Equitable Subordination

Last Updated: Jun 7, 2019

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Equitable subordination refers to the legal action, typically in a bankruptcy case, by which a court rearranges the lien priority position of various creditors to move a lower priority lien up in the order. Lien priority governs the order in which creditors are paid or can foreclose on assets used to secure loans made to a company.

Traditionally, equitable subordination has been limited to cases involving:
a. fraud, illegality, or breach of fiduciary duty;
b. undercapitalization; or
c. control or use of the debtor as an alter ego for the benefit of the claimant.

In such cases the court determines that a senior lien holder has acted in a manner that the court believes warrants the senior lender's lien position be restated to become junior to other lienholders, subordinating the formerly senior lienholder's position to other that of other, previously junior, lienholders.