Structural subordination

Structural subordination arises from the way the group is organised. When third-party debt sits at subsidiary level, the subsidiaries’ lenders have direct access to their assets in a liquidation. The parent company’s lenders hold a claim on the parent, whose assets consist of the shares of its subsidiaries. They recover part of the value of the operating assets once the subsidiaries’ creditors have been paid in full. This lower ranking follows from the group structure and applies in the absence of any contractual subordination clause. This disadvantage worsens quickly as the probability of insolvency rises. Rating agencies take it into account when rating debt issued by the parent company. In acquisition financing, the debt raised by the acquisition holding company suffers this subordination relative to the target’s creditors. Lenders respond with guarantees from the subsidiaries, a pledge over the target’s shares and debt caps at subsidiary level. In France, a guarantee given by the target for the debt used to buy it runs into the prohibition on financial assistance in article L. 225-216 of the Commercial Code. For the borrower, the allocation of debt between the parent and the subsidiaries determines each lender’s real ranking and the price it charges.

A holding company borrows €150m to acquire a packaging company whose operating subsidiary owes €40m to its own creditors. The subsidiary is liquidated and its assets fetch €160m. Its creditors recover their €40m first. The holding company, as shareholder, receives the €120m balance and its lenders lose €30m on their €150m claim.

• The allocation of debt between the parent company and the subsidiaries
• The guarantees given by the subsidiaries and their legal limits
• The pledge over the subsidiaries’ shares in favour of the parent’s lenders
• The debt caps imposed on the subsidiaries in the agreement