Effect of equitable, contractual and structural subordination
Effect of equitable, contractual and structural subordination

The following Restructuring & Insolvency guidance note provides comprehensive and up to date legal information covering:

  • Effect of equitable, contractual and structural subordination
  • Contractual subordination
  • Structural subordination
  • Registration as a charge
  • Impact on debtor's insolvency
  • Relationship to pari passu rule
  • Relationship with set-off
  • Equitable subordination
  • Global trends and future reforms

Senior creditors will ensure that in addition to having higher security rights over junior creditors, juniors are also subordinated to them.

Generally creditors closest to the main asset-owning companies (Opcos) exert most control over any restructuring/insolvency, meaning their final dividend is often higher.

The three main types of subordination are:

  1. contractual subordination—lending to the same debtor entity

  2. structural subordination—seniors lending to Opcos, juniors lending to Holdcos

  3. equitable subordination—shareholder loans re-characterised as equity; common in the US and parts of Europe, but not recognised in the UK

The common theme is that juniors should not be able to retain payment until the seniors are paid in full.

Contractual subordination

All parties lend to the same debtor company and the relative priorities are agreed contractually in an Inter-creditor Agreement/Priority Agreement/Security Trust Deed (see Practice Note: Intercreditor agreements for R&I lawyers) or are contained in the terms of the junior debt (eg bonds) itself. Typically, the payment waterfall will set out the order of payments between senior and junior creditors. See Figure 1

$1

There are three main types of contractual subordination:

Contingent debt subordination

The junior creditor agrees with the company that its debt will not be due and payable until the seniors are paid in full ie the company's liability to repay juniors is contingent on the seniors being repaid in full. It's not necessary for the