Legal Definitions - subordination clause

A subordination clause is a specific provision within a legal agreement that establishes a hierarchy between that agreement and another. Essentially, it states that the terms and conditions of the document containing the clause will be secondary or "subordinate" to the terms of another specified document. This means that if there's a conflict or inconsistency between the two documents, the provisions of the higher-ranking (or "senior") document will take precedence.

Here are some examples:

• Imagine a small business owner leases office space in a commercial building. Their lease agreement might contain a subordination clause stating that the lease is subordinate to any existing or future mortgage on the building. This means that if the building owner defaults on their mortgage and the bank forecloses, the bank's rights under the mortgage would take priority over the tenant's rights under the lease. The tenant might find their lease terminated or subject to new terms dictated by the bank, even if their original lease had favorable conditions.

• Consider a homeowner who takes out a second mortgage or a home equity line of credit (HELOC) on their property. The document for this second loan will almost certainly include a subordination clause. This clause explicitly states that the second mortgage is subordinate to the first, primary mortgage on the home. If the homeowner were to default on both loans and the property was sold, the proceeds from the sale would first be used to fully repay the first mortgage lender. Only if there are funds remaining after the first mortgage is satisfied would the second mortgage lender receive payment, ensuring the primary lender's priority.

• In the context of business finance, a company might secure a loan from one bank (Bank A) and later seek additional financing from another lender (Bank B). The loan agreement with Bank B, or a separate intercreditor agreement, could include a subordination clause. This clause would stipulate that Bank B's claim for repayment is subordinate to Bank A's claim. If the company were to face financial distress and declare bankruptcy, Bank A would be paid back before Bank B, even if Bank B's loan was more recent or had different interest rates. This clause clearly defines the order in which creditors will be repaid.