Keepwell Agreement

What is a Keepwell Agreement?

Also known as the comfort letters, it is referred to a contract that is made between a Parent Company and the subsidiary to preserve financial backing and solvency through the terms and conditions mentioned in the agreement.

When a subsidiary is experiencing a financial crunch and problems accessing cash to continue the operations, it signs a keepwell agreement with the parent company for a specific time period. This agreement not just helps the subsidiary but the parent firm as well.

Moreover, it also leads to boosted confidence among bondholders and shareholders that the subsidiary will run smoothly and meet its financial responsibilities. Even suppliers favour troubled subsidiaries that have a keepwell agreement.

Understanding Keepwell Agreements

Generally, subsidiary companies sign a keepwell agreement to increase their creditworthiness of corporate borrowing and debt instruments. Through this contract, the parent company offers a written guarantee to keep the subsidiary in good financial health and solvent by maintaining specific equity levels or financial ratios.

Additionally, the parent firm also commits to Offering the financing needs to the subsidiary for a specific time period. This predetermined period is based upon what both the firms agree upon when the contract is made.

As long as the period of keepwell contract is active, the parent company ensures the payment for interest or principal is made on behalf of the subsidiary. In case the subsidiary steps into solvency problems, the lenders and bondholders get enough option from the parent company.

Example of Keepwell Agreement

While putting forward a Keepwell agreement example, here suppose there is a subsidiary, called ABC Inc., which is a part of XYZ International. The firm is experiencing a financial crisis, and its supplies are limited.

In this situation, to continue the production for new products, ABC Inc. requires a loan of approximately Rs. 2 million. Availing such a huge amount is not a seamless thing because the firm has a lower credit rating.

Now, it doesn’t have any other option than to create a keepwell agreement with the parent company, XYZ International to continue the production, get a lowest possible interest rate and guarantee the financial solvency for the loan term.