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Middle-market and larger corporate borrowers increasingly find themselves with off-shore manufacturing, assembly or distribution subsidiaries and wishing to obtain credit based on their global cash flows, including those arising from such foreign subsidiaries. From a U.S. lender's perspective, the simplest, and preferred, approach for extending such credit is generally to make the loan to the U.S. parent and take guaranties from all of its subsidiaries, including foreign subsidiaries.1 Unfortunately, in many instances, foreign subsidiaries may be limited in their ability to provide such guaranties, or to extend grants of collateral on their assets, by foreign law restrictions on upstream guaranties and collateral grants.2 In addition, guaranties by non-U.S. subsidiaries may cause the U.S. parent to be deemed to recognize for U.S. tax purposes dividend income from such subsidiaries (the so-called Section 956 "deemed dividend" tax problem).3 Furthermore, taking pledges or security interests directly on nonU.S. subsidiary assets often entails the additional expense, and sometimes delay, of retaining foreign counsel and satisfying notarization, stamp tax and other local legal requirements. In some cases, it may be cumbersome or impossible, under a given foreign law, to obtain floating liens directly on receivables or inventory of the foreign subsidiary.4
As a result, in order to avoid the "deemed dividend" problem, and to avoid entanglement with foreign law restrictions on upstream guaranties and collateral grants and other complications, the compromise solution often agreed to by U.S. lenders in cash flow deals is to accept a pledge of 65 percent of the foreign subsidiary's voting stock held by the U.S. borrower (or any U.S. subsidiary holding stock in such foreign subsidiary).5 For simplicity, this article assumes that the U.S. borrower, a Kansas corporation, is also the direct parent of the foreign subsidiaries in question and is therefore the pledger under the stock pledge agreement.
Two common questions
Two practical questions often raised by lenders in connection with the foreign subsidiary stock pledge scenario are: (1) whether a U.S. law (as opposed to foreign law) pledge agreement can be used for such purposes, and (2) whether the lender should engage the assistance of foreign counsel to ensure compliance with foreign law lien perfection and enforcement rules. Or, to paraphrase Dorothy in The Wizard of Oz, "Am I still in Kansas?"...