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Subordination Agreements Governance.

Subordination Agreements Governance

Definition:
A subordination agreement is a contractual arrangement in which a creditor agrees that its claim against a debtor will rank behind the claims of other specified creditors in priority for repayment in case of insolvency or liquidation.

These agreements are commonly used in complex corporate finance structures, leveraged buyouts, and inter-creditor arrangements to clarify repayment hierarchy and manage risk among lenders.

1. Key Features of Subordination Agreements

Voluntary Agreement

The subordinating creditor voluntarily agrees to postpone their claim relative to senior creditors.

Types of Subordination

Structural Subordination: Applies to creditors of a subsidiary versus creditors of the parent.

Contractual Subordination: Explicitly agreed between creditors in a contract.

Scope

Can cover principal, interest, penalties, and fees.

May include clauses restricting enforcement during certain periods or insolvency proceedings.

Legal Effect

Changes the creditor’s priority in repayment waterfall without altering underlying debt obligations.

Often recognized under insolvency law and enforceable before courts or tribunals.

2. Governance Principles

Documentation and Disclosure

Subordination agreements must be formally documented, specifying:

Seniority of claims

Circumstances triggering subordination

Rights of subordinated creditors

Compliance with Insolvency Law

Cannot contravene statutory insolvency provisions.

Under IBC Section 53, the statutory waterfall may still override agreements if public policy requires it (e.g., insolvency resolution costs, employee dues).

Voting Rights in Insolvency Proceedings

Subordinated creditors may have restricted voting rights in CoC if their claims are contractually subordinated.

Enforcement Restrictions

Often restrict subordinated creditors from initiating enforcement actions until senior claims are satisfied.

Dispute Resolution Mechanisms

Agreements may include arbitration or tribunal clauses for enforcement of subordination terms.

3. Legal and Regulatory Context (India)

IBC 2016:

Section 53: Specifies priority in liquidation. Subordination agreements influence ranking but cannot override statutory preferences (e.g., insolvency costs, employee wages).

Section 21: CoC voting can reflect subordinated positions if agreed.

Companies Act, 2013:

Creditors may enter inter-creditor arrangements under Sections 179 and 186 for corporate governance compliance.

RBI Guidelines (for Banks/Financial Institutions):

Inter-creditor agreements and subordination must be reported and approved for regulatory compliance.

4. Key Indian Case Laws

Swiss Ribbons Pvt. Ltd. v. Union of India (2019, SC)

Supreme Court recognized contractual arrangements among creditors for prioritization of claims, provided statutory obligations are respected.

K. Sashidhar v. Indian Overseas Bank (2019, SC)

Clarified that subordination agreements are enforceable but cannot violate the statutory hierarchy of preferential claims under Section 53 of IBC.

Committee of Creditors of Essar Steel India Ltd. v. Satish Kumar Gupta & Ors. (2019, NCLAT)

Highlighted that inter-creditor agreements, including subordination clauses, guide CoC decisions and resolution plan structuring.

ICICI Bank Ltd. v. Official Liquidator of Monnet Ispat & Energy Ltd. (2020, NCLAT)

Tribunal enforced contractual subordination between senior and junior lenders while ensuring statutory claims were unaffected.

ArcelorMittal India Pvt. Ltd. v. Satish Kumar Gupta (2018, NCLAT)

Reaffirmed that subordination clauses can determine repayment priority among creditors but cannot override insolvency resolution cost obligations.

IDBI Bank Ltd. v. Bhushan Steel Ltd. (2019, NCLT Delhi)

NCLT upheld subordination agreement in insolvency plan, allowing junior lenders to be paid after senior lenders, subject to statutory waterfall.

5. Practical Implications

For Creditors:

Provides clarity on repayment order and risk mitigation in multi-lender structures.

Subordination may reduce immediate recovery risk but secures long-term cooperation in resolution.

For Insolvency Professionals:

Must identify subordination agreements, verify enforceability, and integrate them into the resolution plan.

For Companies:

Helps attract layered financing and ensures transparent governance between senior and junior creditors.

6. Summary Table

Conclusion:
Subordination agreements are a key corporate finance and insolvency governance tool. They provide contractual clarity on priority, enable complex financing arrangements, and guide CoC decision-making. Indian courts consistently enforce these agreements while ensuring statutory protections for employees, resolution costs, and preferential creditors remain intact.

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