Contractual subordination is a financial arrangement by which a creditor agrees to rank its claims below those of other creditors (senior creditors) in the repayment priority order. It is a common structuring tool in leveraged finance and financial structuring: mezzanine debt is subordinated to senior bank debt, shareholder loans are subordinated to all third-party debt. In due diligence, the mapping of debt subordination arrangements is essential to understand the actual debt priority structure and the recovery risk for each creditor in a distress scenario.

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Example: a Swiss LBO structure uses CHF 15.0 million of senior bank debt (first priority), CHF 5.0 million of subordinated mezzanine debt (second priority) and CHF 3.0 million of shareholder loans (third priority, fully subordinated). Contractual subordination agreements between the three creditor classes are embedded in an intercreditor agreement, defining payment stop mechanics, cure periods and enforcement restrictions.

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Hectelion analyses debt subordination structures in leveraged transactions and advises on intercreditor arrangements in financial structuring mandates.