Quick answer
Subordination is an agreement that one debt or security interest will rank behind another, so it is only repaid after the higher-ranking debt. In business lending it usually comes up when a lender asks directors or related companies to subordinate money the business owes them, or when two secured lenders sign a deed setting out who is paid first.
Key points
- A subordinated debt is repaid only after the senior debt it sits behind
- Lenders often ask directors to subordinate their shareholder or director loans
- Two secured lenders record their ranking in a priority or subordination deed
- Australia's PPS Act lets secured parties agree to change their priority
Subordination means agreeing to stand further back in the queue. One lender or creditor accepts that its debt will be repaid only after another debt has been paid, either in full or up to an agreed amount.
It’s a ranking tool. Nothing about the debt itself disappears; what changes is who gets paid first from the business’s cash or assets if there isn’t enough to go around.
Where subordination shows up in business lending
There are two common situations.
1. Director and shareholder loans. Many private companies owe money to their owners, often from early start-up funding or profits left in the business. On the balance sheet this appears as a loan from directors or related parties. A new lender may ask the owners to sign a subordination deed promising not to withdraw that money, or to claim it ahead of the lender, until the new loan is repaid.
2. Two lenders over the same assets. When a business has a first lender and adds a second mortgage or a second general security, the lenders usually sign a priority deed. It confirms which one ranks first, sometimes caps the amount the first lender can claim ahead of the second, and sets rules for enforcement. Over personal property, the Personal Property Securities Act lets secured parties agree to subordinate their interests in this way.
Who ranks where
| Position | Typical examples | Repaid |
|---|---|---|
| Senior secured | First mortgage, first-ranking general security agreement | First, from the assets it holds |
| Subordinated secured | Second mortgage, second GSA, mezzanine debt | After the senior lender, from what’s left |
| Unsecured creditors | Suppliers, most trade debts | After secured lenders, subject to legal priorities in an insolvency |
| Subordinated unsecured | Director loans signed over to a deed | After the creditors they agreed to rank behind |
| Equity | Shareholders | Last |
A worked example
A manufacturing company owes its two directors $150k from money they put in years ago. It applies for a $400k equipment and working capital loan. The lender is comfortable with the business but notices the director loans and asks both directors to sign a subordination deed.
Under the deed, the directors agree the company won’t repay that $150k while the new loan is running unless the lender agrees. In a worst case, the lender is paid before the directors see their money. For the lender, that $150k now behaves almost like equity, which strengthens the application. For the directors, it means planning around not drawing that money back for the life of the loan.
If your lender has raised subordination as a condition and you’d like a second opinion on the structure, send us the details and we’ll talk through other ways to set it up.
Things worth checking before you sign
- Whether any payments are allowed on the subordinated debt, such as interest, and when they stop
- What happens to the deed if you refinance the senior loan
- Whether the deed covers future loans you make to the company, not just the current balance
- Your accountant’s view on tax treatment of the loan account while it’s frozen
Related terms
Senior debt is what subordinated debt sits behind. Mezzanine finance is a product built around a subordinated position. And the first vs second mortgage comparison shows how ranking changes the cost and availability of property-backed loans.
Ranking issues holding up your loan?
Second-ranking security, frozen director loans and priority deeds are ordinary parts of the deals we see, and plenty of lenders are comfortable sitting behind a bank. Getting in touch is a one-minute form, not a credit application, so nothing is recorded on your credit file. It reaches one specialist who calls you personally, and nobody shops your information around to other funders. Fill the form in carefully, including any existing lenders, so we can see the full picture straight away.
Frequently asked questions
Why would a lender want my director loan subordinated?
If the company owes you money, you could repay yourself ahead of the lender, or claim alongside it if things go wrong. A subordination deed stops that, so the lender knows the business's cash goes to its loan first.
Can I still be repaid a subordinated loan?
Usually only with the senior lender's consent, or once the senior loan is repaid. Some deeds allow limited payments, such as interest, as long as the business isn't in default.
What is a deed of priority?
A document signed by two or more secured lenders, and usually the borrower, that sets out which lender ranks first over the same assets and sometimes caps the amount each can claim in that position.
Is subordinated debt the same as mezzanine debt?
Mezzanine debt is one type of subordinated debt. It sits behind senior lenders but ahead of shareholders' equity, and it is normally priced higher because of that extra risk.
Does subordination affect what happens in a liquidation?
Yes. A creditor that has agreed to subordinate its debt will generally only receive money after the creditors it agreed to rank behind have been paid.