DEFINITION of 'Downstream Guarantee'

Downstream guarantee (or guaranty) is a pledge placed on a loan on behalf of the borrowing party by the borrowing party's parent company or stockholder. By guaranteeing the loan for its subsidiary company, the parent company provides assurance to the lenders that the subsidiary company will be able to repay the loan.

BREAKING DOWN 'Downstream Guarantee'

A downstream guarantee is a form of intercorporate guarantee which refers to an obligation taken by a third party (typically a holding company) to perform another’s (its subsidiary) financial obligation on a debt. In the event that the borrowing entity is unable to make good on its repayments, the guarantee requires the parent company to repay the loan.

A downstream guarantee can be undertaken in order to help a subsidiary company obtain debt financing that it otherwise would be unable to obtain, or to obtain funds at interest rates that would be lower than it could obtain without the guarantee from its parent company. In many instances, a lender may be willing to provide financing to a corporate borrower only if an affiliate agrees to guarantee the loan. This is because, once backed by the financial strength of the holding company, the subsidiary company's risk of defaulting on its debt is considerably less. The guarantee is similar to one individual cosigning for another on a loan.

For instance, a company that wishes to borrow funds from a lending institution but does not have thecollateral required to secure the loan may have its parent company put up real estate as lien for the loan. While the property pledged as collateral provides the lender with additional assets to secure repayment of the loan, the subsidiary is able to obtain the loan on more favorable terms and at a lower cost than it could obtain as a separate legal entity. The loan is used to improve or expand the operations of the borrower which, in turn, improves the financial strength of the parent company. Since the parent owns stock in the subsidiary, it is said to receive reasonably equivalent value from the loan proceeds reflected in the increased value of the stock.

A downstream guarantee lies in contrast to an upstream guarantee, which is a loan taken by a parent company that is guaranteed by its subsidiary. Typically, a lender will insist on an upstream guaranty when it lends to a parent whose only asset is stock ownership of a subsidiary. In this case, the subsidiary owns substantially all the assets upon which the lender bases its credit decision. The problem with upstream guarantees is that lenders are exposed to the risk of being sued for fraudulent conveyance when the guarantor is insolvent or without adequate capital at the time it executed the guarantee. If the issue of fraudulent conveyance is successfully proved in a bankruptcy court, the lender would become an unsecured creditor, clearly a bad outcome for the lender. Since the subsidiary guaranteeing the debt payments owns no stock in the parent company borrowing the funds, the former does not directly receive any benefits from the loan proceeds and, hence, does not receive a reasonably equivalent value for the guarantee provided.

RELATED TERMS
  1. Financial Guarantee

    A financial guarantee is a non-cancellable indemnity bond backed ...
  2. Demand Guarantee

    A demand guarantee is a form of protection for a contract that ...
  3. Unsecured Loan

    An unsecured loan is a loan that is issued and supported only ...
  4. Loan Stock

    Loan stock refers to common or preferred stock shares that are ...
  5. Indirect Loan

    An indirect loan can refer to any loan in which the issuer or ...
  6. Parent Company

    A parent company is a company that has a controlling interest in ...
Related Articles
  1. Personal Finance

    Personal Loans vs. Car Loans

    How to tell whether a personal loan or a car loan is better for you.
  2. Investing

    Commercial real estate loans

    Obtaining a commercial real estate loan is quite different from borrowing for residential real estate. Here's what to expect and how to get what you need.
  3. Small Business

    Lending Clubs: Better Than Banks?

    If you need to borrow money and your credit is making it tough, this new option may be just what you're looking for.
  4. Retirement

    10 Ways to Borrow in Retirement

    Before you take money from your nest egg, consider these 10 other ways to borrow in retirement.
  5. Investing

    Financing Basics For First-time Homebuyers

    If you're looking to get your first mortgage, there are many financing options available.
  6. Personal Finance

    Personal Loans: Consider These Alternative Lenders

    Looking for an alternative source of financing for a personal loan? Take a look at these companies.
  7. Financial Advisor

    Tips To Improve Chances Of A Small Business Loan

    Enhance your small business loan eligibility by keeping these important tips in mind.
  8. Personal Finance

    Home Improvement Loans: What Are Your Best Options?

    If you plan on taking out a home improvement loan, you should know what your options are and which ones might be best for your situation.
  9. Personal Finance

    8 Cheaper Ways to Raise Cash Than Car Title Loans

    Before you sign up for a car title loan, investigate these eight alternate cash-raising strategies rather than using the value of your lien-free vehicle.
  10. Personal Finance

    College Loans: Private vs. Federal

    Not all student loans are the same. Learn the difference between federal vs private student loans.
RELATED FAQS
  1. The difference between a bank guarantee and a bond

    Understand the differences between a bank guarantee and a bond – including which one is a debt instrument. Read Answer >>
  2. Are Subsidiaries Included in Company Statements?

    Learn how foreign and domestic subsidiaries are listed on the balance sheet of the parent company. Read Answer >>
  3. What is the difference between secured and unsecured debts?

    Learn about the differences between secured and unsecured debt — and how banks buffer risks associated with each type of ... Read Answer >>
  4. Understanding the Five Cs of Credit?

    Learn how the five C's of credit affect new credit application decisions, and understand how a lender analyzes each aspect ... Read Answer >>
Trading Center