A Keepwell Agreement: What Is It?

A keepwell agreement is a written commitment made by a parent business to its subsidiary to sustain financial stability and solvency throughout the agreement. Another name for keep-well agreements is comfort letters. A subsidiary can sign a keep-well agreement with its parent business for a predetermined amount of time if it finds itself in a cash constraint and is having difficulty obtaining financing to continue operating. Keepwell agreements benefit both the subsidiary and the parent business. They also increase bondholders’ and shareholders’ trust that the subsidiary can fulfill its financial responsibilities and operate efficiently. If a problematic company has a keep-well agreement, raw material suppliers will likely see it favorably.

The Operation of a Keepwell Agreement

Subsidiary businesses sign Keepwell agreements to increase the creditworthiness of corporate borrowing and financial instruments. A keep-well agreement is a written assurance the parent company gives to the subsidiary to maintain specific financial ratios or equity levels, thereby keeping the subsidiary solvent and in good financial health. The parent firm agrees to cover the subsidiary’s financial requirements for a predetermined time.

What the parties agree upon when the contract is drafted will define the predetermined guarantee period. The parent business will cover the subsidiary’s interest and principal payback obligations as long as the keep-well contract period is in effect. Bondholders and lenders have adequate redress against the parent company if the subsidiary experiences financial difficulties.

Maintain Contracts and Creditworthiness

A corporation that wants to draw investors into its security offerings uses credit enhancement, a risk-reduction strategy, to try and improve its creditworthiness. Credit enhancement lowers interest rates and raises an entity’s total credit rating by lessening debt’s credit or default risk. An issuer might, for instance, use credit enhancement to raise the bonds’ credit rating. A company can improve its creditworthiness through a keep-well agreement by securing third-party credit support.

Lenders are more likely to grant loans to a subsidiary than businesses without one since a keep-well agreement improves the subsidiary’s creditworthiness. Additionally, suppliers are more likely to give businesses with keep-well agreements better terms. A keep-well agreement may give the subsidiary firm a better credit rating than otherwise because of its financial commitment to the parent company.

Implementing Keepwell Contracts

Keepwell agreements are not assurances, even when they show a parent company’s commitment to help its subsidiary. The assurance that these agreements will be upheld is not guaranteed and cannot be used in court. If the subsidiary fails to make bond payments, the bond trustees, acting on behalf of the bondholders, may execute a keep-well arrangement.

A Keepwell Agreement Example

Assume that Laptop International is the parent company of Computer Parts Inc. The business is experiencing financial difficulties, and supplies are limited. Computer Parts Inc. has to borrow $2 million to keep up with manufacturing its new range of hard drives. Its weaker credit rating might make this challenging.

Conclusion

• A keep-well agreement is an understanding between a parent business and a subsidiary to keep the subsidiary solvent and financially backed for a specific time.
• Lenders, owners, bondholders, and suppliers can be sure that the subsidiary will not fail on its debts and will continue to run its business thanks to these deals.
• Under keep-well agreements, subsidiary companies make debt instruments and business borrowing more creditworthy.