Keepwell Agreement

A Keepwell Agreement, sometimes referred to as a comfort letter or maintain-well agreement, is a contractual arrangement typically used in corporate finance and debt issuance, particularly among multinational corporations. This agreement is designed to provide a subsidiary or affiliate company assurance of financial support from a parent company or a more financially robust entity. This assurance is not an outright guarantee but rather a promise to maintain certain financial health conditions to ensure the subsidiary can meet its obligations.

Origin and Purpose

The parent company, usually possessing a stronger credit rating, agrees to ensure that the subsidiary remains “well-kept” in terms of its financial health. This could involve maintaining certain financial ratios or providing necessary funding if required. The intention behind a Keepwell Agreement is to provide comfort to bondholders, creditors, and investors regarding the financial stability and creditworthiness of the borrowing entity.

Key Features

  1. Non-binding Assurance: Unlike a guarantee, a Keepwell Agreement typically does not create a direct financial liability for the parent company. It serves more as a moral commitment rather than a legal obligation.
  2. Financial Covenants: The agreement may include specific covenants about maintaining net worth, debt-to-equity ratios, liquidity levels, and other financial metrics.
  3. Support Mechanisms: The parent company may promise to infuse equity, provide intercompany loans, or extend lines of credit as necessary.
  4. Credit Enhancement: The primary function is to enhance the creditworthiness of the subsidiary, thereby lowering borrowing costs and facilitating fundraising activities.
  5. Duration: These agreements can be short-term or long-term depending on the nature of the debt being issued or the financial arrangement being supported.

Structure of a Keepwell Agreement

Parties Involved

Clauses Included

  1. Purpose Clause: Specifies the intention behind the agreement, often highlighting the need to support the subsidiary’s financial commitments.
  2. Definition Clause: Detailed definitions of key terms used within the agreement.
  3. Financial Maintenance Clause: Specifies the financial covenants and conditions the parent company agrees to maintain for the subsidiary.
  4. Support Undertaking Clause: Details the type of support (like equity infusion or loans) the parent company may provide.
  5. Duration and Termination Clause: Outlines the lifespan of the agreement and conditions under which it may be terminated.
  6. Governing Law: Identifies the legal jurisdiction under which the agreement will be interpreted and enforced.
  7. Miscellaneous Provisions: Other essential clauses such as dispute resolution, amendment procedures, and confidentiality agreements.

Use Cases and Benefits

Capital Market Transactions

In bond issuance or syndicated loans, a Keepwell Agreement can significantly enhance the borrowing costs for subsidiaries. Investors and lenders feel more secure lending money to a subsidiary knowing that the parent company will ensure its financial stability.

Mergers and Acquisitions

During M&A activities, parent companies may use Keepwell Agreements to support newly acquired entities until they can stand on their own financially. This can help smooth out operational transitions and stabilize the acquired company’s credit rating.

International Operations

Multinational corporations may use Keepwell Agreements to support overseas subsidiaries. This is crucial in jurisdictions where direct guarantees or cross-border loans may be restricted or taxed disadvantageously.

Regulatory Perspective

Regulatory bodies may have specific requirements or limitations on the use of Keepwell Agreements. For example, in China, the use of Keepwell Agreements is relatively common among international ventures as part of the financial structuring to align with local regulations.

Accounting Treatment

The financial commitments under Keepwell Agreements are generally not recognized as liabilities on the balance sheet, considering they are not legally binding guarantees. However, disclosures are necessary in the financial statements to inform stakeholders about the potential obligations.

Credit Rating Agencies

Credit rating agencies evaluate the credibility and financial strength of the Keepwell provider. They may adjust the subsidiary’s credit rating positively if the parent company has a robust financial profile and a history of fulfilling such commitments.

Real-world Examples

One notable example is the case of China Oceanwide Holdings Group, which provided Keepwell Agreements to support its overseas subsidiaries in various financial transactions. The agreements covered bond issuances that were crucial for funding expansion projects and operational activities.

Another instance involves Greenland Holding Group, which has used Keepwell Agreements to support its offshore debt issuances, making it an instrumental part of their global financial strategy.

Criticisms and Controversies

Moral Hazard

Critics argue that Keepwell Agreements may create moral hazard issues where subsidiaries take on excessive risks, relying on the parent company’s support. This can lead to financial mismanagement and potential failures if the parent company is unable to fulfill its commitments.

Although Keepwell Agreements provide comfort, their non-binding nature means they may not be legally enforceable in some jurisdictions. This can make them less effective in providing the intended financial security compared to guarantees.

Market Perception

The market’s perception of the value of Keepwell Agreements can vary. While some investors and creditors may view them positively, others may see them as insufficient, especially if the parent company’s financial health is questionable.

Conclusion

Keepwell Agreements are essential financial instruments that play a significant role in enhancing the creditworthiness of subsidiaries and facilitating more favorable borrowing conditions. They serve as a reassurance tool for creditors and investors, providing a form of financial commitment from a stronger parent company. While they are not without criticisms and limitations, their strategic use in corporate finance, particularly among multinational corporations, underscores their importance in global business operations.