A Matter of Contractual and Trust Subordination
14 Pages Posted: 21 Nov 2005
Date Written: November 21, 2005
A debt subordination may in general take two forms, viz., contractual subordination and turnover subordination. A contractual subordination occurs where, by agreement between a debtor and a creditor, debts owed to the creditor are to rank below other debts of the debtor. A turnover subordination (which may or may not involve a trust) requires the junior creditor, on the insolvency of the debtor, to turn over to the senior creditor all recoveries received by the junior creditor in respect of the junior debt. Where a trust is utilised, this technique is also called trust subordination.
A trust is not a charge. They are mutually exclusive. Despite the fact that a trust may perform a security function, "a trust by way of equitable charge" is never a trust. It is merely a charge masquerading as a trust. The trust subordination in Re SSSL demonstrates this proposition vividly.
In line with the general policy considerations in favour of the enforcement of contractual subordination, the decision in Re SSSL helpfully confirms that a subordination agreement is unlikely to be liable to disclaimer by a liquidator of the subordinated creditor.
A proper reading of the decision in Re SSSL confirms yet again that British Eagle is wholly unconcerned with the principle of pari passu distribution. Hence the standard de rigueur caution against the enforceability of subordination agreements on British Eagle/pari passu grounds is simply misconceived. Decades of concern over the British Eagle/pari passu violation is in fact a schism over an ism that is now an anachronism.
Keywords: Subordination agreement, trust subordination, British Eagle, pari passu principle, disclaimer
JEL Classification: K11, K12, K39
Suggested Citation: Suggested Citation