It is common for key shareholders of companies to provide financial letters of support. These endorsements can be vital to the ongoing financial position of companies at various times. But how much consideration is actually given to the content and nature of these letters?
Before key shareholders or stakeholders provide a letter of support, they should seek professional advice as to the content and form of the letter. In certain circumstances, letters of support can be enforced by the company, as seen in a case earlier this year in the Victorian Supreme Court.
In Newtronics Pty Ltd v Atco Controls Pty Ltd, Atco (the parent company of Newtronics) had provided a range of letters of support to the auditors of Newtronics, promising not to call on secured debt owed by Newtronics to Atco, and to provide financial assistance to Newtronics to enable the company to meet its obligations and trading debts.
In 2001, Atco demanded immediate repayment of its secured debt. Newtronics was unable to repay its debt to Atco and receivers and managers were appointed, who sold Newtronics and its assets to a third party. Following the sale, Newtronics was unable to satisfy the judgment debt and was placed into liquidation.
Newtronics then sued Atco on the basis that the substantial financial assistance provided by Atco, as well as the numerous letters of support given by Atco, created contractual obligations for Atco to support Newtronics and not call on its secured debt to the detriment of unsecured creditors.
The Court held that the letters of support were created to enable the accounts of Newtronics to be prepared on a "going concern" basis each financial year and that the directors of Atco were aware of the legal and commercial consequences of providing these letters to Newtronics' auditors. The context in which the letters were provided supported the finding that these letters included the essential terms of an agreement by Atco to provide financial support to Newtronics and to subordinate its debt to that of Newtronics' other unsecured creditors. As a result, the Court held that Atco breached its contractual obligations by demanding repayment of its secured loans.
This decision has a commercial impact on those who provide letters of support. This is because in certain circumstances the terms of a letter of support may create, or evidence the creation of, contractual obligations which may be enforceable against the person providing the letter according to the terms of the letter.
Consideration of this matter is timely, as the end of financial year has just passed, and key shareholders or stakeholders often provide letters of support to a company's auditor in preparing and finalising the company's end of financial year accounts and audit report.
If, in the future, you are considering providing a letter of support regarding the financial position of a company, we would urge you to consider the terms of the letter carefully, and where appropriate, seek professional advice to make sure that you are fully aware of the implications of providing the letter.
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