Structural subordination
Risk management.
A reduction in the effective ranking of the claim of a lender or other creditor resulting from a combination of:
- The ownership structure of the borrower, for example in a group of companies; and
- Holding a claim against the 'wrong' legal entity.
For example, the claims of the creditors of a holding company may become structurally subordinated to the claims of creditors of the subsidiary companies in the same group. This is because the claim of the holding company itself - as a shareholder of the subsidiary - is generally subordinated to the claims of the other creditors of the subsidiary.
Lenders will usually seek to lend to a group company which holds material assets, or to a holding company where other lender claims over the subsidiaries' assets are less than 15% of the group debt. Loans to subsidiaries are therefore not preferred for group funding unless there is a material cost benefit, a regulatory reason such as we have in UK utility regulation, or limited liability to the group as may be the case in some forms of project finance.
Structural subordination can be particularly problematic where the subsidiary is in a different country from the holding company, where local legal and other claims may effectively erode the position of the holding company's creditors.
