Subordination Agreements, Bankruptcy and the PPSA

Abstract

Although subordination agreements are widely used, they are less comprehensively understood. In order to devise a workable framework for analyzing the legal issues associated with them, a fundamental distinction must be drawn between debt subordination and security interest subordination. In order to resolve questions concerning the characterization of subordination as security interests, the effect of bankruptcy of the junior or subordinating creditor, and the effect of assignments or consecutive subordinations, it is necessary to determine if the agreement creates a real right or a personal right. A promise not to assert a claim or a promise to pay a creditor an equivalent amount to that received creates only a personal right. This will not give the recipient a proprietary right that can be asserted against the junior or subordinating creditor’s trustee in bankruptcy or against a subsequent assignee. But if the subordination agreement transfers the junior or subordinating creditor’s claim to the recipient, it creates a proprietary right and must be perfected under the PPSA in order to be effective against the junior or subordinating creditor’s trustee in bankruptcy or a subsequent assignee.