By Steven L. Schwarcz and Isabelle Stewart (Duke University School of Law)
Editor’s Note: Professor Schwarcz and Isabelle’s article will appear in the Journal of Corporation Law (forthcoming March 2027).
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. This 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 is 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. For example, contractual subordination is a useful tool for borrowers and creditors alike, enabling parties to allocate and price credit according to their risk tolerance. Creditors willing to assume more risk may accept a subordinated, or lower, repayment priority in exchange for a higher interest rate. In contrast, risk-averse creditors may accept a lower interest rate in exchange for a senior, and thus safer, repayment priority. Subordination’s flexibility can also benefit borrowers in at least two ways. It can widen firms’ access to credit by enabling investors 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.
The Article analyzes and critiques the legal frameworks for subordination, showing that courts remain 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 the debtor to pay senior creditors before juniors, whereas others require the debtor 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. Furthermore, in contrast to the prior scholarship which focuses narrowly on individual forms of subordination, the Article demonstrates that although the four types of subordination (contractual, structural, equitable, and statutory) 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.
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