Keepwell Agreement: Definition & Overview

KEY TAKEAWAYS

• A keepwell agreement is a pact between a parent business and its subsidiary.
• It commits both parties to preserve solvency and financial support for a predetermined amount of time.
• These agreements assure creditors, bondholders, shareholders, and suppliers. It assures that the subsidiary won’t go into default. It also ensures that they will carry on with business as usual.
• These agreements improve the credibility of loan instruments and corporate borrowing.

What Is a Keepwell Agreement?

A keepwell agreement is a commitment made by a parent business and its subsidiary to remain solvent and financially secure. This is for the duration of the contract. 

A subsidiary may enter into a keepwell arrangement with its parent business for a predetermined contract period of time. This tends to happen when it encounters financial difficulties. As well as when it struggles to obtain capital to continue operations.

Keepwell agreements benefit the subsidiary, its parent company, and also shareholders and bondholders. This is by providing more assurance that the subsidiary will be able to pay its debts. As well as operate efficiently. A struggling subsidiary that has a keepwell agreement is also more likely to be seen positively by raw material suppliers.

Another term for a keepwell agreement is a comfort letter.

What Are the Essentials of a Keepwell Agreement?

Keepwell agreements are a way to keep a company in business. 

The agreements increase the likelihood that subsidiaries will receive loans on favorable terms. This is from banks, suppliers, and lenders. Additionally, Keepwell contracts increase the trust of bondholders, stakeholders, and shareholders. These agreements are created and managed by organizations using contract management software. It can also be done through legal agreement writing software.

How Does a Keepwell Agreement Work?

A keepwell agreement is a contract between a parent business and its subsidiary. The parent company guarantees in writing that it will maintain specific financial ratios or equity levels. This is to keep the subsidiary solvent and in good financial health. 

In essence, the parent business agrees to cover all of the subsidiary’s finance requirements. This is for a predetermined amount of time.

Why Does a Keepwell Agreement Matter?

Lenders are more likely to grant loans for a subsidiary than for businesses without one. This is because a keepwell agreement increases the subsidiary’s creditworthiness. 

Suppliers are also more likely to provide better conditions to businesses that have a keepwell agreement. The subsidiary firm may benefit from a higher credit rating than it would without a signed keepwell agreement. This is because of the financial responsibility imposed on the parent company by such an arrangement.

What Are the Advantages of a Keepwell Agreement?

A keepwell agreement is beneficial when a subsidiary finds it challenging to get financing. 

Its parent firm will provide financial backing and assistance to ensure solvency for the duration of the agreement. A company’s keepwell agreement improves the borrowing and debt instrument creditworthiness.

Example of a Keepwell Agreement

Let’s say that Company X is a subsidiary of Company Y. Company X needs a cash injection of $3m for operations. No bank or supplier is willing to lend any capital to Company X, because it has a low credit rating. 

Under a keepwell agreement, Company X can instead turn to Company Y. This is for financial solvency and stability throughout the term of the loan.

Summary

Keepwell agreements are a common way for parent companies to guarantee the future of their subsidiaries. 

Although it is important to note that a keepwell agreement is not a guarantee that a parent will support its subsidiary. However, it does show that intent. The pledge to uphold these agreements is only a pledge and cannot be legally acted upon.