Downstream Guarantee
DEFINITION of Downstream Guarantee
Downstream guarantee (or guaranty) is a pledge put on a loan for the borrowing party by the borrowing party's parent company or stockholder. By guaranteeing the loan for its subsidiary company, the parent company gives assurance to the lenders that the subsidiary company will actually want to repay the loan.
BREAKING DOWN Downstream Guarantee
A downstream guarantee is a form of intercorporate guarantee which alludes to an obligation taken by an outsider (ordinarily a holding company) to perform another's (its subsidiary) financial obligation on a debt. If the borrowing entity is unable to follow through with its repayments, the guarantee requires the parent company to repay the loan.
A downstream guarantee can be embraced to assist a subsidiary company with getting debt financing that it in any case would be unable to get, or to get funds at interest rates that would be lower than it could get without the guarantee from its parent company. In many examples, a lender might give \ufb01nancing to a corporate borrower provided that an af\ufb01liate consents to guarantee the loan. This is on the grounds that, when backed by the financial strength of the holding company, the subsidiary company's risk of defaulting on its debt is extensively less. The guarantee is like one individual cosigning for one more on a loan.
For example, a company that desires to borrow funds from a lending institution however doesn't have the collateral required to secure the loan might have its parent company put up real estate as lien for the loan. While the property pledged as collateral gives the lender extra assets to secure repayment of the loan, the subsidiary can get the loan based on additional favorable conditions and at a lower cost than it could get as a separate legal entity. The loan is utilized to improve or grow the operations of the borrower which, thus, works on the financial strength of the parent company. Since the parent claims stock in the subsidiary, it is said to receive sensibly equivalent value from the loan proceeds re\ufb02ected in the increased value of the stock.
A downstream guarantee lies as opposed to a upstream guarantee, which is a loan taken by a parent company that is guaranteed by its subsidiary. Ordinarily, a lender will demand an upstream guaranty when it loans to a parent whose main asset is stock ownership of a subsidiary. In this case, the subsidiary possesses substantially every one of the assets whereupon the lender bases its credit decision. The problem with upstream guarantees is that lenders are presented to the risk of being sued for fraudulent conveyance when the guarantor is ruined or without adequate capital at the time it executed the guarantee. In the event that the issue of fraudulent conveyance is effectively proved in a bankruptcy court, the lender would turn into a unsecured creditor, obviously a terrible outcome for the lender. Since the subsidiary guaranteeing the debt payments claims no stock in the parent company borrowing the funds, the former straightforwardly receives no benefits from the loan proceeds and, consequently, doesn't receive a sensibly equivalent value for the guarantee gave.
