Legal Definitions - equitable subordination

Equitable subordination is a legal principle that protects outside creditors by giving them priority over insiders who are also creditors. This principle is designed to prevent a single creditor from unfairly benefiting at the expense of others.

For example, imagine a company has two creditors: a bank and the CEO of the company. If the CEO has also invested in the company and is therefore an insider, the bank may be able to use equitable subordination to gain priority over the CEO in the event of bankruptcy. This is because the CEO's insider status may have given them an unfair advantage over the bank.

Equitable subordination is only applicable when the insider creditor has acted unfairly or wronged the company and its outside creditors. This principle is intended to protect the interests of all creditors, not just those who happen to be insiders.