Suntech isn’t who we think it is
The company known as Suntech isn’t simply Suntech at all. It’s a group of 41 different holding companies, intermediate holding companies, and operating subsidiaries tied together by common ownership. Suntech Power Holdings Company Ltd., based in the Cayman Islands, is the parent company, the ultimate owner, directly or indirectly, of all the others. Wuxi Suntech Power Company Ltd., in the Peoples Republic of China, controls the most important operating subsidiaries.
Each company in the Suntech group is a separate legal entity with its own assets and liabilities. Suntech Power Holdings’ biggest assets are its shares of three intermediate holding companies; its biggest liability is $585 million in debt held by U.S. investors and the World Bank. Wuxi Suntech’s subsidiaries own most of the plant, equipment, and inventory and generate nearly all of the cash flow; its biggest liability is $1.7 billion in debt held by Chinese banks.
Structural subordination
Suntech’s legal complexity is more than just an opportunity for lawyers; it’s also a problem for Suntech Power Holdings’ bondholders. Even though their bonds are senior under the terms of their own indentures, they are junior to Wuxi Suntech’s bank loans. That’s because of something called structural subordination.
Structural subordination occurs when a holding company borrows money at the same time as an operating subsidiary does. Suntech Power Holdings relied on cash from Wuxi Suntech for debt service, but Wuxi Suntech had its own debt payments to make to the banks. By forcing Wuxi Suntech into bankruptcy, the banks blocked payments from Wuxi Suntech to Suntech Power Holdings and to the bondholders.
Mount Kellett Capital Management, Driehaus Capital Management, Pioneer Investment Management, and Suntech Power Holdings’ other big bondholders, have no way to get at Wuxi Suntech’s assets and cash flows because of where they are lending in Suntech’s legal structure. They’re structurally subordinated to Industrial and Commercial Bank of China, Agricultural Bank of China, Bank of China, and the other banks.
That means the bondholders will have to wait until the banks’ claims are satisfied before they will be paid anything. No wonder Suntech’s bond prices have been below 50 cents on the dollar lately. Bondholders are expecting to get very little at all.
Credit considerations
The broader lesson is to know your borrower. And not just in the sense of risk factors, cash flows, management, and the usual credit concerns; but in the sense of who your borrower is and who the other borrowers are. Which company in the consolidated corporate family? What other companies are borrowing? Where is your borrower in the legal hierarchy?
How do you protect yourself against structural subordination? One way is to limit the amount of borrowing below you: have your loan agreement with the holding company limit borrowings by operating subsidiaries. Another way is to have operating subsidiaries with substantial assets and cash flows guarantee your debt. Better yet, do both.