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There is, however, one exception to the general principle that subordination must be consensual: a borrower may use a security interest, under the rule of full priority, to subordinate creditor C2’s claim to creditor Cl’s claim. Thus, while a borrower may not subordinate the claim of unsecured creditor C2 to that of creditor Cl without creditor C2’s consent, that borrower can achieve the exact same result under the rule of full priority by giving creditor Cl a security interest. Given the general rule that the debtor may not give creditor Cl’s claim priority over that of a single other creditor, it would appear peculiar that by complying with a few mechanical procedures, the debtor and creditor Cl can arrange to give creditor Cl’s claim priority over the claims of all unsecured creditors without obtaining those unsecured creditors’ consent. One could argue that, although subordination through the use of a security interest does deviate from the general norm that explicit consent is required, unsecured creditors implicitly consent to subordination. The following discussion identifies two possible implicit consent arguments and explains why neither has much force.

The first implicit consent argument in defense of full priority is that there is implicit consent to the creation of each security interest. In most cases, a security interest created by the debtor gives creditor Cl’s claim full priority over that of creditor C2 only if creditor Cl perfects the security interest by recording it in a public registry. Because the security interest is publicly registered, creditors whose bankruptcy allocations have been reduced by the creation of the security interest are able to adjust their terms or can refuse to lend in the first instance. Consequently, by entering into a transaction with the borrower, these creditors implicitly consent to having their fractional share of the borrower’s bankruptcy assets reduced.

This post was written by , posted on July 1, 2014 Tuesday at 3:26 pm