how a keepwell agreement works
subsidiary companies enter 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 provides a written guarantee to keep the subsidiary solvent and in good financial health by maintaining certain financial ratios or equity levels in effect the parent company commits to providing all the subsidiary s financing needs for a specified period of time the predetermined guarantee period depends on what both parties agree upon when the contract is drawn up as long as the keepwell contract period is still active the parent company will guarantee any interest payments and or principal repayment obligations of the subsidiary if the subsidiary runs into solvency issues its bondholders and lenders have sufficient recourse to the parent firm keepwell agreements and creditworthinesscredit enhancement is a risk reduction method whereby a company attempts to increase its creditworthiness to attract investors to its security offerings credit enhancement reduces the credit or default risk of a debt thereby increasing the overall credit rating of an entity and lowering interest rates for example an issuer may use credit enhancement to improve the credit rating on its bonds a keepwell agreement is one way to enhance a company s credit is by obtaining third party credit support since a keepwell agreement enhances the subsidiary s creditworthiness lenders are more likely to approve loans for a subsidiary than for companies without them suppliers are also more willing to offer more favorable terms to companies with keepwell agreements due to the financial obligation placed on the parent company by a keepwell agreement the subsidiary company may enjoy a better credit rating than it would without a signed keepwell agreement enforcing keepwell agreementsalthough a keepwell agreement indicates a parent s willingness to provide support for its subsidiary these agreements are not guarantees the promise of enforcing these agreements is not a guarantee and cannot be legally invoked however a keepwell agreement can be enforced by the bond trustees acting on behalf of bondholders if the subsidiary defaults on its bond payments example of keepwell agreementlet s say computer parts inc is a subsidiary of laptop international the company is going through a financial crunch and supplies are short in order to continue production for its new line hard drives computer parts inc needs to take out a loan of 2 million this may be difficult because it has a lower credit rating in order to help keep production on track and keep the loan s interest rate as low as possible 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 