11.1 Summary

689. Some creditors are willing to agree to a deterioration of their possibilities to take recourse against their debtors’ assets for the benefit of other creditors. Figuratively speaking, they take a step back in the line of creditors, or a step down in the ranking of creditors. One may say that they have subordinated their claims to those of other creditors. For the purposes of this study, a subordinated claim is defined as a claim the settlement of which has been made secondary to the settlement of other claims which may be recovered from the same estate, without security rights in rem being vested in favour of the latter, or such other claims having a preference in ranking for other reasons. A subordinated claim is usually referred to as a junior claim (juniorvordering), the claims the junior claim is subordinated to are referred to as senior claims (seniorvorderingen). The definition adopted above excludes from the scope of this study so called ‘structural subordination’, where the transaction is structured so that some creditors can take recourse against different debtors or different estates than other creditors can, so that for some creditors it is easier than for others to take recourse against the main assets of the debtor(-group). This creates a secondary position for some creditors, but is not a subordination for the purposes of this research.

Under Dutch law subordination usually originates in an agreement. This creates a rich variety of different types of subordinations that can be discerned in various ways.

One prominent distinction is that between lowering the ranking of a claim and various other ways to subordinate a claim, such as extending its maturity date to a moment in time after the senior claims will have been paid. In this study, any subordination agreement that lowers the ranking of the subordinated claim is referred to as a genuine subordination (eigenlijke achterstelling). In literature, this is sometimes referred to as contractual subordination. Other ways of subordinating a claim, such as extending its maturity date or by obligations between the creditors, are referred to as de facto subordination (oneigenlijke achterstelling). A single subordination agreement often contains provisions of both types, i.e. provisions that make it a genuine subordination and provisions that make it a de facto subordination. The two are not mutually exclusive.

Another important distinction is that between specific subordination (specifieke achterstelling) and general subordination (algemene achterstelling). In case of specific subordination, the junior claim is subordinated to one or more specifically identified senior claims. In the case of general subordination, the junior claim is subordinated to all other claims against the same debtor, with the possible exclusion of some categories of claims.

Under Dutch law a specific subordination can be a genuine subordination. This means that under Dutch law it is possible to lower the ranking of a claim vis-à-vis certain other claims, but not vis-à-vis all other claims against the same debtor. This is even possible if the claims the subordinated claim is subordinated to, the senior claims, rank equally with claims the subordinated claim is not subordinated to. In this way Dutch law fundamentally differs from German and U.S. federal bankruptcy law.

690. The Dutch Civil Code barely contains any provisions on subordination of claims and its effects. Therefore, the consequences of subordination agreements are unclear. This research aims to diminish that lack of clarity by mapping out the consequences of the subordination of claims under current Dutch law. This research focuses on the consequences that the subordination of claims has on the position of the junior creditor in a bankruptcy (faillissement) of his debtor.

691. The first part of this research explores the application in practice of subordinated claims under Dutch law. A distinction is made between subordinations that are based on contract and subordinations that take effect by operation of law, also referred to as statutory subordinations.

Dutch law contains very few statutory subordinations. Loans made by shareholders to their company are not subordinated by statute under Dutch law. The most prominent examples of statutory subordinations are claims out of legacy and quasi-legacy in the law of succession and the claim of an insurer that, through subrogation, has acquired part of the claim for damages the insured victim had. Out of moral considerations, the ranking of such claims is lowered. Also, the creditors of such claims must turn over any payments received on such claims to other creditors of their common debtor, in case he is unable to satisfy all his debts.

A subordination can also arise out of statutory provisions as a means of compensation for damages. The foundation for the subordination then lies in the statutory provisions regarding compensation for damages.

In some cases, Dutch statutes make satisfaction of one claim secondary to the satisfaction of other claims without applying subordination in the definition used in this research. In such cases, usually the ‘subordinated’ creditor cannot take any recourse until the ‘senior’ creditors are satisfied in whole, so that the recourse of their claims can never conflict. This is the case with entitlements that the providers of capital to a company may have towards the net remains after liquidation and with interest-claims arising after the opening of bankruptcy proceedings in respect of the debtor. Such claims cannot be admitted in a Dutch bankruptcy, hence no recourse can be taken for these claims in competition with other creditors trying to take recourse on the same assets. Therefore, these are not subordinated claims within the scope of this research.

692. Subordinations based on subordination agreements are much more common under Dutch law than statutory subordinations. Chapter three deals with some common applications of subordination agreements. These vary from the one-and-a-half-page subordination agreements regarding shareholder loans in small and medium size enterprises to the intercreditor agreements in leveraged finance transactions that can easily cover one hundred and fifty pages. Subordination agreements that contain little detail raise questions concerning the rules that apply in circumstances that the parties have not provided for in their subordination agreement, while very detailed subordination agreements raise the question whether all provisions that parties have agreed to can indeed be given effect under Dutch law.

The subordination agreements that have been studied in this research all contain a genuine subordination clause. They also contain various forms of clauses of de facto subordination. In many of the subordination agreements studied, the maturity date of the junior claim is extended beyond that of the senior claim. Also, the junior creditor regularly agrees to not take recourse for the junior claim until the senior claim has been paid in full. Moreover, in many subordination agreements the junior creditor agrees to turn over to the senior creditor any distributions or payments made by the debtor on the junior claim.

The subordination agreements studied contain remarkably few provisions regarding the position of the junior creditor in bankruptcy proceedings opened in respect of the debtor.

In some of the subordination agreements studied in this research, the senior is a party to the subordination agreement, whereas in respect of certain important other subordination agreements, including agreements regarding subordinated notes, he is not. When the senior creditor is not a party to the subordination agreement, the question arises how the senior creditor can invoke the subordination of the claims of the junior vis-à-vis the junior, the debtor, or a possible bankruptcy trustee appointed in bankruptcy proceedings with regard to the debtor.

693. To provide answers to the various questions that subordination agreements raise, such agreements must first be interpreted or constructed and subsequently the subordination clauses contained in the agreements must be analysed from a legal perspective. Part two of this thesis addresses these topics. Chapter four deals with the interpretation of subordination agreements, chapters five and six analyse genuine and de facto subordinations.

When it comes to the interpretation or construction of subordination agreements, the general rules of interpretation of contracts apply. Subordination agreements are essentially agreements like all other agreements. This means that all circumstances that are relevant in the interpretation of contracts under Dutch law can also play a role in the interpretation of subordination agreements. It is submitted that the subordination clause in the contract barely influences the interpretation of that contract. A subordination clause is much less significant for the interpretation than other factors that usually play a role in interpretation under Dutch law, such as the capacity of the parties to the agreement and the number of parties affected by it.

The goal of a subordination agreement, i.e. to provide some form of security to the senior, can play a special role in the interpretation of subordination agreements. It would be in line with this goal to interpret any ambiguity or unclear terms in the subordination agreement for the benefit of the senior. However, a subordination agreement only limits the powers of the junior creditor as much as the junior has agreed to such limitations. In this area of tension, one can recognize the tension between the contractual nature of subordination agreements and their function as a security right. A contract can only provide security for the circumstances provided for in the contract, but the security the contract provides depends on the interpretation of the contract, which in itself creates uncertainty.

694. Chapter five analyses (clauses that lead to) what in this study is referred to as genuine subordination. Such genuine subordination clauses alter the junior’s right to take recourse in the sense that the ranking of the junior’s claim is lowered. It is argued that ranking of claims only concerns the distribution of proceeds of foreclosure or liquidation within or outside of bankruptcy. The ranking of claims that is applied to determine the distribution of the proceeds of liquidation addresses a conflict between the parties with a right of recourse only. The debtor has no role in that conflict.

Therefore, a genuine subordination does not affect the relationship between the junior creditor and the debtor. It only affects the relationships between the creditors. Hence, it is submitted that, under Dutch law, a creditor can lower the ranking of his claim without involving the debtor. Such a genuine subordination that does not involve the debtor should have the same consequences as a genuine subordination agreement to which the debtor is a party. It is argued that in both cases, the assignment of the junior claim does not affect the subordination of that junior claim.

A genuine subordination can be limited in various ways. When subordinating his claim, the junior creditor can for example limit the so-called ‘senior headroom’ (seniorruimte). In that case, the junior claim is not subordinated to any amounts of the senior claims surpassing such senior headroom.

It is argued that a genuine subordination by itself does not create any rights or claims for the senior creditors. They do not derive any direct claims against the junior creditor or in respect of the junior claim on the mere basis of a genuine subordination. In the view presented in this thesis, a genuine subordination constitutes a lack of rights for the junior creditor rather than a surplus of rights for the senior creditor. The junior’s right to take recourse against the debtor’s assets includes its lowered rank vis-à-vis the seniors resulting from the subordination agreement. This is sufficient for the senior to invoke the effects of the genuine subordination. Should the junior try to take recourse in competition with other creditors, then any other creditor, including the senior, can point out the rankaltering characteristic of the junior claim. That should then be given effect to, for example by a bankruptcy trustee in the distribution of the proceeds of liquidation in a bankruptcy proceeding.

695. In case of de facto subordination, the settlement of the junior claim is made secondary to the satisfaction of other claims without lowering the ranking of the junior claim. This can be done in various ways. Most prominently, a de facto subordination can be created by delaying the maturity date of the junior claim, by turning the junior claim into a contingent claim (i.e. contingent upon the senior having been paid in full), and by the junior committing to certain obligations towards the senior. Chapter six analyses such de facto subordinations.

Although the nature of contingent claims and unmatured claims is very different, it is argued that under Dutch law the consequences of a contingency in a claim are very similar to the consequences of an unattained maturity date. For example, both a contingency built into a claim and an unattained maturity date functioning as a de facto subordination prevent the debtor from discharging the junior claim by payment before the senior claim has been paid in full. Moreover, a senior creditor can benefit in the same way from a maturity date built into the junior claim and from a contingency built into it. Both subordinations have third-party effects in the same manner as a genuine subordination. The junior claim only exists with the subordination ‘built into it’ as a characteristic of that claim and any other party can point that out. That is enough to invoke the effects of and benefit from the subordination.

A de facto subordination can also take the shape of a (set of) obligation(s) between the creditors. The most prominent example is a turnover subordination. In a turnover subordination the junior creditor is under an obligation to turn over any payments on the junior claim to the senior, until the senior claim has been satisfied in full. However, turnover subordinations under Dutch law cannot be enforced by a turnover trust, as is often employed under English law. Therefore, in a turnover subordination under Dutch law the senior creditor bears the risk of bankruptcy of the junior creditor.

The allocation of payments made by the junior towards the senior in connection with the turnover obligation is a delicate matter. Unless the subordination agreement provides otherwise, these payments may leave the junior emptyhanded. The payment by the debtor to the junior (partly) discharges the junior claim, whilst the payment by the junior to the senior may only discharge the obligation to turn over proceeds between them, without the junior receiving anything in return. Without further provisions in the agreement, the junior can only expect the senior to repay towards the junior any payments the senior may receive in excess of the senior claim. It is submitted that a fitting solution to this problem is to consider any payments from the debtor to the junior that are turned over by the junior towards the senior, as payments by the debtor discharging the senior claim. However, this attribution of payments can only be effected if the subordination agreement provides as much. The subordination agreement may also provide that the junior will acquire the senior claim through subrogation in exchange for turning over payments towards the senior.

696. Part III of this thesis, chapters seven through nine, explores the consequences of subordination agreements for the position of the junior creditor in the bankruptcy proceedings opened in respect of his debtor. Chapter seven discusses the powers of a subordinated creditor to request the opening of bankruptcy proceedings of his debtor, the admittance of the subordinated claim in such bankruptcy proceedings and the distribution of the proceeds of liquidation in such a bankruptcy proceedings.

Like other creditors, subordinated creditors have a right to take recourse against the bankrupt estate of their debtor. Therefore, bankruptcy proceedings also serve to take recourse for the subordinated claims. Hence, subordinated creditors are creditors in the sense of the bankruptcy proceedings and their claims can be admitted in the bankruptcy.

From this, it follows that a subordinated creditor has the power to file for the bankruptcy of his debtor. The subordination may however hinder a subordinated creditor in meeting the requirements for the opening of Dutch bankruptcy proceedings. Under Dutch law bankruptcy proceedings are opened if the debtor has ceased to pay its debts as they fall due. This is usually inferred from the existence of unpaid debts. It is submitted that in determining whether the debtor has ceased to pay his debts, the court cannot rely on the existence of de facto subordinated debts if the de facto subordinations hinder the maturity of the junior claims. It does not follow from the mere existence of unmatured debts that the debtor has ceased to pay his debts as they fall due.

This research shows that when a subordinated creditor files his claim in the bankruptcy of his debtor, he should notify the bankruptcy trustee of the subordinated nature of the claim. A genuinely subordinated claim can then be admitted for the full amount, with annotation of its lowered ranking. That annotation must mention the claims with respect to which the ranking of the junior claim has been lowered and whether that genuine subordination has been limited in any (other) way.

Claims in respect of which, upon prima facie examination, only a de facto subordination appears to have been agreed, should be subject to careful scrutiny in order to determine whether the parties to the subordination agreement nevertheless have intended for the claim to be genuinely subordinated. If that is the case these claims can be admitted in the bankruptcy in the manner described above. It is submitted that in many cases under Dutch law admitting a claim that is also de facto subordinated as a genuinely subordinated one will best express the intention of the parties to the subordination agreement. The alternative is to admit the de facto subordinated claim to the bankruptcy by applying the statutory provisions for the legal concepts that are applied to implement de facto subordination. In that case, the de facto subordinated claim will be admitted in the bankruptcy with application of the statutory provisions for admitting contingent or unmatured claims in a bankruptcy. That means unmatured claims will be admitted as regular unpreferred claims for the amount of their present value. Contingent claims will either be admitted in the same way, or for full value, but maintaining the contingency. The contingent creditor is then treated as a regular unpreferred creditor in the insolvency proceedings for the full amount of his claim, whilst his powers are partially limited by the contingency in his claim. It is argued that these provisions yield unfortunate results when applied to claims with a suspended maturity or a contingency that serves to effect a subordination.

The manner in which the claims are admitted in the bankruptcy has consequences for the distribution of the proceeds of liquidation in bankruptcy. A creditor that is genuinely and generally subordinated can only receive dividends if all other creditors have been satisfied in full. A genuinely and specifically subordinated creditor can receive dividends if the claim of the senior creditor to which the junior claim was subordinated, has been satisfied in full.

Specific subordinations can complicate the distribution of the proceeds of liquidation. If one of the claims admitted in a bankruptcy proceeding is specifically subordinated, the ranking of the claims does not necessarily take the shape of an ordered list. A specifically and genuinely subordinated creditor may rank below the senior creditor whilst ranking equally to a third creditor that in turn ranks equal to the senior creditor. This expresses the relative nature of ranking under Dutch law. In this regard Dutch law differs profoundly from U.S. federal bankruptcy law and German law. The relative nature of ranking under Dutch law opens up the possibility of specific genuine subordination, but also accounts for the possibility that the transitive property does not hold in the ranking of the claims. This means the ranking of claims cannot be expressed as an ordered list, which in turn complicates the distribution of the proceeds.

697. Admitting subordinated creditors as creditors in a bankruptcy proceeding means that they can (try to) influence the course of the proceeding in the same manner as other creditors can, such as by taking part in a creditors committee or by petitioning the supervisory judge. In principle, subordinated creditors can participate in the decision-making regarding the course of the bankruptcy proceeding in the same manner as other creditors in the bankruptcy. Their means to do so are discussed in chapter eight.

Whenever a subordinated creditor exercises his rights to influence the course of the bankruptcy proceeding he may find himself in opposition to other creditors. The subordination changes the interests of the subordinated creditor, which may therefore no longer align with the interests of other creditors. In the system of the Dutch Bankruptcy Code such conflicts are addressed by the supervisory judge (rechter-commissaris). Creditors who wish to influence the course of the proceedings (ultimately) have to file a request with the supervisory judge. The supervisory judge then considers whether the course proposed by the (possibly subordinated) creditor is in the interest of the estate and body of creditors as a whole. The interest of the subordinated creditor is part of this abstract common interest of the creditors.

The possible difference in interests between subordinated creditors and other creditors is of particular interest in proceedings regarding a composition plan in or outside of bankruptcy. Modern plan proceedings generally provide for a system of voting in classes, so that creditors with similar interests cast their votes together. Thus, the classes that vote on the plan generally coincide with the classes in the ranking of the claims. Therefore, in such proceedings subordinated creditors are generally placed in their own class. The class formation with regards to specifically subordinated creditors is more complicated. It is argued that, as a starting point, specifically subordinated creditors, the seniors, and the uninvolved creditors should each be placed in separate classes. However, in a concrete case a specifically subordinated creditor may be placed in the same class as the senior or the uninvolved creditors, due to the circumstances of that specific case. Classes must always be made-to-measure.

The current provisions of Dutch law regarding a composition plan in bankruptcy do not provide for voting in classes. This research suggests that these provisions should be amended. Under current law subordinated creditors can vote on a plan in bankruptcy. Their votes are cast together with the votes of other creditors of unpreferred claims. This incentivises the debtor to ‘buy’ the votes of the subordinated creditors by promising them a marginal distribution under the proposed plan. These cheap votes may then outweigh the votes of more senior creditors.

Subordinated creditors are, however, not entirely free to cast their votes as they please. Because of the subordination, they must take the interests of the seniors into account when casting their vote. Moreover, in the judicial confirmation of a composition plan in bankruptcy the judge may assess whether the plan is not being forced upon the disagreeing seniors by the votes of the juniors, whilst the plan does not treat the seniors fairly. It is submitted that, in this assessment, the judge may draw inspiration from the provisions on the confirmation of plans in procedures where the voting does take place in classes.

698. A subordinated creditor can, like other creditors, improve his position by vesting security rights to secure his claim. The combination of subordination and security rights is remarkable but not impossible. That combination is the topic of chapter nine.

It is argued that, because a genuine subordination only affects the ranking of the junior’s right to take recourse, such a subordination only affects the relationship between the creditors. Therefore, securing a genuinely subordinated claim with in rem security rights such as pledges (pandrechten) or mortgages (hypotheken), only raises a conflict in the determination of the ranking of that claim. Other powers the junior may infer from the security right do not conflict with a genuine subordination.

It is argued that when a genuinely subordinated claim is secured by a pledge or mortgage, the determination of the ranking of that claim is a question of interpretation of the subordination agreement and the deed of establishment of the security right. In case the security right was vested first and the claim was subsequently subordinated, the ranking of the claim is generally determined by the subordination. If the claim was first subordinated and subsequently secured by a right of pledge or mortgage, then the ranking depends on whether or not the subordination was terminated when creating the security right. In case the subordination has not been terminated, the subordination still determines the ranking of the junior claim. In such a case the junior can exercise his right of summary foreclosure (parate executie), but due to the low ranking of his claim the proceeds of such a foreclosure will be distributed to the senior creditor or the bankruptcy trustee.

De facto subordinations can hinder the summary foreclosure by the subordinated creditor, because de facto subordinations alter the relationship between the junior creditor and the debtor, e.g. by altering the maturity date of the subordinated claim. However, these obstacles largely disappear if the debtor is declared bankrupt.

It is also possible to secure subordinated claims with contractual security rights, such as guarantees, or third-party security rights. A subordination does not necessarily affect the relationship of the subordinated creditor with a co-debtor or guarantor that is jointly and severally liable for the subordinated claim, or his relationship with a third-party security provider. Moreover, a subordination does not necessarily affect the relationship between the subordinated creditor and the creditors of the second debtor or third-party security provider. Whether or not the claim of the junior against the jointly and severally liable co-debtor or third- party security provider is also subordinated is to be determined through interpretation of the subordination agreement.

To the extent that a co-debtor has satisfied the junior claim for a larger amount than he was obliged to in relation to the main debtor, that co-debtor can seek to take recourse against the main debtor. When seeking recourse, the co-debtor can employ both the statutory recourse claim (regresvordering) and the junior claim that the co-debtor acquires through subrogation. The statutory recourse claim originates by operation of law, without it being subordinated. It is only subordinated if the co-debtor and the main debtor contractually agree on its subordination. The junior claim that the co-debtor acquires through subrogation remains subordinated, inasmuch as it was subordinated by a genuine subordination, a delayed maturity date, or a contingency built into it. To the extent that the subordinated nature of the junior claim was the result of contractual obligations between the junior and the senior, the subordination is lost when the junior claim is transferred to the co-debtor by means of subrogation. The co-debtor is not bound to the obligations of the original junior creditor towards the senior creditor.

A junior creditor may also try to enforce his claim against the debtor by means of set-off. Subordination in and of itself does not necessarily prohibit set-off, but subordination agreements generally do exclude set off. They can do so directly and explicitly in the subordination agreement, but also in a more indirect manner. A subordination agreement indirectly excludes set-off if the methods used for de facto subordination impede the junior in meeting the criteria for set off. For example, under Dutch law, an unmatured claim cannot be set off outside of bankruptcy.

699. Returning to the main research question, the analysis shows that the position of a subordinated creditor in Dutch bankruptcy proceedings is primarily that of an ordinary creditor with an admissible claim in the bankruptcy. The position of a creditor with a subordinated claim only differs as far as that follows from the subordination agreement. A genuine subordination in principle only affects the distribution of the proceeds of liquidation. A de facto subordination can have considerable other consequences for the position of the subordinated creditor, if that subordination is also intended to affect the powers of the junior creditor during a bankruptcy. The consequences of a subordination agreement always depend on the interpretation of that agreement.