Where You Actually Rank

Capital structure risk is the second question in the middle block of our framework: where do you sit, and who is allowed to move before you do? Most people think they've priced it, because the term sheet had a snazzy label. Senior secured. First lien. Preferred, with a liquidation preference.

That describes your position in one entity, on one specific day, under one country's law. All three of those can move, and when they do, it's often against you.

The ladder is per entity, not per group

The expensive mistake is assuming there is only one waterfall. There are usually several.

Every legal entity in a group has its own. Creditors of a subsidiary are paid out of that subsidiary before any value passes up to its shareholder. If your instrument was issued by the holding company, your claim is against the holding company, and what a holding company owns is shares of other companies. Those shares rank behind every creditor of the subsidiary.

That is called structural subordination. To understand your real risk, you need to understand the hierarchy of claims.

Technically nothing went wrong. The structure is designed to work this way. So the first question isn't what rank you hold, it's which entity owes you. Where does that entity sit in the group? What does it own? What ranks ahead of you?

Inside the right entity, the queue is longer

Assume you're a creditor of the entity with the assets. You can still be behind a long queue that most investment memos never mention.

There are two important takeaways from that chart.

First, a floating charge, meaning security a lender takes over a company's changing assets like stock or customer debts, doesn't fully protect the lender. In most common-law countries the insolvency costs and the workers' wages are paid out of that collateral first. So if you lent against inventory, the employees get paid before you do. Countries differ on which claims get this treatment, including tax, so check the local rules.

Second, preferential claims are usually capped per employee, and the cap does real work for you. Below it, the workforce ranks ahead of you. Above it, the claims are pari passu, meaning they stand beside you.

Take Singapore as the example. The cap is S$13,000 per employee, or five times the monthly salary threshold if that is lower, under section 203 of the IRDA. So an employee owed S$26,000 in unpaid wages has half the claim ranking ahead of you and half of it standing beside you.

The ladder can move after you sign

This is the part that surprises people.

Most modern restructuring regimes let a court grant new rescue money a security interest ranking equal to or ahead of an existing secured lender.

If that happens your first lien becomes a second lien, and if there isn't enough value beneath the new money you can be wiped out entirely. It happens through a court order, in a proceeding you didn't start, to fund a rescue you may well oppose. If you hold secured paper heading into a restructuring, watch any new money coming in and what it does to your position.

And it changes at the border

Different countries have different rules, policies and caps. A claim that ranks preferentially in one is ordinary unsecured in the next.

So a borrower operating in three countries doesn't give you one waterfall. It gives you three ladders. Which one governs is decided by where the proceedings open, that is not always where you expected, and it is sometimes chosen by the debtor.

What to actually check

Figure out which legal entity owes you, and what it holds that isn't shares in something else.

Price the non-debt liabilities sitting inside that entity: payroll, retirement contributions, tax. They rank ahead of you and they don't appear on a cap table.

Find out whether your security is fixed or floating, because that decides whether your collateral pays those claims before it pays you. Then assume everything moves. Rescue financing, a proceeding opening in a different country, or assets shifting between entities.

The honest floor

This is how ranking works. It is not legal advice. You need lawyers in the jurisdiction that will hear the case, and you need to pick the right ones.

Knowing where you rank doesn't tell you what you'll recover. That depends on what the assets can fetch and how long it takes. Ranking tells you whether the recovery has any chance of reaching your class at all.