6.3 Loan-based Mezzanine Instruments 2936.3.2 Structural Subordination of Debts
There is a distinction between subordination of debts and structural subordination.
Structural subordination typically arises where the main assets of a group are
owned by one or more subsidiaries, but the borrowing is undertaken by the parent
company.^30
Structural subordination is based on the fact that distributions by a company to
its shareholders are constrained by company law rules and require the availability
of distributable assets.^31 The debts of an operating company in which the assets are
usually invested are therefore structurally more senior than the debts of its holding
company. In other words, creditors of the holding company (junior creditors) ef-
fectively rank behind creditors of the operating company (senior creditors) be-
cause they are creditors of a shareholder rather than creditors of the company that
owns the assets.^32
The parties may create structural subordination through holding companies and
debt push-up.^33 The use of holding companies as debtors will increase structural
subordination. Debt push-up means that the debt is assigned to the parent com-
pany of the debtor. The assignment of a debt normally requires the prior consent
of the creditor and the consent of the security giver (such as a guarantor or owner
of collateral).^34
The parties may reduce structural subordination through the assignment of the
holding company’s debts to its operating subsidiary.^35 This may nevertheless be
constrained by company laws. Depending on the jurisdiction, the assignment of a
shareholder’s debts to the (subsidiary) company can be regarded as distribution of
assets to a shareholder, or be contrary to the principle of the equivalent treatment
of shareholders. Furthermore, the assignment of debts can be constrained by the
general purpose and stated objects of the subsidiary.^36
6.3.3 Repayment Schedules as a Form of Subordination
There is a distinction between subordination and the use of different repayment
schedules. In a loan transaction, the mezzanine effect can generally be achieved
through the equity technique. For example, the use of different repayment sched-
ules can help to create senior term loans, junior term loans, and mezzanine debt.
It is characteristic of senior term loans that they have the shortest maturity and
will be repaid in regular instalments over the term of the loan.^37 The junior tranche
can have a longer maturity than the senior tranche and be repaid in fewer instal-
(^30) Fuller G, Corporate Borrowing. Third Edition. Jordans, Bristol (2006) paragraph 8.3.
(^31) Article 15(1)(a) of Directive 77/91/EEC (Second Company Law Directive).
(^32) Diem A, op cit, § 39 number 4.
(^33) Ibid, § 39 numbers 5–6.
(^34) For German law, see §§ 418, 182(2) and 766 BGB.
(^35) Diem A, op cit, § 39 number 7.
(^36) See, for example, Article 9(1) of Directive 68/151/EEC (First Company Law Directive).
(^37) Diem A, op cit, § 5 number 6.