Distressed Debt Case Study - OpCo/HoldCo Guarantee Problem
Hey guys,
Got a distressed case study and was wondering about your opinion. People I have consulted in the industry thus far have differing opinions and want to know your thoughts.
HoldCo A has $100 in assets and $100 in liabilities ($100 unsecured debt). OpCo A has $0 in assets and $100 in liabilities ($100 unsecured debt). HoldCo A has a guarantee on OpCo A. What would be the recoveries?
My opinion is that because there is a guarantee and both debt securities are unsecured, the value of A would just be pro rata distributed to both HoldCo debt and OpCo debt, i.e $50 for HoldCo unsecured and $50 for OpCo unsecured.
However, some people are telling me that HoldCo A should pay off their obligations first before paying a single dollar downstream toward the guarantee. Hence, It would actually be 100% recovery for HoldCo debt and 0% for OpCo.
I was wondering what you guys think is the right answer? Have been looking online for how guarantees rank in seniority, but haven't found anything thus far.
If there is an downstream parent guarantee in benefit of the Opco Notes, it's pari. If there isn't, which you have failed to mention therefore you cannot assume, it is full recovery at Holdco and nothing at Opco.
Also this isn't a case study; this is a entry level question RX bankers ask Wharton juniors on first round on campus interviews for RX summer positions FWIW.
Can you elaborate why Opco Note would beneift from an upstream guarantee? Doesn't an upstream guarantee indicate the OpCo is guaranteeing the holdco, not the other way around?
And yes sorry it's not a case study. I am a student and this was an interview question I came across.
Seriously? Do you ask them that because you think it's a qualifying question or you're just being a dick and want to see how they handle it?
Yes, it's debt / RX 101, but I wouldn't expect a college junior to have any idea what a holdco, opco, or downstream parent guarantee is. Moyer isn't part of the 3rd year curriculum, is it?
Its part of getting into finance clubs these days :/
To see how they handle it - I wouldn't have known at all how to answer it when I recruited but I found over 80% kids do. It's part of the "could I get into same college today" dilemma. Unfortunate truth.
It's sophomores these days that answer these questions, not juniors. You'd be surprised by the amount of freshman that know how 50% PIK flows through the three statements.
Typically the assets are at the opco box (hence the term operating company) and debt is sitting at an empty holding company. In such a case holdco bond holders may desire an upstream guarantee from the opco. Under such a scenario the opco and holdco debt would rank pari passu. In your example it seems that assets are sitting at the holding company and the opco is the empty box. You say that "HoldCo A has a guarantee on OpCo A" but it's not clear to me if you mean the holdco has provided a downstream guarantee to the opco or if the opco has provided an upstream guarantee to the holdco. In the event that the holdco has provided a downstream guarantee to the empty opco, all debt would be treated as pari passu and recoveries would be 50% for both bonds. If the opco has provided an upstream guarantee then recoveries would be 100% for the holdco and 0% for the opco. Of course a judge could just lump everything together under "substantive consolidation" and treat both boxes as a single issuer so you need to check the case law to see how that jurisdiction operates, Generally under US bankruptcy law the courts recognize structural and contractual subordination.
Your initial answer is right. For those telling you they "should" pay off their obligations first, I'd be very curious to hear where they got that from. There is no concept of a legal duty to pay off one obligation before another, and if you pay off anyone outside of normal course of business the other parties can sue to have that party subordinated to account for the payment they got.
Another peculiarity (and especially important in bankruptcy proceedings of foreign debtors) is the circumstances upon which the upstream guarantee from Opco subsidiary to Holdco debt came about. If the company's Opco assets become encumbered by a sub gty but reasonably equivalent value was not transferred to the guarantor it can setup strong argument for fraudulent conveyance if one can prove no indirect or direct benefit was received by the guarantor entity in an especially unfriendly bankruptcy jurisdiction (read: France).
Mind explaining why France is Bankruptcy unfriendly? Based in Europe and only saw Rx in the UK so far.
There is no need to be cute and over think. You have a deficiency claim of 100 at OpCo, which is an unsecured claim that looks into the HoldCo for recovery. HoldCo doesn't have secured claim, therefore both both tranches are pari.
Good stuff mate +1 Would you mind sharing resources to learn how to analyse such deals / situations?
Depends on whether or not Holdco sits outside the box of opco bonds. Opco claims do not always go up to the holdco, not sure why people are saying its definitely pari when in reality it depends. Its kinda the point in many situations to prevent such a claim.
If OpCo guarantees an unsecured term loan issued to HoldCo and there's a lawsuit claim against HoldCo, is unsecured term loan generally pari passu with lawsuit claim?
You’re getting different opinions because the question isn’t clear enough -
HoldCo A has $100 in assets and $100 in liabilities ($100 unsecured debt).
Assets = cash, fixed property, claims?
Debt = one bond issue? One loan from bank? Multiple issues at different times? Content of agreement/deed? (Is there any priority/structure in the debt? Even if unsecured doesn’t mean there isn’t a ranking)
Is their unclaimed wages? (Most jurisdictions favour wage claims) Does the cash sit on the bank’s account? (And therefore bank would have priority if assets cannot make whole)
OpCo A has $0 in assets and $100 in liabilities ($100 unsecured debt).
OpCo has no agreements that also include HoldCo (given that’s where assets are)? I.e check for specifics that would allow piercing of corporate veil.
HoldCo A has a guarantee on OpCo A. What would be the recoveries?
Has a guarantee, I.e is it a financial guarantee? When was it made? Is this mentioned in the debt agreement of OpCo? (Is this a loan, bond, facility?) if mentioned in the debt documentation then is there any pre-conditions to it being invoked/revoked? If HoldCo is in default (despite assets, say willingness to pay); will that nullify guarantee?
Prima Facie - T0 financial guarantee between HoldCo/OppCo on debt, triggered when OppCo defaults T1 OppCo creditors use guarantee to HoldCo, HoldCo pays out in so far as it can without wilful default T2 If trigger of guarantee leads HoldCo to default, then creditors of HoldCo will move to prevent this - argue either they were not aware of guarantee being made, or priority of their claims as debt in HoldCo occurred earlier in time. If there is a depositor bank involved will lay priority claim over bank accounts. T3 OpCo gets screwed, HoldCo folds. T4 OpCo creditors claim malfeasance with structure given it’s the OpCo, try get judge to pierce veil.
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