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Subordination of Contract Clause

Subordination of Contract Clause: A Brief Guide

The subordination of contract clause is a provision in a contract that specifies the hierarchy of liens or claims on a particular property in the event of default. It is commonly used in mortgage agreements, lease contracts, and other types of lending agreements.

In simple terms, a subordination clause elevates the priority of one debt over another. For instance, if a borrower defaults on a mortgage and there are multiple liens on the property, the subordination clause determines which lien has priority over the others.

Here’s how it works. Suppose a borrower takes out a second mortgage on a property that already has a first mortgage. The second mortgage lender would typically require a subordination clause to be included in the contract. This clause would state that the second mortgage lender’s claim on the property is subordinate to the first mortgage lender’s claim. This means that in the event of default, the first mortgage lender would have priority over the second mortgage lender in terms of collecting on the debt owed.

Why is the subordination of contract clause necessary?

The subordination of contract clause is crucial in situations where there are multiple creditors involved. Without it, it would be challenging to determine which creditor has priority in the event of default. This could lead to disputes and legal battles that could further delay the collection of debts owed.

Subordination clauses are standard in many types of lending agreements, such as loans secured by real estate, equipment leasing, and other forms of financing. They ensure that lenders have a clear understanding of their priority status and what to expect in the event of default.

Types of subordination clauses

There are two types of subordination clauses: general and specific.

General subordination clause: This clause refers to a situation where the subordinate lienholder agrees to give priority to the senior lienholder regardless of the transaction or circumstance. This type of clause is commonly used in real estate transactions involving mortgages.

Specific subordination clause: This clause applies to a specific transaction or circumstance. For instance, a lender may agree to subordinate its lien to a tax lien filed against the property.

What to consider when drafting a subordination clause

When drafting a subordination clause, it’s essential to be clear and specific about the hierarchy of liens and claims. This ensures that all parties understand their priority status and can act accordingly in the event of default.

Here are some factors to consider when drafting a subordination clause:

– Identify the senior lienholder and the subordinate lienholder(s) clearly.

– Specify the type of subordination clause (general or specific) and the applicable circumstances.

– Include a provision that requires the subordinate lienholder to take action to protect the senior lienholder’s interest in the event of default.

– Provide a mechanism for resolving disputes between the senior and subordinate lienholders.

– Ensure that the clause complies with applicable laws and regulations.

In conclusion, the subordination of contract clause is a crucial provision in lending agreements that determines the priority status of liens and claims in the event of default. By being clear and specific about the hierarchy of claims, parties can avoid disputes and act accordingly to protect their interests.

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