Subordination Agreements in Ontario Business Financing: What They Do

A business rarely borrows money just once. An owner lends the corporation money to get it started, a vendor extends financing on equipment, and years later a bank steps in with a term loan or line of credit. Each of those creditors may have some claim against the business's assets — and the new lender wants to know exactly where it stands compared to everyone who came before.

That's where a subordination agreement comes in. It's a contract between two creditors — not the borrower alone — in which one agrees that its claim will rank behind the other's, regardless of when each debt actually arose.

This article explains what these agreements do, when Ontario lenders typically demand one, and what they usually contain.

What a Subordination Agreement Does

At its core, a subordination agreement reorders priority between two creditors by contract, rather than leaving it to whatever the default rules (like the PPSA's first-to-register approach) would otherwise produce. The subordinated creditor agrees, in writing, that the other creditor's claim to be repaid — and often its claim to specific collateral — ranks ahead of its own.

This is a private arrangement between the two creditors. The borrower is typically a party to the agreement too, but the substance of the deal is between the two people or institutions owed money.

Why Lenders Demand Them Before Extending New Credit

A new lender — especially a bank or institutional lender — generally will not advance significant funds to a business that already has other debt outstanding unless it can be confident about where its new loan will rank if things go wrong. If an existing creditor (commonly a shareholder who lent the company money informally, or a vendor who financed a piece of equipment) would otherwise rank ahead or alongside the new lender, the new lender will typically insist on a subordination agreement as a condition of funding.

Without it, the new money effectively takes on the risk of being paid after an existing, sometimes informal, debt — a risk most lenders won't accept.

Common Situations Where Subordination Comes Up

• Shareholder or owner loans. An owner who has informally lent money to their own corporation is frequently asked to subordinate that loan before a bank will lend.
• Vendor take-back financing. A seller who financed part of a purchase price is often asked to step back behind the buyer's primary lender.
• Refinancing. A new lender replacing an old one may still require subordination of any debt that isn't being paid out as part of the refinancing.
• Intercompany loans. Loans between related companies within the same corporate group are commonly subordinated to outside lenders as a standard condition of financing.

What a Subordination Agreement Typically Covers

1. Priority ranking — a clear statement of which debt ranks ahead of the other, and for what amount.
2. Payment restrictions — limits on when (or whether) the subordinated creditor can be paid while the senior debt is outstanding, sometimes called a payment "standstill."
3. Restrictions on demanding repayment or enforcing — the subordinated creditor typically agrees not to demand repayment or take enforcement steps while the senior lender's debt remains unpaid, at least without notice or consent.
4. Notice obligations — requirements to notify the senior lender of certain events, such as a default by the borrower.
5. What happens on default or insolvency — how proceeds are to be distributed if the business can't pay everyone, confirming the agreed order.

How the Process Typically Unfolds

1. A new lender identifies existing debt owed to another creditor during its due diligence.
2. The new lender makes a subordination agreement with that creditor a condition of funding.
3. The parties negotiate the specific terms — how much can still be paid to the subordinated creditor, under what conditions, and what notice is required.
4. The subordination agreement is signed alongside the new loan documents, before or at closing.
5. Any related security registrations are updated or coordinated to reflect the agreed order, where applicable.

Frequently asked questions