Commitment letter

Commitment letter is a letter of the institution which undertakes to correct deficiencies which could lead to dangerous or risky conditions. Usually, a letter of commitment is initiated by the agency and sent to the management of the institution, accompanied by a request to the institution to execute the letter. Commitment letters are typically used in institutions which are in good general condition but have limited issues in isolated areas of activity.

While regulators usually require a letter of commitment, it may be initiated spontaneously by the institution's board of supervisors. In both cases, the letter of commitment is not prepared by the agency in a formal style (as opposed to a memorandum of understanding). However, these letters set out concrete corrective actions to be taken and timetables for their implementation. Commitment letters are considered less stringent than Memoranda of Understanding and are in fact officially considered the least painful corrective action by the Currency Competence Office, although some regulators consider that board resolutions are in fact the least painful.

Types of commitment letters

In principle, there are two types of commitment letters:

• A one-page letter of intent from banks and some venture capital companies,
• Long, more specific letter of commitment from other venture capital companies.

What is in the commitment letter?

Commitment letters vary considerably from company to company managing the project. "Each company devises its own form. but this form is representative and contains the information and data normally provided in most commitments". They also vary considerably depending on whether they are preferred shares or mezzanine loans. A well-prepared commitment letter is much more preferred than its shorter brother, the term sheet that gives only a small portion of the transaction.

A number of items in the commitment letter duplicate or confirm in a more detailed way what was originally set out in the safety data sheet. Nevertheless, since this is to be a legally binding agreement, the language of the commitment is more formal, with a milder legalism than the language of the term sheet.

There are five basic segments in the standard commitment letter:

• The first segment sets out the terms on which your investment in company is made and the terms of any capital options.
• The second part gives a hedge of the investment and this part usually exists only for mezzanineloans.
• The third part deals with the conditions of the investment, both negative and positive.
• The fourth part outlines the recapitulative statements that led the venture capital fund to make a commitment.
• The fifth part concerns the conditions under which the commitment was made.

Examples of Commitment letter

• A commitment letter may be used to ensure that an organization or institution complies with applicable laws and regulations. For example, a commitment letter may be sent to a medical clinic to ensure that its medical practices meet the standards of the state medical board.
• A commitment letter may be used to ensure that an organization or institution meets the requirements of a grant or loan. For example, a commitment letter may be sent to a university to ensure that it has the resources to implement a grant or loan program.
• A commitment letter may be used to ensure that an organization or institution meets its obligations to its employees. For example, a commitment letter may be sent to an organization to ensure that it has the resources to provide adequate salary and benefits to its employees.

Advantages of Commitment letter

• Commitment letters are an effective tool for ensuring that institutions remain compliant with regulations and standards. They provide a sense of assurance for the institution's stakeholders that the institution is taking appropriate steps to address any issues that may arise.
• Commitment letters can be used to set expectations for the institution's performance and to ensure that the institution is addressing any potential risks in a timely manner.
• Commitment letters also provide a mechanism for the institution to document its compliance and corrective action plans. This documentation can be used to demonstrate a commitment to compliance and provide evidence of corrective action.
• Commitment letters also serve as a reminder to the institution of their responsibility to meet the expectations set out in their commitment letter. This can help to ensure that the institution is taking the necessary steps to remain compliant.
• Lastly, commitment letters can be used to build trust between the institution and its stakeholders, as stakeholders can be assured that the institution is taking the necessary steps to ensure compliance.

Limitations of Commitment letter

A commitment letter is a useful tool in ensuring that an institution is compliant with relevant regulations and laws, but it can also be limited in its effectiveness due to a few factors:

• The commitment letter only applies to the specific areas of activity outlined within and cannot be applied to any other part of the institution.
• It is not legally binding and is usually voluntary, which means that the institution may not fulfill the commitments outlined in the letter.
• It is not an enforceable document and cannot be used to take legal action if the commitments outlined in the letter are not fulfilled.
• A commitment letter cannot be used as a substitute for effective oversight and management of the institution.
• It does not provide any legal protection or immunity from legal action in the event of non-compliance with the commitments outlined in the letter.

Other approaches related to Commitment letter

The commitment letter is usually issued by an institution to correct any deficiencies that could lead to dangerous or risky conditions. Other approaches related to commitment letter include:

• Corrective Action Plan (CAP): It involves identifying the issue, setting goals and objectives, and formulating strategies to eliminate or reduce the risks associated with the issue.
• Internal Audit: This approach involves a comprehensive review of the institution's internal processes and procedures to identify any deficiencies or issues.
• Risk Management Plan: This approach involves identifying and assessing potential risks, developing strategies to mitigate them, and monitoring their implementation to ensure that the risks are managed effectively.
• Quality Assurance/Quality Control (QA/QC): This approach involves the implementation of standards and procedures to ensure that all products and services are of the highest quality.
• Safety Plan: This approach involves the development of a safe and secure environment and the implementation of procedures to reduce the risk of any accidents or incidents.

In summary, commitment letter is a document issued by an institution to address any potential issues that could lead to dangerous or risky conditions. Other approaches related to commitment letter include Corrective Action Plan (CAP), Internal Audit, Risk Management Plan, Quality Assurance/Quality Control (QA/QC), and Safety Plan.

Footnotes

Commitment letter — recommended articles

Internal audit — Legal risk — Corporate governance theory — Taping Rule — Certificate of acceptance — Management rights — Compliance test — ISO 9004 — Information security management system

References

• Collier N.S., Collier C.A., Halperin D.A. (2007), Construction Funding: The Process of Real Estate Development, Appraisal, and Finance, John Wiley & Sons
• Gladstone D., Gladstone L. (2002), Venture Capital Handbook: An Entrepreneur's Guide to Raising Venture Capital, FT Press
• Zisman B. S. (2018), Banks and Thrifts: Government Enforcement and Receivership, LexisNexis

Author: Dominika Kania