Legal Definitions - subordination agreement

A subordination agreement is a legal contract that ensures that a senior debt is paid before any other "subordinated" debt in case the debtor goes bankrupt. This agreement is usually signed by the debtor and the original creditor when the debtor needs to take on more debt after having a previous loan.

For example, let's say a company has a loan from Bank A, and they need to take on more debt to expand their business. However, they cannot get another loan without the agreement of Bank A. Bank A will require the company to sign a subordination agreement, which guarantees that they will be paid before any other creditors if the company goes bankrupt. This ensures that Bank A is not taking on high risks.

Once the subordination agreement is signed, the company may be able to get other loans from creditors who are willing to give the risky loan because they can charge a much higher interest rate. This is because the other creditors know that Bank A will be paid first if the company goes bankrupt.