Wendy’s/Arby’s Group, Inc. (ticker WEN) was formed in September 2008 through the merger of the 
Wendy’s and Arby’s fast food chains. In March 2009, WEN announced it had redone its main loan agreement to reflect the merger. Nothing unusual there. The surprise is that Wendy’s/Arby’s Group, Inc. is not a party to the loan agreement. Here’s why.
Holdco – Opco Structure
Wendy’s/Arby’s Group, Inc. is a holding company (“holdco“) – it has over 60 direct and indirect subsidiaries that actually own, franchise, or operate the restaurants (the operating companies, or “opcos“).
- The opcos have real assets (buildings, inventory, receivables, contracts, etc.) and hopefully generate cash flow from their operations.
- The holdco’s assets are stock in the opcos, and the holdco’s primary source of cash is dividends from the opcos.
A Quick Lesson on Bankruptcy
Under the absolute priority rule, a bankrupt company must repay its creditors (i.e. lenders, suppliers, employees, etc.) in full before it can distribute any cash to its owners. So, if WEN and its subsidiaries ever went bankrupt, who would be repaid first: lenders to the holdco (i.e. Wendy’s/Arby’s Group, Inc.) or lenders to the opcos (i.e. the 60 subsidiaries)? Answer: the opcos, since they have the assets and cash flow and must repay their creditors before paying dividends to the holdco.
Structural Subordination
The idea that opco creditors are paid before holdco creditors is referred to as structural subordination. Because of structural subordination:
- Lenders to high risk companies (such as WEN) often prefer to lend to operating subsidiaries rather than to a parent company.
- Loans to holdcos often include a subsidiary debt limitation and upstream guarantees in order to limit the impact of structural subordination.
- The rating agencies typically rate the debt of a holdco lower than the debt of its operating subsidiaries. For example, Standard and Poor’s rates Wendy’s/Arby’s Group, Inc. “B-” but assigned the slightly higher “B” to the loans of its subsidiaries.