Contractual subordination

Where a lender ranks is mostly a matter of contract. An intercreditor agreement between the senior lenders and every junior creditor sets the order, and contractual subordination is the part of it that stops the junior claim being paid while the senior debt is outstanding, or permits payment only where there is no default and leverage sits below an agreed level.

Two companion mechanisms come with it and are worth naming together. An enforcement standstill prevents the junior creditor from suing, accelerating or petitioning while the senior lenders decide what to do. A turnover obligation requires the junior creditor to hold on trust and hand over anything it receives that it was not entitled to receive, which closes the gap that would otherwise exist if a payment slipped through.

It is not the same as structural subordination, and interviewers test the difference. Contractual subordination is an agreement about the order of payment among creditors of the same company. Structural subordination is a fact about where in a group a claim sits: a creditor of a holding company ranks behind every creditor of the operating companies below it, because the holding company owns only shares and shares are paid last.

A vendor loan note is normally subject to both. It is subordinated by agreement to the acquisition debt, unsecured, and often issued by a holding company above the borrower, so the seller's claim sits behind essentially everything.