Agreement to subordinate: Overview, definition, and example
What is an agreement to subordinate?
An agreement to subordinate is a contractual arrangement in which one party agrees to prioritize the interests of another party over its own. In financial terms, subordination typically occurs in the context of debt agreements, where a lender agrees to allow their debt to be repaid after other debts or obligations are settled. This means that if the borrower defaults or faces liquidation, the subordinated debt holder will only be paid after the senior debt holders have been fully compensated. Subordination can also apply in other contexts, such as in real estate, where a lender agrees that their lien on a property will rank behind another lender’s lien.
For example, a lender might agree to subordinate its loan to a new loan issued by another lender, meaning the new lender’s loan takes priority in case the borrower defaults.
Why is an agreement to subordinate important?
An agreement to subordinate is important because it helps establish a clear order of priority in the event of financial difficulty or liquidation. By agreeing to subordinate, a lender may make it easier for the borrower to secure additional financing or negotiate more favorable terms with other creditors. Subordination can also help reduce risks for senior lenders, as they are guaranteed to be paid first, while subordinated lenders take on more risk but may receive higher interest rates in return. This agreement helps create flexibility in financial transactions, allowing borrowers to access capital even when existing debt is a concern.
Understanding an agreement to subordinate through an example
Let’s say a company already has an existing loan agreement with a lender but needs additional financing to expand its operations. The new lender agrees to provide the required funds, but only if the existing lender agrees to subordinate its debt to the new lender. The existing lender accepts the subordinated position, agreeing that if the company faces liquidation, the new lender will be paid first before any remaining balance of the original loan is settled. In return for assuming this additional risk, the subordinated lender may negotiate higher interest rates on their loan.
In another example, a real estate developer has multiple loans on a property. The primary lender holds the senior lien, while a secondary lender holds a subordinate lien. If the developer defaults, the senior lender gets paid first, and only after that will the subordinate lender receive any repayment. This structure is crucial in determining how funds are distributed in case of foreclosure or bankruptcy.
An example of an agreement to subordinate clause
Here’s how an agreement to subordinate clause might appear in a loan agreement or contract:
“The Lender agrees to subordinate its lien and any claims against the Borrower to the rights and interests of any new lender providing financing to the Borrower under this Agreement. The Lender acknowledges that in the event of default or liquidation, the new lender’s claims shall take priority over any claims of the Lender, and the Lender shall only receive repayment after the new lender has been fully compensated.”
Conclusion
An agreement to subordinate is a critical tool in financial and legal agreements, especially when dealing with multiple creditors or complex debt structures. By establishing a clear priority of payments or claims, subordination helps facilitate new financing and ensures that all parties understand their rights and risks. While subordinated parties take on more risk, they may also be rewarded with higher returns, making this arrangement a common feature in corporate lending, real estate, and other financial transactions.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.