A subordination agreement is the contract in which a junior creditor — commonly a mezzanine lender or a seller holding a take-back note — agrees its claim will be repaid only after a senior secured lender, and often accepts a standstill on collecting or enforcing until the senior debt is satisfied.
Deavo’s summary of vendor take-back financing lists this as a standard coordination point whenever a bank is also in the deal: “standstill or subordination terms if a bank or CSBFP lender is also financing part of the same deal, since senior lenders typically require the vendor take-back to rank behind them.” Security given to back a junior position does not escape this on its own: Treadstone’s answer on a seller demanding a share pledge instead of an unsecured note is direct that “a bank providing senior financing may object to, or require subordination of, a seller’s share pledge just as it might for other vendor take-back security,” so taking security does not by itself hand the seller priority over the bank — the buyer still has to “coordinate it with any other lenders involved in the deal.”
Where a senior term loan and a mezzanine facility are both registered against the same collateral under a province’s Personal Property Security Act, it is the subordination agreement — not the order the two facilities happened to be registered in — that fixes which lender actually gets paid first.
A seller finances $1,500,000 of a $12,000,000 sale price with a take-back note secured by a share pledge. The buyer’s senior lender agrees to fund the balance only if the seller signs a subordination agreement confirming the pledge ranks behind the bank’s general security agreement and imposing a standstill on the seller collecting anything — even a scheduled payment — while the senior loan is in default.
See also: Mezzanine debt · Senior secured term loan · Personal guarantee.
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