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What is a subordinated loan agreement? It is a loan in which the lender agrees that, in the event of bankruptcy or liquidation, repayment will only take place after other creditors have been satisfied. The claim ranks lower than ordinary (unsecured) debts. As a result, such a loan often counts as a form of equity in practice — which is why banks and financiers require it before providing funds themselves.
The short answer
- What: a loan the repayment of which is subordinated to other creditors.
- Consequence: in the event of bankruptcy, the subordinated borrower is paid only after the ordinary creditors.
- Why: the bank or financier wants assurance that other cash flows are “at the back of the queue”.
- Who issues them: often the director-major shareholder, family, an investor, or a parent company.
- Key point: the subordination must be explicitly and legally correctly established, otherwise it is not enforceable.
What exactly is a subordinated loan agreement?
An ordinary loan gives the creditor an unsecured claim: in the event of bankruptcy, he shares in the bankruptcy estate, together with all other ordinary creditors, in proportion to their claim. In the case of a subordinated loan, the parties agree that this claim ranks lower. The subordinated creditor only receives payment once all higher-ranked creditors have been fully satisfied.
Legally, this is based on Article 3:277 paragraph 2 of the Dutch Civil Code: creditors may agree that a claim is subordinated to all or certain other claims. Subordination is therefore a contractual agreement, not an automatic statutory consequence. Without a clear clause, the loan simply counts as a concurrent claim.
The ranking of creditors
In the event of bankruptcy, the proceeds of the estate are distributed in a fixed order. Simplified:
- Estate debts: costs of the trustee and settlement.
- Separators: creditors with pledge or mortgage rights (security).
- Preferential creditors: including the Tax and Customs Administration and the UWV.
- Concurrent creditors: ordinary creditors, suppliers, ordinary loans.
- Subordinated creditors: only after this, and only if there is anything left.
In practice, the estate is often already empty in a bankruptcy before unsecured creditors get their turn. A subordinated creditor must therefore take into account that they will effectively receive nothing in return. This explains why subordinated loans typically carry a higher interest rate.
Why banks ask for it
A bank that grants credit wants its position to be as strong as possible. If the director-major shareholder or an investor also puts money into the company, the bank does not want that lender to share in the balance with it. By subordinating that other loan, the bank takes the lead in the ranking.
For the bank, a subordinated loan therefore counts almost as equity: it is risk-bearing capital that strengthens solvency without being formally share capital. Lenders often require the director-major shareholder to subordinate their current account receivable or a family loan as a condition for the credit. Sometimes the bank co-signs a separate subordination agreement.
Interest and conditions
Because the risk is higher, different conditions usually apply than with a regular loan:
- Higher interest rate. A risk premium compensates for the subordinated position. Pay attention to arm's length: for affiliated parties, the Tax Authorities check whether the interest is “at arm's length”.
- Limited repayment. Often, repayment is only permitted once certain ratios have been met, or only after the bank has been repaid.
- Prohibition of interest payments in the event of losses. The bank may stipulate that no interest is paid out as long as certain agreements (covenants) are not met.
- Duration and callability. Subordinated loans often have a long maturity and are not callable before the end of the term.
Example: A director-major shareholder lends €100,000 to his own private limited company (BV). The main bank also provides a credit of €250,000 and requires that the director-major shareholder's loan be subordinated. The director-major shareholder signs a subordinated loan agreement with an interest rate of 6% and the agreement that repayment will only take place once the bank credit has been repaid.
Subordination: hard or soft
There are two variants that differ significantly legally:
- Soft subordination. The loan is only placed at the back of the queue in the event of bankruptcy or dissolution. Until that time, normal interest and principal payments may be made.
- Hard subordination. Even during the term, no principal repayments or interest payments may be made as long as the higher-ranked creditor has not been satisfied. Banks typically require this variant.
The difference determines whether the director-major shareholder is allowed to withdraw funds from the company in the interim. Anyone who fails to clearly document this runs the risk that payments will subsequently be deemed undue or fraudulent.
Honest recommendation
A subordinated loan agreement is not a standard fill-in-the-blanks exercise. Whether the subordination is hard or soft, whether the bank co-signs, and how interest and repayment are arranged determine your actual risk. For a simple family loan without bank financing and without complex conditions, a good template is often sufficient—in which case you do not necessarily need a lawyer. However, as soon as a bank requires subordination, related parties are involved, or tax issues arise (arm's length interest, debt forgiveness), it is wise to have the agreement drafted or reviewed.
Want to know more? View the subordinated loan agreement, read how to draft a subordinated loan agreement or when to have a subordinated loan agreement drafted.
Frequently Asked Questions
A loan in which the lender agrees that, in the event of bankruptcy or dissolution, it will only be repaid after other creditors have been satisfied. The claim ranks lower. The subordination is based on Article 3:277 paragraph 2 of the Dutch Civil Code and is a contractual agreement.
The bank wants to rank ahead of other lenders. By subordinating the director-major shareholder's loan, for example, it counts almost as equity and strengthens solvency. Subordination is often a condition for granting credit.
With soft subordination, the loan is only at the back of the queue in the event of bankruptcy; interest and principal payments may be made in the interim. With hard subordination, no principal or interest payments may be made during the term as long as the higher-ranked creditor has not been satisfied. Banks usually require the hard variant.
Only if there is anything left after the estate debts, secured creditors, preferred creditors, and concurrent creditors. In practice, the estate is often already empty before the subordinated creditor gets their turn. Expect a real risk that you will not see anything back.
Usually, a higher interest rate than on a standard loan, as compensation for the extra risk. With affiliated parties, the interest rate must be at arm's length; otherwise, the Tax Authorities may make adjustments. The rate depends on the risk, maturity, and market conditions.
Formally, it remains debt, but economically and for banks, it counts almost as equity because it is risk-bearing and ranks last. It strengthens the solvency position without issuing shares.
Often, yes. Banks want assurance that the subordination applies to them and therefore have a separate subordination agreement co-signed. This establishes that the subordinated creditor is paid only after the bank.
