Subordination: A Functional and Theoretical Analysis

There has been no serious scholarship on subordination since a 1961 Yale Law Journal article which described subordination as then utilized and discussed how it applied in practice. Our recent Article updates and, in scope, goes beyond that earlier article, analyzing subordination not only from a functional but also from a theoretical perspective. The inquiry is important because subordinated debt has become universal, representing hundreds of billions of dollars of outstanding financing domestically and trillions worldwide.

The Article classifies and compares the four types of subordination—contractual, structural, equitable, and statutory—and examines their rationales and uses. The most widespread type is contractual subordination, which occurs when a party that holds an otherwise senior interest agrees to subordinate that interest to a normally lesser interest. Contractual subordination is a useful tool for creditors and borrowers alike.

Contractual subordination allows creditors, for example, to invest according to their risk tolerances. Investors willing to assume more risk may accept a subordinated, or lower, repayment priority in exchange for a higher interest rate. In contrast, risk-averse investors may accept a lower interest rate in exchange for a senior, and thus safer, repayment priority. 

Contractual subordination can also benefit borrowers in at least two ways. It can widen firms’ access to credit by enabling investors (as explained above) to participate at varying risk levels, thereby expanding the investor base beyond what a single class of pari passu debt could achieve. Additionally, it can allow firms to borrow notwithstanding covenants limiting their incurrence of additional senior debt. Lenders often include such covenants in loan agreements to prevent later-issued senior debt from diluting their repayment. Having the flexibility to borrow additional (subordinated) debt can enable firms to satisfy capital needs and add to their general liquidity.

Structural subordination occurs by virtue of a company’s organizational structure. The most common example is a holding company, in which a parent firm holds stock in one or more operating subsidiaries. Parties that extend credit to the parent are effectively subordinated to creditors of the subsidiaries with respect to subsidiary assets. As businesses have increased their use of holding company structures for tax, liability-management, and other reasons, structural subordination has become more common.

Equitable subordination most often results from a judge’s ruling that equity requires the court to subordinate the repayment priority of a claim. This typically occurs in bankruptcy, enabled by provisions of bankruptcy law that judges view as giving them broad equitable powers. In the United States, the equitable subordination doctrine was effectively established in a Supreme Court case that subordinated the claims of a parent company against its controlled subsidiary to the interests of the subsidiary’s preferred shareholders. The Court’s rationale was that the parent company had engaged in inequitable conduct towards its subsidiary. Equitable subordination was subsequently codified, albeit without definition, in § 510(c) of the US Bankruptcy Code. Since then, some courts controversially have expanded the doctrine’s parameters to dispense with the need for inequitable conduct and control.

Statutory subordination involves the law dictating that certain claims take priority over others. The goal is to help further legislative policies. Although this indirectly subordinates the other claims, it might more intuitively be described as a form of prioritization of the favored claims (as opposed to directly moving the other claims to a lower priority). Common examples include tax liens, government pension claims, environmental liens, and various priority-granting provisions of bankruptcy law.  

One form of statutory subordination is so common that few would recognize its relationship to subordination: prioritization of private claims through the creation of security interests. Collateral would not exist without statutory authorization because contract law does not normally permit claims to be lowered in repayment priority without the claimant’s consent. Statutes such as the Uniform Commercial Code and, in the UK, a combination of laws nonetheless authorize the contractual granting of collateral absent the need for third-party consent.  

The Article analyzes and critiques the legal frameworks for these four types of subordination, showing that courts are profoundly confused about some of subordination’s basics, let alone its sometimes arcane and inconsistent terminology. For example, absent an organizing principle, some courts move subordinating creditors below the priority of all non-subordinating creditors, whereas other courts move subordinating creditors below the priority of only specifically defined ‘senior’ creditors. Courts are also divided on the underlying payment mechanics; some require a firm to pay senior creditors before juniors, whereas others require the firm to make pari passu payments to all creditors with the juniors thereafter making turnover payments to the seniors.

The Article also analyzes how subordination law should be improved, including by systematizing its terminology, settling its judicial splits, and, more generally, resolving doctrinal confusion. In contrast to the prior scholarship, which focuses narrowly on individual forms of subordination, the Article demonstrates that although the four types of subordination have different rationales and are governed by different bodies of law, they all share a common effect: directly or (in the case of statutory subordination) indirectly lowering the priority of certain claims relative to other claims. By situating the types of subordination within a unified framework, the Article seeks to bring coherence to a fragmented body of law. To further that coherence, the Article also provides a glossary of subordination-related terminology.

The authors’ article will appear in the Journal of Corporation Law (forthcoming March 2027) and is available here.

A prior version of this post has been published by the Harvard Law School Bankruptcy Roundtable.

Steven L Schwarcz is the Stanley A. Star Distinguished Professor of Law & Business at Duke University School of Law and a Senior Fellow at the Centre for International Governance Innovation. 

Isabelle Stewart is a 2026 JD Graduate of Duke Law School and an Associate at Vinson & Elkins LLP.