Opening summary

Collateral subordination decides who gets paid first from pledged assets when multiple lenders claim the same collateral. For business borrowers, signing a subordination agreement can make new financing possible — but it usually raises the subordinated lender’s perceived risk, which shows up in higher rates, stricter covenants, or reduced borrowing amounts.

Why priority matters (quick primer)

  • Lien priority controls the order of repayment from collateral if a borrower defaults. Priority typically follows perfected lien timing and specific legal exceptions like purchase‑money security interests (PMSIs) (Uniform Commercial Code §9‑322; Cornell LII).
  • A subordinated lien is still secured, but it’s paid after senior liens. If collateral value is insufficient, subordinate lenders may recover little or nothing.

How collateral subordination actually works

  1. Existing collateral and UCC filings: Lenders perfect security interests by filing UCC‑1 financing statements or by taking possession. Priority usually goes to the first perfected interest unless a legal exception applies (UCC §9‑322).
  2. Request for subordination: A new lender may require existing lenders to sign a subordination agreement or an intercreditor agreement that specifies priorities, enforcement rights, cure periods, and standstill provisions.
  3. Intercreditor agreement: This document is common in deals with multiple secured lenders. It lays out who can foreclose, who can collect, whether the senior lender must preserve collateral value, and how proceeds are split after liquidation.

Real‑world example (simplified)

A manufacturer has $300,000 of machinery with a first‑lien bank loan and a second lender offering $100,000. The second lender asks the first bank to remain senior. If the business goes into default and the machinery sells for $250,000, the senior bank is paid first. The subordinate lender may get whatever, if anything, remains after senior claims and sale costs are satisfied.

Common variants and legal points

  • First lien vs. second lien: A senior (first) lien has priority; a subordinated (second) lien waits in line.
  • Blanket liens: A lender may hold a lien on all business assets. Subordination of a blanket lien can materially affect access to capital.
  • Purchase‑money security interest (PMSI): In some cases a PMSI (for goods purchased with loan proceeds) can have special priority if properly perfected.
  • Bankruptcy effects: In bankruptcy, secured priority and the intercreditor agreement determine distribution; subordination generally remains binding unless a court sets it aside for cause.

Who is affected

  • Business owners with multiple secured loans (term loans, equipment financing, lines of credit).
  • Startups that pledge founder assets or grant blanket liens to early lenders.
  • Lenders who want to protect a larger exposure by remaining senior.

Negotiation and practical strategies (professional tips)

  • Map current liens: Pull UCC filings and create a lien priority table before negotiating. This prevents surprises.
  • Ask for carve‑outs: Negotiate exceptions that let subordinate lenders be paid for specific items (e.g., working capital or vendor payments) ahead of others.
  • Seek defined remedies: Limit the senior lender’s ability to foreclose immediately (notice/cure periods, standstill clauses) in the intercreditor agreement.
  • Consider partial subordination: You can agree to subordinate only specific collateral (e.g., equipment but not accounts receivable).
  • Use counsel experienced in UCC and intercreditor negotiations; the language matters materially.

Common mistakes to avoid

  • Not checking recorded liens: Failing to search UCC‑1 filings or property records can leave hidden senior claims.
  • Over‑subordinating: Giving up first priority on critical assets (like a factory or major equipment) may block future borrowing or recovery.
  • Ignoring bankruptcy risk: Assume subordinate positions may be disfavored in liquidation and plan liquidity accordingly.

Frequently asked questions

  • Can subordination be revoked? Typically no — subordination is a contractual agreement. It may be modified only by agreement of the parties or in limited court‑ordered situations.
  • Will subordination lower my interest rate? Usually no. Subordination typically increases risk for the subordinated lender and can raise cost or reduce the loan amount unless another concession offsets that risk.
  • Is there a standard form? There’s no single standard; intercreditor and subordination agreements are negotiated documents and should be reviewed by counsel.

When to get advice

If you’re considering subordination — either as a borrower or a lender — consult an attorney who handles UCC and secured finance and a financial advisor who can model recovery scenarios. In my practice advising small businesses, an early lien search and a clear intercreditor draft avoided costly surprises during refinancing.

Related resources on FinHelp

Authoritative sources and further reading

Disclaimer

This article is educational and not legal or financial advice. For decisions about loan documents, subordination, or intercreditor agreements, consult a qualified attorney and a financial advisor familiar with your situation.