What is Keepwell Agreement?
257 reads · Last updated: December 5, 2024
A keepwell agreement is a contract between a parent company and its subsidiary to maintain solvency and financial backing throughout the term set in the agreement. Keepwell agreements are also known as comfort letters.When a subsidiary finds itself in a cash crunch and has trouble accessing financing to continue its operations, it can sign a keepwell agreement with its parent company for a set period of time.Keepwell agreements not only help the subsidiary and its parent company, but they also boost confidence in shareholders and bondholders that the subsidiary will be able to meet its financial obligations and run smoothly. Suppliers that provide raw materials are also more likely to look at a troubled subsidiary more favorably if it has a keepwell agreement.
Definition
A comfort letter, also known as a maintenance agreement, is an agreement between a parent company and its subsidiary aimed at maintaining the subsidiary's solvency and financial support during the agreed period. When a subsidiary faces financial difficulties and struggles to secure necessary funds for continued operations, a comfort letter can be signed with the parent company to provide support for a certain period.
Origin
The concept of a comfort letter originated from the need for financial management within corporate groups, especially during economic instability when parent companies need to ensure the financial stability of their subsidiaries. With the rise of globalization and corporate mergers, such agreements became more common in the late 20th century.
Categories and Features
Comfort letters can be categorized into formal and informal types. Formal comfort letters are typically written, legally binding, and specify the amount and duration of support. Informal comfort letters may be mere verbal commitments, lacking legal enforceability. The advantage of formal agreements lies in their legal protection, while informal agreements offer more flexibility but carry higher risks.
Case Studies
Case Study 1: During the 2008 financial crisis, a large multinational company signed a comfort letter with its struggling subsidiary, providing necessary financial support to help the subsidiary overcome its difficulties. Case Study 2: A technology company provided short-term loans through a comfort letter to its subsidiary facing cash flow issues, ensuring the subsidiary's continued operations.
Common Issues
Investors might worry about the reliability of comfort letters, especially informal ones. Additionally, the parent company might face its own financial pressures, affecting its ability to fulfill the agreement. Investors should carefully assess the parent company's financial health and the specific terms of the agreement.
