Structural subordination
LBORanking behind another creditor because of where in a group your borrower sits, rather than because of anything either of you agreed.
Also written: structurally subordinated
A waterfall runs entity by entity. Each company's assets pay that company's creditors, and only what is left flows up to its shareholder. A lender to a holding company is therefore paid out of what the holding company owns, which is shares in the operating company, and shares rank behind every creditor of the company that issued them.
That is structural subordination, and it is a fact about the structure rather than an agreement about ranking, which is what separates it from contractual subordination. No intercreditor agreement is needed to produce it and none can undo it. A holding company note calling itself senior still sits behind every trade creditor of the business below.
Guarantees and security are the cure. An upstream guarantee from the operating companies gives the holding company lender a direct claim at the level where the assets are, and security over those assets improves it further, which is why the guarantor coverage tests in a credit agreement matter more than the label on the tranche.
In a distressed European group this is the first thing to establish, because two structures with identical instrument names can have completely different waterfalls, and the fulcrum can sit at a different level in each entity. Working out which company owes each claim, and which companies have guaranteed it, comes before any recovery analysis.
Worked example
An operating company owes 400 of secured bank debt and its business is worth 450, illustratively.
A holding company above it has issued 200 of payment in kind notes with no guarantee from the operating company.
The notes are paid from the 50 of residual equity value, so they recover 25% while the bank debt is money good, whatever the notes are called.