A power company's holding company owes Rs 1,000 crore and its operating company owes Rs 2,000 crore on Rs 2,400 crore of value. What do holdco creditors recover with no guarantee, and with an unsecured upstream guarantee?

Without a guarantee holdco creditors recover 40%; with the guarantee they recover 80%, and opco creditors fall from 100% to 80%. Holdco owns only the operating company's equity, so it gets what is left after Rs 2,000 crore of opco debt: Rs 400 crore. The guarantee moves holdco lenders from the equity queue into the creditor queue, where Rs 2,400 crore is shared rateably over Rs 3,000 crore of claims.

Behind everyone at the operating company. A parent that owns a shop owns what is left after the shop's suppliers are paid, nothing more. Holdco's only asset is its shares in the operating company, so holdco creditors are paid from the equity left after opco creditors are paid in full, which is structural subordinationCreditors of a parent rank behind creditors of its subsidiaries, because the parent owns only equity in them.. Rs 2,400 crore less Rs 2,000 crore leaves Rs 400 crore for Rs 1,000 crore of holdco debt: 40%.

It gives holdco lenders a second door. An upstream guarantee makes the operating company itself liable for the holdco debt, so holdco lenders now claim at the operating company as creditors, not as owners of its equity. Because the guarantee is unsecured and ranks equally, Rs 2,000 crore of opco claims and Rs 1,000 crore of guarantee claims share Rs 2,400 crore in proportion: 80% each. The equity is now worth nothing, so nothing more reaches holdco through its shares.

Trace both cases across a range of values, because the interviewer's follow-up is usually a different number. Without the guarantee, holdco gets nothing until value passes Rs 2,000 crore and full recovery at Rs 3,000 crore; with it, holdco recovers value over Rs 3,000 crore from the first rupee. The guarantee matters most when value is low, which is exactly when lenders need it.

Three things. First, security: if opco debt were secured on the plants, it would be paid before the unsecured guarantee, and holdco would be back to about 40%. A guarantee is only as good as its rank at the guarantor. Second, enforceability: upstream guarantees can be challenged where the subsidiary received little in return, so lawyers test them under the governing law, and the current position should be confirmed rather than assumed. Third, limits: guarantees are often capped, and a capped guarantee gives a claim only up to the cap.

The view to close on: the same business can give a holdco lender 40% or 80% depending on one document, and opco lenders pay for that difference. That is why lenders at both levels read the guarantee package before the financials.