Priority and Subordination: Who Gets Paid First in Multi-Lender Deals

Overview

In multi-lender financings—real estate deals, corporate loans, or structured financings—priority and subordination decide who recovers money first if the borrower defaults, sells collateral, or enters bankruptcy. Priority can be set by law (e.g., lien perfection timing under the Uniform Commercial Code) or by contract (subordination clauses and intercreditor agreements). The difference matters: it changes pricing, covenants, collateral structure, and enforcement rights.

This article explains the legal mechanics, practical examples, negotiation levers, and common pitfalls. It also points to documents and internal resources that clarify related topics like intercreditor agreements and mezzanine financing.

How legal priority is established

• Secured vs. unsecured claims: Secured lenders hold a lien on collateral. In default, secured claims are satisfied from the collateral proceeds before unsecured creditors. (See UCC Article 9 on perfection and priority: https://www.law.cornell.edu/ucc/9).

• Perfection and first-to-file/first-to-perfect: For many types of collateral, priority goes to the party that perfects its security interest first (commonly by filing a UCC-1 financing statement) or otherwise obtains statutory priority (e.g., a purchase-money security interest).

• Purchase-money security interests (PMSI): PMSIs often receive special priority over earlier liens for the same collateral when statutory requirements are met.

• Real property vs. personal property: Mortgage lenders on real estate usually determine priority by the recording date in county land records. A first mortgage typically trumps later mortgages unless a subordination agreement or other exception applies.

• Statutory liens and tax liens: Government tax liens and certain statutory liens can have priority over private liens under specific rules. The IRS explains notice-of-federal-tax-lien rules and filing here: https://www.irs.gov/businesses/small-businesses-self-employed/filing-a-notice-of-federal-tax-lien

Subordination by contract: what that looks like

Subordination is an agreement—often in writing—that one creditor’s claim will be paid after another’s. Common forms:

• Subordination agreement: A lender expressly agrees its security interest (or judgment) will rank behind another lender.

• Intercreditor agreement: A detailed contract between two or more creditors that sets out relative rights, enforcement steps, remedies, standstill periods, payment waterfalls, and cure rights. Intercreditor agreements are common in syndicated loans and deals with a bank (senior) lender and mezzanine or junior lenders (subordinate). See our internal explainer: Intercreditor Agreements in Multi-Lender Deals (https://finhelp.io/glossary/intercreditor-agreements-in-multi-lender-deals/).

• Subordination clauses in loan documents: Many loan agreements include built-in subordination or non-disturbance clauses that automatically define ranking in certain events.

For practical examples of language and typical warranties, see our Subordination Agreement glossary page (https://finhelp.io/glossary/subordination-agreement/).

What happens in enforcement or bankruptcy

• Foreclosure or collateral sale: Secured lenders are repaid from the collateral sale proceeds in order of priority. The senior lender’s claim is satisfied first; any remainder flows down the waterfall.

• Receivership or workout: Intercreditor agreements usually control whether a junior lender can seize collateral or force a sale. Senior lenders often have the right to control enforcement to protect collateral value.

• Bankruptcy: Bankruptcy introduces the automatic stay that pauses most creditor actions. The trustee or debtor-in-possession treats secured claims based on perfected priority, but there are special categories (administrative claims, priority tax claims) that can be settled differently. In bankruptcy, subordination agreements remain contracts but courts scrutinize whether the deal prejudices other creditors or violates bankruptcy rules. The U.S. Bankruptcy Code and case law determine how contractual subordination operates in practice.

Real-world example (practical numbers)

A mixed capital stack for an apartment complex:

• Senior mortgage: $10,000,000 (first lien)
• Mezzanine loan: $2,000,000 (subordinated to senior, secured by an equity pledge rather than first mortgage)
• Preferred equity: $1,000,000

If the property sells for $11,000,000 after foreclosure costs:

• Senior lender recovers $10,000,000 first.
• Mezzanine lender is paid from what’s left ($1,000,000) and likely remains short of its full claim.
• Preferred equity receives nothing. Mezzanine lenders frequently structure with an equity pledge or convertibility rights to improve recovery potential.

In my practice, mezzanine investors accept higher coupon rates and tighter enforcement provisions because the recovery gap between senior and subordinated claims often determines loss severity.

Negotiation levers lenders and borrowers use

• Interest rate and fees: Subordinated debt typically carries higher interest and fees to compensate for lower recovery priority.

• Security package: Senior lenders insist on exclusive first-lien collateral and negative pledge clauses to prevent dilution. Juniors may accept second liens or security in subsidiary assets.

• Intercreditor terms: Senior lenders will negotiate protections—standstill periods, consent rights before enforcement, payment-blocking triggers, and subordination of collateral shares—to avoid value-destroying races to enforcement.

• Covenants and reporting: Senior lenders demand tighter covenants; juniors may obtain reporting and inspection rights.

• Swap and lien release mechanics: In complex financings, lenders define how partial releases and prepayments affect priorities.

Practical checklist before signing subordination or intercreditor documents

• Confirm perfection mechanics for each lender (UCC-1 filings, mortgage recordings, security interests).
• Read intercreditor agreements carefully for enforcement standstills, remedies, and voting thresholds.
• Verify whether any statutory liens (tax, mechanics) could jump ahead of private liens.
• Understand cure and modification rules—changing priorities later typically requires the consent of affected parties.
• Obtain legal review from counsel experienced in secured transactions and bankruptcy.

Common mistakes and myths

• Myth: “Subordination only matters at default.” Reality: Subordination affects pricing, covenants, and negotiation even before default.

• Mistake: Failing to perfect security interests. A subordinated lender may lose not because of contract but because they never perfected their lien.

• Mistake: Assuming one agreement controls all assets. A junior lender may have priority on different collateral if not explicitly subordinated across the entire collateral pool.

• Misunderstanding bankruptcy treatment: Contractual subordination is respected in many cases, but bankruptcy courts can prioritize certain claims and scrutinize arrangements that unfairly prejudice other creditors.

Tips for borrowers

• Use subordination strategically to access cheaper senior debt while keeping junior capital available.
• Get all subordination-related promises in writing and coordinate closing to avoid timing-perfected priority problems.
• Ask for clear release mechanics so refinancing or partial paydowns don’t trap capital.

Further reading and authoritative resources

• Uniform Commercial Code, Article 9 — secured transactions (priority and perfection rules): https://www.law.cornell.edu/ucc/9
• IRS — Filing a notice of federal tax lien: https://www.irs.gov/businesses/small-businesses-self-employed/filing-a-notice-of-federal-tax-lien
• U.S. Small Business Administration — financing basics and loan structures: https://www.sba.gov/
• American Bar Association — materials on intercreditor agreements and secured lending (search ABA resources): https://www.americanbar.org/

Internal guides on financing structures:

• Intercreditor Agreements in Multi-Lender Deals — practical breakdown and sample clauses: https://finhelp.io/glossary/intercreditor-agreements-in-multi-lender-deals/
• Subordination Agreement — common language and negotiation points: https://finhelp.io/glossary/subordination-agreement/
• What is Mezzanine Financing? — how mezzanine sits in the capital stack: https://finhelp.io/glossary/what-is-mezzanine-financing/

Professional perspective

From 15+ years advising borrowers and negotiating lender positions, I’ve seen two recurring themes:

1) Documentation timing and perfection matter as much as signed subordination language. A late filing or missed recording can undo negotiated priorities.

2) Intercreditor agreements are where value is preserved after default. Senior lenders who build reasonable enforcement protocols keep collateral value higher, benefitting all secured parties.

These practical realities often determine recoveries far more than headline interest rates.

Frequently asked questions (brief)

• Can priorities be changed after closing? Yes, with written consent and usually amendments, but doing so often requires lender approval and may trigger fees or covenant waivers.

• Do subordination agreements hold in bankruptcy? Generally yes, but bankruptcy courts can re-order claims under specific statutory rules and case law; counsel should evaluate the facts.

• Is a junior lender protected by a subordination agreement that is never filed? Not from third parties—perfecting steps still matter to protect priority.

Disclaimer

This article is educational and does not constitute legal or financial advice. For transaction-specific guidance, consult qualified legal counsel and a lending professional. The content cites legal principles and government resources current as of 2025, but laws and procedures change over time.