligence" defense, demonstrating that they took reasonable steps to verify the financial data before offering securities to the public. This helps them mitigate potential liability for securities fraud if the financial information later proves to be inaccurate.

The level of assurance provided in a comfort letter depends on whether the financial statements have been audited or are unaudited. For audited financial statements, the auditor provides a "positive assurance," confirming their accuracy. For unaudited financial statements (such as interim quarterly reports), the auditor provides a "negative assurance," stating that based on their review, they did not identify any apparent issues or material misstatements.

• Example 1: Initial Public Offering (IPO)

  Imagine a rapidly growing software company, "CodeFlow Inc.," is preparing to go public with an IPO. An investment bank, "Apex Securities," is underwriting the offering. Apex Securities will request a comfort letter from CodeFlow Inc.'s independent auditors. This letter will assure Apex Securities that the financial figures in the IPO prospectus – such as CodeFlow's revenue, profit margins, and asset valuations – have been thoroughly reviewed and accurately reflect the company's financial position. This allows Apex Securities to demonstrate that it performed its due diligence in verifying CodeFlow's financial health before presenting the shares to potential investors.

• Example 2: Corporate Bond Issuance

  Consider "MegaCorp Manufacturing," a large industrial company, which decides to issue new corporate bonds to fund a significant factory expansion. "Global Bonds Inc." is the lead underwriter for this bond offering. Global Bonds Inc. will require a comfort letter from MegaCorp's auditors. This letter will provide assurances regarding the financial data included in the bond offering documents, particularly focusing on MegaCorp's financial stability and ability to repay the debt. If the offering includes recent unaudited quarterly financial results, the comfort letter would offer a "negative assurance" on those interim figures, indicating that the auditors reviewed them and found no material issues, while providing a "positive assurance" on the most recently audited annual financial statements.

2. In a corporate context, particularly between related entities, a comfort letter (sometimes called a letter of comfort) is a statement from one company, often a parent corporation, expressing its support for the activities or commitments of another company, typically a subsidiary. Crucially, this type of comfort letter falls short of a legally binding guarantee. It provides reassurance to third parties (like lenders, suppliers, or business partners) dealing with the subsidiary, indicating the parent company's intent to support its subsidiary, without taking on direct, full legal responsibility for the subsidiary's obligations.

• Example 1: Subsidiary Seeking a Loan

  Suppose "FutureTech Holdings," a large technology conglomerate, has a new subsidiary called "AI Innovations Ltd." AI Innovations is seeking a substantial loan from "City Bank" to develop a groundbreaking new product. Because AI Innovations is a new entity with limited independent financial history, City Bank might request a comfort letter from FutureTech Holdings. This letter would state FutureTech's commitment to supporting AI Innovations' business and its intention to maintain its financial backing, but it would explicitly avoid being a formal guarantee of the loan. This provides City Bank with a degree of confidence in AI Innovations' stability without FutureTech Holdings becoming directly liable for the loan if AI Innovations were to default.

• Example 2: Subsidiary Entering a Major Contract

  "Global Shipping Group," a major logistics provider, has a subsidiary, "Ocean Freight Services Inc.," which is bidding for a long-term contract to manage port operations for a new international trade hub. The port authority is cautious about awarding such a significant contract to a relatively new subsidiary. Global Shipping Group could issue a comfort letter to the port authority. This letter would express Global Shipping Group's strong support for Ocean Freight Services Inc. and its intention to provide ongoing operational and financial resources to ensure the subsidiary's success in fulfilling the contract. This reassures the port authority about the subsidiary's capabilities without Global Shipping Group becoming a direct guarantor of the contract's performance.