Keepwell Agreement
What Is a Keepwell Agreement?
A keepwell agreement is a contract between a parent company and its subsidiary to keep up with solvency and financial backing all through the term set in the agreement. Keepwell agreements are otherwise called comfort letters.
At the point when a subsidiary ends up in a cash crunch and experiences difficulty getting to financing to proceed with its operations, it can consent to a keepwell arrangement with its parent company for a set period of time.
Keepwell agreements not just assist the subsidiary and its parent with companying, however they additionally support confidence in shareholders and bondholders that the subsidiary will actually want to flawlessly meet its financial obligations and run. Providers that give raw materials are likewise bound to take a gander at a troubled subsidiary all the more well assuming it has a keepwell agreement.
Keepwell agreements give confidence to lenders as well as to a subsidiary's shareholders, bondholders, and providers.
How a Keepwell Agreement Works
Subsidiary companies go into keepwell agreements to increase the creditworthiness of debt instruments and corporate borrowing. A keepwell agreement is a contract between a parent company and its subsidiary in which the parent company gives a written guarantee to keep the subsidiary solvent and in great financial wellbeing by keeping up with certain financial ratios or equity levels. In effect, the parent company commits to giving all the subsidiary's financing needs for a predetermined period of time.
The predetermined guarantee period relies upon what the two players concur upon when the contract is drawn up. However long the keepwell contract period is as yet active, the parent company will guarantee any interest payments or potentially principal repayment obligations of the subsidiary. Assuming that the subsidiary runs into solvency issues, its bondholders and lenders have adequate recourse to the parent firm.
Keepwell Agreements and Creditworthiness
Credit enhancement is a risk-decrease method by which a company endeavors to increase its creditworthiness to draw in investors to its security offerings. Credit enhancement decreases the credit or default risk of a debt, in this way expanding the overall credit rating of an entity and lowering interest rates. For instance, an issuer might utilize credit enhancement to further develop the credit rating on its bonds. A keepwell agreement is one method for upgrading a company's credit is by getting third-party credit support.
Since a keepwell agreement improves the subsidiary's creditworthiness, lenders are bound to support loans for a subsidiary than for companies without them. Providers are likewise more ready to offer better terms to companies with keepwell agreements. Due to the financial obligation put on the parent company by a keepwell agreement, the subsidiary company might partake in a better credit rating than it would without a consented to keepwell arrangement.
Implementing Keepwell Agreements
Albeit a keepwell agreement demonstrates a parent's readiness to offer help for its subsidiary, these agreements are not guarantees. The commitment of upholding these agreements isn't a guarantee and can't be legally summoned.
Notwithstanding, a keepwell agreement can be implemented by the [bond trustees](/bond-legal administrator), following up for bondholders, if the subsidiary defaults on its bond payments.
Illustration of Keepwell Agreement
Suppose Computer Parts Inc. is a subsidiary of Laptop International. The company is going through a financial crunch and supplies are short. To proceed with production for its new line hard drives, Computer Parts Inc. necessities to apply for a new line of credit of $2 million. This might be troublesome in light of the fact that it has a lower credit rating.
To assist with keeping production on target and keep the loan's interest rate as low as could really be expected, Computer Parts Inc. can go into a keepwell agreement with its parent, Laptop International, to guarantee its financial solvency for the term of the loan.
Features
- A keepwell agreement is a contract between a parent company and its subsidiary to keep up with solvency and financial backing for a set period of time.
- These agreements give confidence to lenders, shareholders, bondholders, and providers that the subsidiary won't default and proceed with its operations.
- Subsidiary companies go into keepwell agreements to increase the creditworthiness of debt instruments and corporate borrowing.
