Keepwell Agreement (Letter of Comfort) - Explained
What is a Letter of Comfort?
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Table of ContentsWhat is a Keepwell Agreement?How is a Letter of Comfort Used? Importance of Keepwell Agreement
What is a Keepwell Agreement?
Keep-well agreement refers to a legal contract initiated by a parent company to its subsidiary, for the purpose of maintaining financial backing and solvency, throughout the agreed period. A subsidiary refers to a company with fifty percent of shares owned by a parent company. The support provided in the contract gives potential lenders confidence, and at the same time, increasing the creditworthiness of the subsidiary. Keepwell agreements are also known as comfort letters.
How is a Letter of Comfort Used?
Keepwell agreement gives specifications on how long the parent company is willing to offer financial support to the subsidiary. What this means is that a subsidiary with this document has a high chance of the lending institutions approving its loan requests. The contract also enables the subsidiary and the suppliers to close business deals easily. Note that this document is an assurance to the suppliers that they will receive their payment. The document helps the subsidiary to increase its creditworthiness. Through this, it can easily attract potential investors to invest in its securities. Through credit enhancement, a company is able to reduce the risk related to default. So, this document is among the many financial documents that offer credit support to the third-party. The document is usually for a period of time, depending on what the two parties have agreed on. It means that provided that the contract is active, the parent company will continue to guarantee the subsidiary's principal and interest payments obligation. So, when the subsidiary company happens to run into solvency issues, its shareholders, and lenders will be covered by the parent company.
Importance of Keepwell Agreement
- The document also increases the creditworthiness of a subsidiary company, making it easy to access loans from lenders.
- The document places a financial obligation on a parent firm. A subsidiary with this document has a high credit rating compared to those without.
- The document also increases the creditworthiness of the subsidiary company, making it easy for it to access loans from lenders.
- The contract places a financial obligation on a parent firm. A subsidiary with a keepwell agreement, in most cases, has a high credit rating compared to that without.