[Avanish and Eshan are students at NALSAR University of Law and Maharashtra National Law University, Nagpur, respectively.]
A keepwell agreement/ undertaking is an arrangement wherein a parent company promises to a third-party lender that it will provide the subsidiary with all necessary financial wherewithal to put it in a position to honor the obligations under the primary facility / loan agreement. The purpose of keepwell agreements is to improve the creditworthiness of the subsidiary and reduce the risk involved in the facility agreement. Keepwell agreements have in sometimes been treated as guarantees, whereas an analysis of their language would reveal that they are the closest to, if not synonymous with, letters of comfort.
The enforceability of keepwell agreements has been subject to extensive debate in courts in China and Hong Kong, where these agreements are popular. As recently as May 2023, the High Court of Hong Kong held a keepwell deed to be enforceable and awarded USD 164 million in damages to the defendant who breached its obligations under the keepwell deed.
Keepwell agreements are gaining currency, especially in transactions involving foreign lenders. With the new impetus given to external commercial borrowings by the Reserve Bank of India (RBI) by relaxing norms, foreign lenders are using a variety of instruments to secure their lending transactions. Whether these instruments provide a legal and enforceable security or a mere sense of “comfort”, needs to be tested on the touchstone of the first principles of the Indian Contract Act 1872 (ICA).
Is There a Valid Consideration for Parent Company?
One crucial aspect in determining the enforceability of an agreement is consideration. In a standard keepwell agreement, no specific money consideration moves from the lender to the parent company. However, consideration can be in terms of performances or promises to perform in the future, which must be valuable.
Is there anything valuable being moved from the lender to the parent company? In a keepwell agreement, a promise (express or implied) is indeed moved from the lender to the parent company, in the form of a covenant to honour the facility agreement. The next question is, whether this promise is sufficient consideration, given that it is of value to the subsidiary, a separate legal entity? It is settled law that this consideration would be sufficient based on Section 2(d) of the ICA, as explained below with the help of a reference to the authoritative text of Pollock and Mulla.
As per Pollock and Mulla, “consideration can be of benefit to the promisor or a third party or even no apparent benefit but merely to the detriment to the promisee. Detriment to the promisee suffices even if there is no benefit to the promisor (O’Sullivan v. Management Agency & Music Ltd (1985) 3 All ER 351; Re Dale (1994) Ch 31; Jones v. Padavatton (1969) 1 WLR 628 (giving up a job), Tanner v. Tanner (1975) 3 All ER 776; Coombes v. Smith (1986) WLR 808)”.
The detriment to the promisee in a keepwell agreement is the risk of giving a loan under the facility agreement. The benefit to the third party in a keepwell agreement is the benefit to the subsidiary company taking the loan on the basis of the keepwell agreement. Mulla also states, “consideration may move from promisee to any person and not necessarily only to the promisor. Contract can still arise even if the promise to do or abstain from doing was for the benefit of a third party.” Therefore, a keepwell agreement is not necessarily unenforceable for the want of consideration.
Are Keepwell Agreements Synonymous with Performance Guarantees, Indemnities and Letters of Comfort?
In Cruz City 1 Mauritius Holdings v. Unitech Limited, the Delhi High Court refused to set aside a foreign award in regarding a contractual dispute arising from a keepwell agreement. The said award treated the keepwell agreement as a guarantee. While the peculiar nature of the keepwell agreement in that case might have made it a guarantee, it is not the case that every keepwell agreement is a guarantee.
As per Section 126 of the ICA, a contract of guarantee is a “contract to perform the promise, or discharge the liability, of a third person, in case of his default.” Superficially, keepwell agreements can be seen as guarantees, but there is a nuanced difference between the two. While it is true that a guarantee can be for the performance of a duty (in the form of a “performance guarantee”), the surety in a guarantee is expected to substitute the performance of the principal debtor. In a keepwell agreement, the parent company does not promise the lender to substitute the performance expected from the subsidiary in the facility agreement. Instead, the parent promises to put the subsidiary in a position to perform its obligations under the facility agreement. Thus, there is no “mirroring” of duties involved in a keepwell agreement, as opposed to a tripartite contract of guarantee. A keepwell agreement therefore creates a duty for the parent company which is different from the specific duties given to a surety under a contract of guarantee.
Section 124 of the ICA defines a contract of indemnity as, “a contract by which one party promises to save the other from loss caused to him by the conduct of the promisor himself, or by the conduct of any other person”. The distinction between a contract of indemnity and a keepwell agreement is thus the requirement of proving actual loss to seek enforcement. It was held by the Supreme Court of India in State Bank of Saurashtra v. M/s Ashit Shipping Services (Private) Limited and Another that in order to sustain a claim based on an indemnity, it has to be established that loss has been sustained. The Supreme Court also remarked that a mere breach may not automatically result in a loss. A keepwell agreement ordinarily stipulates that upon a default by the subsidiary, the lender can require the parent to do all the steps necessary to put the subsidiary in a position to fulfil its obligations. Thus, in contradistinction to an indemnity, a keepwell agreement may be sought to be automatically enforced in case of a default, even if the lender sustains no actual loss.
A letter of comfort, in substance, is the same as a keepwell agreement. The parent’s duties to the lender in a letter of comfort remain the same as those in a keepwell agreement. In United Breweries (Holdings) Limited v. Karnataka Industrial Investment and Development Corporation Limited, the Karnataka High Court defined a letter of comfort as “a document that indicates one party's intention to try to ensure that another party complies with the terms of a financial transaction without guaranteeing performance in the event of default.”
The only difference lies in form. Keepwell agreements, instead of letters, have been drafted as deeds or agreements. It is a recognized principle of contractual construction that the title or form of a document is not determinative of its substance.
Applying the Views of High Courts on Enforceability of Letters of Comfort in the Context of Keepwell Agreements
Thus, the decisions of the High Courts in India which clarified the enforceability of letters of comfort become relevant. The Delhi High Court in Lucent Technologies Inc. v. ICICI Bank Limited and Others, held that with regard to the letter of comfort in question, the circumstances and documents did not indicate the intention to create legal relations. Further, in Yes Bank Limited v. Zee Entertainment Enterprises Limited [LD-VC-IA Number 1 of 2020 in LD-VC-Suit Number 120 of 2020], the Bombay High Court differentiated guarantees from letters of comfort. It said that a letter of comfort can be a guarantee only if the conditions under Section 126 of the ICA are met. However, the Bombay High Court ordered the payment of damages for a breach of the letter of comfort.
Taking cues from these decisions, it is clear that the enforceability of a keepwell agreement, too, would depend upon its language, which should be clear on (1) the sufficiency of consideration, and (2) the intention of the parties to enter into a legally binding relationship. A mention of the facility agreement and the context of the execution of the keepwell agreement in the recitals of it would be a good way to express intention, in addition to a specific covenant to that effect.
Like letters of comfort, the enforceability of keepwell agreements would depend on how the parties express their intention to enter into legal relations. However, the RBI views letters of comfort as unenforceable documents. The RBI in its guidance note to credit rating agencies (CRAs) makes note of letters of comfort as “diluted” or “non-prudent” structures. Therefore, letters of comfort are not to be considered by CRAs while assessing the creditworthiness of a company. Whether this tendency to view letters of comfort as ipso facto unenforceable would be seen in the context of keepwell agreements (given the difference in their form) is something that time will tell.