An arrangement where one creditor or group of creditors (the junior creditor(s)) agrees not to be paid by a borrower or other common debtor until another creditor or group of creditors (the senior creditor(s)) have been paid. Broadly, there are two types of subordination: structural (common in the UK and mainland Europe) and contractual (common in the US).

On a contractual subordination, loans are made to the same company but the senior creditor and junior creditor agree priority of payment by contract.

Structural subordination arises where the senior creditor lends to a company (usually one of the operating subsidiaries in which assets are held) which is lower in the group structure than the company (a holding company) into which the junior creditor lends. Junior creditors as creditors of a holding company effectively rank behind creditors of the operating subsidiaries lower down in the group structure. This is because where a holding company and its subsidiaries become insolvent, the creditors of the operating subsidiaries will be paid out before any distribution is made to the holding company as shareholder in the subsidiary. Only if the holding company receives a distribution from the liquidator of a subsidiary will the holding company be able to meet the claims of its creditors from the proceeds realised from the subsidiaries.

For further details, see Practice note, Subordination.