A subordination agreement is a legal document that sets out the priority of liens or claims on a property or asset. It is typically used in real estate transactions but can also be used in other types of transactions.
The purpose of a subordination agreement is to establish the order in which different creditors have the right to collect on a property or asset in case of default or bankruptcy. The agreement works by subordinating one creditor`s claim to another, which means that the first creditor will receive payment only after the higher-ranking creditors have been paid.
For example, let`s say that a homeowner has a mortgage on their property and then takes out a second mortgage. In this case, the first mortgage will have priority over the second mortgage, meaning that the first lender will be paid before the second lender in the event of default or foreclosure. To formalize this relationship, the second lender will require the homeowner to sign a subordination agreement.
Subordination agreements are also used in commercial lending, where multiple lenders may be involved in a transaction. For example, a company may take out a loan from a bank and then issue bonds to raise additional capital. The bank will require the bondholders to sign a subordination agreement, which establishes the bank`s priority over the bondholders in case of default.
In some cases, a subordination agreement may also be used to facilitate refinancing. For example, if a homeowner wants to refinance their mortgage, the new lender will require the existing mortgage holder to sign a subordination agreement, which ensures that the new mortgage will have priority over the old mortgage.
In summary, a subordination agreement is a legal document that establishes the priority of liens or claims on a property or asset. It is an important tool for creditors to protect their interests in case of default or bankruptcy. If you are involved in a real estate or commercial transaction, it is important to understand the role of subordination agreements and to consult with a legal professional if necessary.