Meaning
Arrangements where creditors of a parent company have a secondary claim on the assets of a subsidiary relative to that subsidiary’s own creditors define this situation. This structural subordination occurs because the parent company only owns the equity of the subsidiary. In a liquidation, the subsidiary’s debts are paid from its own assets before any value is passed up to the parent.
Tiered Access
Flow of capital from the operating level to the holding level is restricted by the needs of the local lenders. Even if the parent company has senior debt, that debt is effectively junior to the smallest loan at the subsidiary level. Structural subordination makes the location of the debt just as important as its rank, location, tier or security status.
Failures Distribution
Failures at the operating level hit the parent company’s creditors first. Because of structural subordination, the equity value in the subsidiary vanishes as soon as its liabilities exceed its assets. This leaves the parent company with an empty asset and no way to repay its own lenders.
Benefits Insulation
Benefits of this arrangement include protecting the assets of one subsidiary from the creditors of another. While it creates risk for the parent, structural subordination limits the spread of a local crisis. This boundary allows a diversified firm to survive the failure of a single business unit.
