Keepwell Agreement

Key takeaways

• A keepwell agreement is a written commitment from a parent company to support a subsidiary’s financial health and solvency for a specified period.
• It is used as a credit enhancement to improve a subsidiary’s ability to borrow and obtain favorable supplier or investor terms.
• Keepwell agreements are often treated as comfort letters and may not be legally binding; enforceability depends on the contract terms and applicable law.

What is a keepwell agreement?

A keepwell agreement (also called a comfort letter) is a contract between a parent company and its subsidiary in which the parent agrees to take steps—such as maintaining certain equity levels or financial ratios—to keep the subsidiary solvent and able to meet its obligations. The commitment typically covers a defined time period and is intended to reassure lenders, bondholders, suppliers, and investors.

How it works

• The parent pledges to provide financing or other support as needed so the subsidiary can pay interest, repay principal, and continue operations.
• The commitment period and the specific support measures are spelled out in the agreement.
• With a keepwell in place, a subsidiary may secure loans or bonds at lower interest rates and obtain better vendor terms than it would otherwise.

Credit enhancement and creditworthiness

Keepwell agreements function as a form of credit enhancement. By reducing perceived default risk, they can:
* Improve the subsidiary’s effective credit profile.
Increase investor and lender confidence.
Lower borrowing costs and expand access to capital.

Enforceability

Keepwell agreements are often characterized as comfort letters rather than guarantees. Practical points:
* Whether a keepwell is legally enforceable depends on the precise language used, the rights it grants, and the governing jurisdiction.
In many cases the agreement indicates intent to support rather than creating an absolute legal obligation.
Bond trustees or other designated parties may have enforcement rights if the agreement explicitly grants them standing or if the agreement is drafted to create binding obligations.

Example

A subsidiary manufacturing computer parts needs a $2 million loan but has a weak credit rating. Its parent company signs a keepwell agreement promising to maintain the subsidiary’s solvency for the loan term. Lenders view the loan as lower-risk and are more likely to extend credit at a favorable rate.

Advantages and risks

Advantages:
* Easier access to financing and potentially lower rates.
Better supplier terms and greater market confidence.
Support for ongoing operations during temporary liquidity issues.

Risks and limitations:
* The parent’s actual willingness or ability to provide support may change.
If not drafted as a binding guarantee, the agreement may offer limited legal recourse.
It can create contingent liabilities for the parent.

Accounting treatment

Keepwell agreements are typically treated as contingent liabilities and disclosed in the guarantees section of financial statements. The appropriate accounting and disclosure depend on the likelihood and terms of the commitment.

Comfort letters

“Comfort letter” is a common synonym for a keepwell agreement. Both terms refer to a written assurance about financial support, but the legal weight of such letters varies with wording and jurisdiction.

Bottom line

Keepwell agreements are pragmatic tools for improving a subsidiary’s credit standing and maintaining operational continuity during financial stress. They provide important comfort to lenders and suppliers, but their protective value depends on the agreement’s wording and the parent’s real ability to honor the commitment. Always review the specific contract language and relevant law to assess enforceability and accounting implications.