Subordination Agreements

Decoding the Code: Bankruptcy Code Section 510(a) – Subordination Agreements in Bankruptcy

Once upon a time, under the Bankruptcy Act of 1898, subordination agreements entered into outside bankruptcy were generally enforced by bankruptcy courts, but the issue was left to the discretion of the courts to be determined on a case-by-case basis. Since 1979, when the current Bankruptcy Code came into effect, however, the treatment of subordination agreements in bankruptcy has been governed by statute: “A subordination agreement is enforceable in a case under this title to the same extent that such agreement is enforceable under applicable nonbankruptcy law.” 11 U.S.C. § 510(a).

Since a bankruptcy court is supposed to enforce a subordination agreement that is enforceable under applicable nonbankruptcy law, section 510(a) closes the door on the exercise of case-by-case discretion by bankruptcy courts, but the statute nevertheless opens up a series of other issues that the courts have been grappling with for over 35 years now.  What constitutes a “subordination agreement”? Must a bankruptcy court enforce all the provisions of a “subordination agreement”?  What about rights of the parties that are not spelled out in the agreement (including rights that are derived from equitable principles) or that are dealt with in the agreement in ambiguous terms?  How are the answers to such questions affected by section 510(a)’s mandate that “subordination agreements” should be enforced in bankruptcy cases?