What is a “Subordination Agreement”?

A subordination agreement is a contract that establishes one debt as ranking behind another debt in the priority for collecting repayment from a debtor. As the Idaho Supreme Court has noted:

The general purpose of a subordination agreement is the “subordination” (or “relegation”) of the right to receive payment of certain indebtedness (the ‘subordinated debt’) to the prior payment of certain other indebtedness (the ‘senior debt’) of the same debtor.

See Blickenstaff v. Clegg, 140 Idaho 572, 97 P.3d 439, (2004) (Citing Culp v. Tri-County Tractor, Inc., 112 Idaho 894, 897, 736 P.2d 1348, 1351 (Ct.App.1987)). This basically means that a party that might otherwise have a debt that has the first right to collect on a debt, may execute an agreement that provides another party the right to collect on the debt first.

There are few reasons that someone might enter into such an agreement. One common example is when someone has a second mortgage on their home and he or she wants to refinance the original mortgage. Refinancing simultaneously cancels the loan and writes a new one. As soon as this happens, the second mortgage becomes senior and the refinanced (original) mortgage falls to second place in priority. The original mortgage lenders usually want to maintain their first position rights in case of a foreclosure sale and will usually not approve a refinance unless the second mortgagee signs a subordination agreement. This ensures that the original lender has priority if the debtor defaults on the loan and the home must be foreclosed upon and sold. The original lender will get paid first from the proceeds of the foreclosure sale.

Additionally, subordinated loans usually carry a higher interest rate because they carry more risk to the lender. The subordinate lender is risking potentially not being paid, or getting paid less, because it can only collect funds after the priority lender has been paid. In some cases, there might not be enough funds to pay the subordinate lender.

The law encompassing subordination agreements is complicated and there are numerous details that only an experienced attorney can accurately analyze. If you need assistance with preparing an agreement or need analysis regarding the terms of an agreement, please contact the experienced attorneys at Brian Webb Legal for a consult.