What Is A Commitment Letter

The following essay has been divided into three parts. In the first part an attempt is made to understand what a commitment letter is? Further the second part would include the issue of a fixed and a floating charge over book debts and whether in this given situation it is a floating charge or a fixed charge over book debts. In the third part the issue of priority over future property and loan advanced for acquisition, would be discussed.

First issue:

Commitment letters are legally binding instruments and are also known as letter of intent. Generally, signed between the lender and a borrower in order to make commitment regarding the loan agreement and the body of the commitment letter include specific terms and conditions for the loan agreement. It can also be said to be an offer from the lender to the borrower of the loan. [1] Neil M. Kaminsky [2] says that, a commitment letter is an achievement of dialogues and discussions, by a lender with a prospective borrower. Kaminsky further says that, the commitment letter lays down the necessary terms and conditions for the loan and also determines the nature of the prospective loan. According to him, commitment letter in the outline of law can be termed as a kind of agreement which initiates a proper official process for loan borrowing. It also contains clauses regarding to expenses rising from diligence, administrative processes and the syndication cost. Commitment letter generally specifies that if expenses occurs during due diligence, the prospective borrower shall pay the same. Further, it may also contain the expenses regarding attorneys fees, other fees and expenses occurred in due diligence for preparation and negotiation of the loan documents, the amount of the loan, the interest rate, repayment terms, collateral and other credit support, financial covenants, borrowing base requirements, closing conditions, and other fees and costs, all to be paid by the borrower, notwithstanding the fact that whether the loan closes or not. [3] 

When a borrower denies paying the fees, as provided in the commitment letter, can a commitment letter bind the borrower for such payments? Under Law of contract when a

party to a loan denies to pay the expenses and fees which occurred in due diligence and preparation and other negotiations regarding the loan, cannot be said that there was no intention of the parties to contract. A failure after the above mentioned preparation and

negotiation process of the loan will not invalidate the previous efforts done in order to reach an agreement. To determine whether a commitment letter was intended to be binding or whether a binding letter is in consistency with the reasonable expectations of the parties, a reference ought to be made in different circumstance and not only to the letter itself. Cranston [4] , suggests that, the following circumstances shall be kept into consideration while performing a test:

How a document is described is some indication. For Example, a document expressed as an ‘agreement ‘and containing a sentence ‘this is provisional agreement until a fully legalized agreement is drawn up’ clearly indicates the intention of the parties to be bound. ‘Offer Document’ can be termed as a less intentional than ‘Commitment Letter’. However, a provision is added in the document to be signed as ‘accepted’ by the borrower and returned to the lender, this provision makes the description ‘offer’ irrelevant in deciding the issue. A financial view for the term ‘commitment’ is that, it does not connote a binding commitment itself, but sets out a definite interest [5] .

Whether the commitment letter contains a reasonably complete statement of the proposed terms is a good condition, but not determinative. The agreement (commitment letter) before the contract shall be mentioning the terms which make it complete, absolute and binding. A commitment letter may contain terms which would be expected in the formal documentation as a result of which it cannot be said that parties did not intend to bind.

The third condition is that, reference shall be made the steps preceding and, and subsequent to, the completion of the commitment letter. The proposed contents of a letter, a considerable degree of formality, a belief by the parties that it will be binding,

and subsequently payment of a commitment fee on completion of the lending process are all indications that the parties refer to the commitment as binding.

The first condition in the above mentioned test will apply to the fact that all the expenses occurred for processing the loan, will emerge as a cost payable by the borrower. The remaining two conditions are treating the issue of processing fees in a different manner. Both these conditions determined that commitment letters are not binding and are a subject matter of a party’s intention to contract. Moreover, according to Cranston, even if a commitment letter does not bind, it cannot be said that there was no intention of the parties to contract and fees and expenses mentioned and occurred during the process are not payable. These fees and expenses may consist of things as, for considering whether to grant the proposed loan, for an ‘in principle’ commitment to lend or even for issuing the commitment letter.

In the given problem Sebb Co. intends to run a business at Paris however, in order to do so it required a sum of 5 million pounds as loan from Olympic bank. The negotiations were on for the proposed loan. It is further given that a term sheet and the commitment letter were ‘drawn up’ by both the parties. After 2 months of negotiations, at the time of the signing of the agreement, Sebb Co without giving notice backs out from the negotiations and further does not sign any agreement with Olympic bank. As it is shown clearly in the above discussion that Sebb Co. by drawing up the term sheet and the commitment letter is bound by the commitment letter itself, because it did contain the main points of the proposed loan. If the main points of the commitment letter are also the main points of the proposed agreement parties who draw up such a consensus, would become bind to each other. Therefore in this case Sebb Co. has the contractual liability of a breach of contract which would also be Olympic bank legal remedy. Damages for such a breach would arise in the form of processing charges and expenses which are to be paid by Sebb Co., in the form of its legal liability.

Second issue:

Fixed Charge:

A fixed charge is one where the assets in question are under direct control of the chargee. Examples of a fixed charge would be material possession of goods in case of mortgage, title deed of land or property etc.

Floating charge:

A floating charge is one where in the chargee does not have direct control over the assets of the chargor. An example of this type of charge would be where the chargee develops a charge over the raw materials of a company, or any other Asset which is fluctuating in nature.

Book debts:

In the ordinary course of business it is normal custom to sell goods on credit and obtain payments for such sale at a later date. Book debts refer to payments which are expected to be received by a company for goods or services delivered.

In the given problem it has been stated that Sebb and Co approached Commonwealth bank to set up a business at Wigan for which it required an amount of 5 million pounds. Commonwealth bank agrees to give the loan to Sebb co and placed the following conditions:

1) Sebb Co is not permitted to divest itself of assets above £500,000

2) Cannot charge other assets held by the company except with the assent of

Commonwealth Bank.

3) It also had a charge over the book debts of Sebb co. The charge is given in the loan agreement in the following words:

“As a continuing security for the payment of the Secured Liabilities, the Borrower charges in favour of the Bank the following assets (or the Borrower’s interest therein), both present and future, from time to time owned by way of first fixed charge:

…all book, and other debts, revenues and monetary claims of the Borrower…"

Therefore there are three vital issues in the form of rights, which Commonwealth has at its disposal. Firstly, it has a right over the book debts, present or future, time to time owned by the company which according to the agreement is termed as a fixed charge. Secondly, it has charge over other assets. Thirdly, it cannot divest over 500,000 worth of assets.

In Illingsworth v Houldsworth case Lord Macnaghten has stated that: 

“A specific charge, I think, is one that without more fastens on ascertained and definite property or property capable of being ascertained and defined; a floating charge, on the other hand, is ambulatory and shifting in its nature, hovering over and so to speak floating with the property which it is intended to affect until some event occurs or some act is done which causes it to settle and fasten on the subject of the charge within its reach and grasp." [6] 

Buckley LJ explained the essential elements of a floating charge in Evans v Rival Granite Quarries Ltd He said:

“A floating security is not a future security; it is a present security, which presently affects all the assets of the company expressed to be included in it. On the other hand, it is not a specific security: the holder cannot affirm that the assets are specifically mortgaged to him. The assets are mortgaged in such a way that the mortgagor can deal with them without the concurrence of the mortgagee. A floating security is not a specific mortgage of the assets, plus a license to the mortgagor to dispose of them in the course of his business but is a floating mortgage applying to every item until some event occurs or some act of the mortgagee is done which causes it to crystallize into a fixed security." [7] 

In the Re Yorkshire Woolcombers Association Ltd [8]  case it was held that,

“The term ‘floating’ is one that until recently was a mere popular term. It certainly had no distinct legal meaning. It is not a legal term. It has recently been used in more than one statute; but when the Courts have to consider whether the charge is a floating one within the meaning of the term as used in the Acts of Parliament, and in particular within the meaning of the Companies Act, 1900, one must, I think, deal with the question of substance to be answered according to the circumstance of each particular case. I certainly do not intend to attempt to give an exact definition of the term “floating charge," nor am I prepared to say that there will not be a floating charge within the meaning of the Act, which does not contain all the three characteristics that I am about to mention, but I certainly think that if a charge has the three characteristics that I am about to mention it is a floating charge. (1.) If it is a charge on a class of assets of a company present and future; (2.) if that class is one which, in the ordinary course of the business of the company, would be changing from time to time; and (3.) if you find that by the charge it is contemplated that, until some future step is taken by or on behalf of those interested in the charge, the company may carry on its business in the ordinary way as far as concerns the particular class of assets I am dealing with." [9]  

Further in the Re Brumark Investments Ltd [10] case it was held that,

“The principal theme of the judgment, however, was that the parties were free to make whatever agreement they liked. The question was therefore simply one of construction; unless unlawful the intention of the parties, to be gathered from the terms of the debenture, must prevail. It was clear from the descriptions which the parties attached to the charges that they had intended to create a fixed charge over the book debts while they were uncollected and a floating charge over the proceeds. It was open to the parties to do so, and freedom of contract prevailed….Their Lordships consider this approach to be fundamentally mistaken. The question is not merely one of construction. In deciding whether a charge is a fixed charge or a floating charge, the court is engaged in a two-stage process. At the first stage it must construe the instrument of charge and seek to gather the intentions of the parties from the language they have used. But the object at this stage of the process is not to discover whether the parties intended to create a fixed or a floating charge. It is to ascertain the nature of the rights and obligations which the parties intended to grant each other in respect of the charged assets. Once these have been ascertained, the court can then embark on the second stage of the process,  which is one of categorization. This is a matter of law. It does not depend on the intention of the parties. If their intention, properly gathered from the language of the instrument, is to grant the company rights in respect of the charged assets which are inconsistent with the nature of a fixed charge, then the charge cannot be a fixed charge however they may have chosen to describe it. A similar process is involved in construing a document to see whether it creates a license or tenancy. The court must construe the grant to ascertain the intention of the parties: but the only intention which is relevant is the intention to grant exclusive possession: see Street v Mountford [1985] AC 809 at p. 826 per Lord Templeman. So here: in construing a debenture to see whether it creates a fixed or a floating charge, the only intention which is relevant is the intention that the company should be free to deal with the charged assets and withdraw them from the security without the consent of the holder of the charge; or, to put the question another way, whether the charged assets were intended to be under the control of the company or of the charge holder." [11]  

Ken Baird in his article has discussed the Spectrum Plus [12] case in three phases, which are as follows:

First instance decision: 

“The Vice Chancellor found that it was clear that the book debts were to be under the control of and available for use by the company in the ordinary course of its business through their collection and the ordinary operation of the bank account. The debenture only affected the collection of debts in that their factoring, block discounting and collection through an account with another bank was forbidden. Otherwise, they were not affected at all. Furthermore, he did not consider that the restriction on collection through an account with another bank made a sufficient difference.

The Vice Chancellor held that no distinction should be drawn between the operation of an account which is in credit and one which is in debit. None of the cases that had applied accepted or distinguished Siebe Gorman had made such a distinction.

Accordingly, although the parties had described the book debts as subject to a specific charge, the Vice Chancellor held that was not the consequence of the rights and obligations granted and imposed by the debenture. Accordingly, as per Agnew, the parties' intention must yield to the nature of the transaction and the charge over book debts granted by Spectrum to NatWest was floating. He held that Slade J.'s conclusion in Siebe Gorman was wrong." [13] 

Court of Appeal decision: 

“Lord Phillips M.R. gave the judgment of the Court of Appeal and overturned the first instance decision. He held that because of the doctrine of precedent, it was not open to the Vice Chancellor to prefer the reasoning of the Privy Council in Agnew to that of the Court of Appeal in New Bullas. Furthermore, it was only open to the Court of Appeal to diverge from one of its own decision in three situations. The disapproval of the Privy Council was not one of them.

On the second limb of the Vice Chancellor's reasoning, Lord Phillips M.R. held that the construction given to the debenture in Siebe Gorman was correct.

The fact that the debenture required proceeds of book debts to be paid into an account at the chargee bank was of “ critical importance"  due to the nature of the relationship of banker and customer. Title to book debt proceeds passes to the bank when they are paid into the bank account. The customer's right to call upon the bank to pay over the amount of proceeds received is contractual, not proprietary. The customer's right could be restricted by contract.

Lord Phillips M.R. held that Slade J. could properly have concluded that the debenture imposed on the company the limited restriction that it would be entitled to draw on its account when in credit unless the bank chose to exercise its right to block the account. Lord Phillips M.R. further held that this limited restriction should not be the “ critical factor"  in determining whether the charge should be categorised as fixed or floating.

Accordingly, it was at least arguable that a debenture which prohibits a chargor from disposing of uncollected book debts and requires him to pay them, beneficially, to the chargee once collected properly falls within the definition of a fixed charge. This is regardless of the extent of the chargor's contractual right to draw out sums equivalent to the amounts paid in. Strictly speaking, the chargor is neither entitled to dispose of the book debts before they fall due (because the debenture prohibits this) or of the proceeds once collected (because of the proprietary analysis).

Finally, Lord Phillips M.R. stated that even had Slade J.'s construction of the debenture been erroneous, he would have held that the form of debenture had, by customary usage over 25 years, acquired the meaning and effect that he had attributed to it." [14] 

House of Lords decision: 

“Their Lordships rejected the bank's arguments that the charge created was fixed and overruled the Court of Appeal in favour of the Crown to conclude that the charge was floating. Siebe Gorman was wrongly decided and should be overruled.

Banks' use for over 25 years of the Siebe Gorman form of debenture was an insufficient reason to decide not to overrule Slade J.'s incorrect construction. The court noted that since the judgment was one of first instance, those who relied on it must be taken to have been aware that the House of Lords may decide that the case had been wrongly decided and open to correction.

Their Lordships were also asked by the bank, should it lose on the fixed charge point, to consider whether their decision that the charge was a floating charge should only take effect prospectively from the date of their judgment. However, they refused to exercise discretion, which was exercisable only in very unusual circumstances, to make the ruling prospective only. The judgment was to have retrospective effect. This article does not concentrate on the prospective overruling issue." [15] 

Therefore it can be safely said that the charge, in the given problem, is a floating charge although the termology used in the given problem states that it is a fixed charge over book debts of Sebb Co. the consequence of this would be that Sebb Co. would be free to use its assets in the ordinary course of its business.

Now, let us turn our attention to the third problem. It is stated that Sebb Co. in order to acquire its rival Ovett Co., requires an amount of £ 3 m. Grandprix Bank agrees to sponsor such an acquisition. Grandprix Bank in return to the loan, require Sebb Co. to give a Security of £ 1.5 m worth of shares in Ovett Co. Sebb Co. agrees to this and transfers share certificates, a blank transfer form and a power of Attorney to Grandprix Bank at the time of the agreement. Thereafter, Sebb Co. makes 5 defaults after which it is announced as a defaulter with Grandprix Bank.

At this point of time Commonwealth Bank realizes that it has a cross default clause in its agreement. Now, what is a Cross default clause?

In simple language, if Bank A has a cross default clause in its agreement with B, and if B commits a default with C Bank, then B can be held as a defaulter with Bank A as well. In this particular case Commonwealth bank has a cross default provision in its agreement with Sebb co. therefore, as illustrated above when Grandprix bank announces Sebb co as a defaulter, Sebb co would become a defaulter of Commonwealth as well. The movement Sebb co becomes a defaulter with Commonwealth bank; Commonwealth bank has a remedy of going to the court of law and suing Sebb co to recover its unpaid dues. It also has a remedy of applying for an injunction along with an application to appoint a receiver. The movement a receiver is appointed by the court crystallization will take place. The movement crystallization takes place the floating charge over the book debts of Sebb co will change from floating to fixed charge. When charges become fixed over book debts Commonwealth bank can adjust the unpaid dues from monies in the account of Sebb co which are in the form of proceeds of book debts.

Thus, in the second case Commonwealth bank has the remedy to get the proceeds of the book debts from the account of Sebb co, which it has with Grandprix bank. Another remedy for Commonwealth bank would be the contractual remedy under a breach of contract. The corresponding liability of Sebb co would be to adjust the unpaid dues of Commonwealth bank from its account where the proceeds of book debts are deposited.

Another interesting thing to mote about the second problem is that, in the loan agreement Commonwealth bank had a negative clause which stated that it had a charge over ‘other assets’. However this charge would not subsist as because other assets (acquisition of Ovett and co) have been held by Grandprix bank who has priority over them.

It is also important to note here that it has not been specified whether asset would be for present or future asset. Shares of Ovett co relate to future asset. In the third case Grandprix bank has a charge over 1.5 million pounds worth of share. Thus, other shares excluding the margin of 1.5 million pounds would go to Commonwealth bank. If however other assets relates to present assets the question of priority would not arise because shares in Ovett and co constitute future assets.

Third issue:

Pronouncing the judgment in Re Connolly [16] case, Cozens-Hardy M.R. along with Buckley L.J. held that:

“This is an appeal from the order of Warrington J., who has decided that Mrs. O'Reilly has an equitable charge on this particular property in priority over the general floating charge created by the debentures and the debenture trust deed. The company had issued debentures in the usual form and executed a trust deed for the purpose of securing them on the present and future property of the company, and by the terms of one of the conditions indorsed on the debentures the company were not to be at liberty to create any other mortgage or charge to rank equally with or in priority to these debentures. In the year 1904 the company wanted to purchase certain freehold property, but could not do so without obtaining the money wherewith to make the purchase. They accordingly applied to Mrs. O'Reilly to advance them the sum of 1000l., and they agreed to give her a charge upon the property so purchased to secure the sum to be advanced by her. She consented to make the advance on those terms. The company thereupon entered into a contract for the purchase of the property for

the sum of 1100l. and paid a deposit of 150l., leaving 950l. of the purchase-money

unpaid. Mrs. O'Reilly found the 1000l., she was present at the completion of the purchase, and her cheque for 1000l. was not handed to the vendor because there was only 950l. due on the purchase. It was paid into the company's banking account, upon which the company drew a cheque for 950l., which was cashed, and on the completion of the purchase that cash was paid over to the vendor.

Now, what was the effect of that? Did the company as between themselves and Mrs. O'Reilly ever become the absolute owners of the property? Or was not the bargain that Mrs. O'Reilly was to have a first charge, and the company was only to get the property subject thereto? In my opinion we should be shutting our eyes to the real transaction if we were to hold that the unincumbered fee simple in the property was ever in the company so that it became subject to the charge of the debenture-holders.

But there is another way of arriving at the same conclusion. Mercer was instructed to act as solicitor for all parties. He was present at the completion, took the deeds, and says he held them on behalf of Mrs. O'Reilly. What reason is there to disbelieve that evidence, which is in accordance with the course of the whole transaction? The learned judge certainly drew that inference from the evidence, and I think it was the proper inference, and that being so, I am of opinion that all the company in equity obtained was the equity of redemption in the property subject to Mrs. O'Reilly's charge of 1000l. The appeal must be dismissed.


I agree. If on March 31, 1904, the company acquired the unincumbered fee

simple in the property, then the debenture-holders are right. If on the other hand on that date the company obtained the property subject to a contractual obligation to give a first charge on it to Mrs. O'Reilly, then the debenture-holders can get no more. For the moment neglect the debenture-holders altogether. Had Mrs. O'Reilly a contractual right as between herself and the company to have the

security? [His Lordship referred to the evidence as to the bargain, and continued:] The facts as to what took place on the completion of the purchase are immaterial if the memorandum of equitable charge dated April 6 was executed by the company in pursuance of the bargain which was entered into previously. I think it was, and that is borne out by the retention of the deeds by Mr. Mercer on Mrs. O'Reilly's behalf. I agree that this appeal should be dismissed." [17] 

In the Wilson v. Kelland [18] case Eve J. also held that:

“As regards the mortgage of January 27, 1905, it is, in my opinion, immaterial whether the mortgagees had, or had not, notice of the deed of 1901 and the debentures thereby secured. Any equity which attached to the property contracted to be purchased in June and conveyed to the company in September, 1904, in

favour of the debenture-holders, or their trustees, was, throughout, subject to the paramount equity of the unpaid vendors; and the legal mortgage which secures the unpaid purchase-moneys must, in my opinion, take priority over any charge to persons claiming through the purchaser. I hold, therefore, that the plaintiff is entitled to priority over the defendant society in respect of the mortgage of 1905." [19] 

In the given problem Sebb Co. wishes to acquire its competing company Ovett Co. such an acquisition would require an amount of 3 million pounds for which Sebb Co. approaches Grandprix bank to lend them the same. Thereafter, an agreement is drawn up between Sebb Co. and Grandprix bank for the proposed loan against which Sebb Co. agrees to transfer share certificate along with a blank transfer form and a power of attorney as instruments of security. It is further mentioned that Sebb Co. fails to make five consecutive payments and is announced as a defaulter by Grandprix bank. The issue here is one of priority over shares as to who would become the preferential owner of the shares. As given in the case above if a loan is given to acquire a property the borrower (Sebb Co.) cannot be called absolute owners of the property they only acquire a right of redemption and unless the lender of the loan is not given back his money the borrower cannot become, in equity, the absolute owner. Thus, Grandprix bank who makes a post acquisition loan would get priority over the securities of Sebb Co.

Grandprix bank had plans of suing Sebb Co. in the court of law and as damages wanted to appropriate the proceeds of the account of Sebb Co. at Grandprix bank, and adjust their unpaid dues from it. However, Grandprix bank would not be able to do so as it is restricted to an amount of 1.5 million pounds and therefore, has no right to appropriate other assets of Sebb Co. thus, as a legal remedy Grandprix bank can sue Sebb Co. for a breach of contact it can further go to the court and has the legal remedy to convert the share certificates in its own name. As a legal liability Sebb Co. would be liable to set off 1.5 million pounds worth of shares of Ovett Co. and give it to Grandprix bank.