Definition
A Keepwell Agreement is a contract between a parent company and its subsidiary, in which the parent company commits to provide financial support to the subsidiary for a specified period. This agreement aims to boost the subsidiary’s creditworthiness and financial stability. In essence, it serves as a guarantee, reassuring creditors of the subsidiary’s ability to meet its financial obligations.
Phonetic
The phonetic pronunciation of “Keepwell Agreement” is: /ˈkiːpˌwɛl əˈgriːmənt/
Key Takeaways
- A Keepwell Agreement is a contract between a parent company and its subsidiary, wherein the parent company commits to provide financial support and maintain the solvency of the subsidiary.
- Keepwell Agreements help to improve a subsidiary’s credit rating, as they increase the guarantee of financial support for the subsidiary, which can lead to better access to market loans and reduced borrowing costs.
- While Keepwell Agreements offer some level of guarantee for lenders and bondholders, they are not legally binding, meaning that the parent company can potentially abandon its obligation to provide financial support to the subsidiary under certain circumstances.
Importance
The Keepwell Agreement is a significant term in business and finance as it represents a contract between a parent company and its subsidiary, wherein the parent company provides assurance of financial support and solvency to the subsidiary. This agreement instills confidence in the subsidiary’s creditors and investors, by reducing their risk exposure and ensuring the subsidiary’s debt obligations will be met. Additionally, it can strengthen the subsidiary’s credit rating, facilitate better loan terms and financing opportunities, and ultimately improve the overall financial stability of both the parent and subsidiary companies.
Explanation
The primary purpose of a Keepwell Agreement is to strengthen the creditworthiness of a subsidiary company and provide assurance to its creditors. It is a legally binding contract in which a parent company pledges to provide financial support to its subsidiary to ensure its financial health, specifically in times of financial stress or economic downturns. Often a Keepwell Agreement is entered into when it is important to assure investors, suppliers, or creditors that the subsidiary will meet its financial obligations. By providing this backing, the parent company boosts the credit rating of its subsidiary, enabling it to secure loans or other financing at more favorable rates, lowering the overall cost of capital and enhancing financial stability.
A Keepwell Agreement is typically used when a subsidiary is operating in a high-risk industry or geographical region, or when it has limited operating history, thereby attracting higher borrowing costs and financial risks. By offering this financial safety net, the parent company not only fosters the growth and development of the subsidiary but also safeguards its own interests, given the performance of the subsidiary may have a direct impact on the overall value of the parent company. As investors and creditors perceive reduced risk in the subsidiary’s operations, the company benefits from improved liquidity, risk mitigation, and better access to capital markets. Ultimately, a Keepwell Agreement is a strategic tool used to maintain a healthy financial ecosystem within a group of companies and to instill confidence in the market about their ability to meet financial obligations.
Examples
A keepwell agreement is a contract between a parent company and its subsidiary, where the parent company promises to provide financial support to the subsidiary, typically to maintain the subsidiary’s solvency and support its business operations. Here are three real-world examples of keepwell agreements:
1. General Electric and GE Capital: In 2015, General Electric (GE) entered into a keepwell agreement with its financial unit, GE Capital, to provide financial support and maintain its solvency. As part of the agreement, GE committed to providing $18.1 billion in capital contributions through December 31, 2021, to support GE Capital’s operations. The agreement helped assure investors and regulators that GE Capital would remain solvent and able to meet its financial obligations.
2. Tencent and Tencent Music Entertainment: In 2018, Chinese technology giant Tencent Holdings Limited entered into a keepwell agreement with its subsidiary Tencent Music Entertainment (TME), in preparation for TME’s initial public offering (IPO) on the New York Stock Exchange. The keepwell agreement assured investors that Tencent would provide financial support to TME to maintain its solvency and ensure its continued operational success.
3. Petrobras and Petrobras Argentina: In 2011, Brazilian state-run oil company Petrobras entered into a keepwell agreement with its Argentine unit, Petrobras Argentina, in which Petrobras agreed to provide financial support to Petrobras Argentina to maintain its solvency and strengthen its credit standing. The keepwell agreement helped Petrobras Argentina maintain its credit rating, and supported its ability to access the capital market for future financing needs.
Frequently Asked Questions(FAQ)
What is a Keepwell Agreement?
A Keepwell Agreement is a legally binding contract between a parent company and its subsidiary, where the parent company commits to provide financial support and ensure the solvency of the subsidiary over a specified period of time.
Why are Keepwell Agreements used?
Keepwell Agreements are primarily used to enhance the creditworthiness of a subsidiary, improve the subsidiary’s financial stability, and facilitate its access to capital markets or debt financing at more favorable terms.
Who are the parties involved in a Keepwell Agreement?
The parties involved in a Keepwell Agreement are the parent company (also known as the guarantor) and its subsidiary (also known as the beneficiary).
How does a Keepwell Agreement benefit a subsidiary?
A Keepwell Agreement benefits a subsidiary by improving its credit rating, increasing lenders’ and investors’ confidence, reducing borrowing costs, and providing additional financial resources when needed.
Is a Keepwell Agreement the same as a guarantee?
No, a Keepwell Agreement is different from a guarantee. While a guarantee is a legally binding promise by a third party to repay a debtor’s obligation in case of default, a Keepwell Agreement is a commitment from the parent company to provide financial support without necessarily guaranteeing the specific obligations of the subsidiary.
What are the key terms of a Keepwell Agreement?
The key terms of a Keepwell Agreement include the duration of the agreement, the type and extent of financial support to be provided by the parent, any financial covenants or conditions that the subsidiary must comply with, and the circumstances under which the parent’s support will be triggered.
Can a Keepwell Agreement be terminated?
Yes, a Keepwell Agreement can be terminated by mutual consent of both parties or by the occurrence of specified events, such as a change in ownership, bankruptcy, or the subsidiary’s failure to meet the stated financial covenants or conditions.
Is a Keepwell Agreement legally enforceable?
Yes, a Keepwell Agreement is a legally enforceable contract, and the beneficiary (the subsidiary) can take legal action against the guarantor (the parent company) if the latter fails to fulfill its commitment as per the agreement terms.
How does a Keepwell Agreement impact financial statements?
A Keepwell Agreement may have an impact on the financial statements of both the parent company and the subsidiary. The parent company may need to disclose the contingent liabilities related to the agreement, while the subsidiary may report an increase in its assets or equity if it records the support as a receivable from the parent.
Related Finance Terms
- Corporate Guarantee
- Parent Company Support
- Subsidiary Credit Enhancement
- Debt Service Coverage
- Financial Covenants
