Seniority and Subordination: Who Gets Paid First

Seniority is where a claim stands in the queue when a borrower stops paying, and it belongs to the claim rather than to the borrower. A senior claim is met before a subordinated one out of whatever is collected. So a rank decides recovery and nothing besides: the chance of a missed payment stays exactly where it already was, because that payment belongs to the borrower and every claim shares it.

One borrower can carry claims that stand at different places in the queue, and when the money stops, all of them stop on the same day. A single stop shared by claims of different rank separates the two things readers most often run together. Whether payment stops is a question about the company, and it is answered once, for everything the company owes. How much each claim then collects is a question about the queue, and it is answered separately, claim by claim. With those two held apart, the rest of this guide follows on its own.

What is seniority, and what is it a property of?

Ask most people what a senior bond is and they will describe a borrower: a bigger company, a steadier business, somebody more likely to keep paying. The description of a bigger, steadier company is about the wrong object. Seniority is not a description of a borrower at all. Seniority is a description of one instrumentOne specific thing that has been issued and can be held: a single bond, a single loan, a single piece of an arrangement. A borrower can have many, all at once., and specifically of where that instrument stands relative to the others the same borrower has issued.

The same company, on the same morning, can owe a senior claim and a subordinated claim. Nothing about the company differs between the two. The cash is the same cash, the business is the same business, the trouble it may or may not run into is the same trouble. The difference is a term written into one of the two arrangements saying that it waits until the other has been met.

An everyday version makes the picture concrete, and the picture is what survives. A shop takes goods from two suppliers. One supplier has agreed, in writing, that if money ever runs short it will wait until the other has been paid in full. Nothing in that agreement makes the shop busier. The agreement does not bring in one extra customer, and it does not stop a slow month. All the agreement decides is what happens at the counter on the day there is not enough in the till for both.

A rank belonging to the claim has a consequence people trip over constantly. If a rank is a property of a claim, and every borrower has its own queue, then comparing the rank of a claim on one borrower with the rank of a claim on another is comparing two positions in two different queues. Two claims can both be called senior and be nothing like each other, because the word describes a position and says nothing about the queue it sits in. Setting the two side by side is not a subtle failure of comparison. It is not a comparison at all.

Does a senior claim make the borrower less likely to stop paying?

No, and this is the hinge the whole subject turns on. When a borrower stops paying, everything it owes stops being paid at that same moment. There is one bank balance, one set of collections, one day on which the money did not go out. A rank cannot reach back and change that day, because the day is a fact about the company and a rank is a term inside one arrangement.

A rank does decide the second question, and only the second: out of whatever is there afterwards, who is met and in what order. So the honest sentence, and the one worth writing down, is that a rank moves the recovery while the chance of a missed payment stays precisely where it was found.

Run the shop example forward to the day it closes. Being first in line at the counter did not keep the shop trading for one extra week. First place did not make the landlord patient or the customers return. Being first decided who reached the till first once the shutters came down. The closure is one event with one date, shared by everybody the shop owed. The division of what was in the till is a separate exercise that happens afterwards, and it has as many answers as there are people in the queue.

Notice how the two questions sit in time, because that is what makes them easy to keep apart. The stop is a moment. The division is a process that starts after the moment and runs on a timetable nobody in the queue sets. A defaultThe event of a payment that was due not being made. What counts as one for reporting purposes, and who declares that it has happened, is fixed by an authority rather than by any lender. is a dated event; a recovery is an outcome of the process that follows it. Merge them and every later sentence about rank comes out slightly wrong.

Ranked ahead of whom, and how much of them is there?

A rank on its own is a word, and a word is not yet a reading. Being first in a queue of one and being first in a queue of forty are both first. Two queues differ not in the place but in the amounts standing around that place. A rank becomes a reading only when two amounts are written next to it: the total of everything that ranks ahead of the claim, and the total of everything that ranks equally with it.

The second of those two is the one people forget, and it is the one that bites. Claims at the same position do not form a little queue among themselves. Claims at the same position share whatever reaches it, in proportion to their sizes. So a small senior claim standing beside a senior claim many times its size is in a much weaker position than the word senior suggests, and nothing in the word says so.

Now put a real set of amounts underneath the word. A queue stops being an idea at exactly that point. Take an invented pool of receivables measuring Rs 1,200 crore, with an order of payment written into it. Three pieces fund it. The senior piece measures Rs 960 crore. The mezzanine piece measures Rs 180 crore. The equity piece measures Rs 60 crore. Set each against the pool and those read 80.0, 15.0 and 5.0 per cent, adding to 100.0 with nothing left over. The shares are not the point. The three pieces are met in a fixed order, so each one can be asked the only question that turns its rank into a reading.

Ask it piece by piece. Nothing has to be met before the senior piece, so the amount ranking ahead of it is Rs 0 crore. The mezzanine piece waits on the senior piece, so Rs 960 crore ranks ahead of it. The equity piece waits on both, so add the senior piece to the mezzanine piece and Rs 1,140 crore ranks ahead of it. Read those three numbers as they stand and they are just descending sizes. Read each one against its own piece and the queue suddenly has a length.

Sit with the last column, because it is the whole point of the block. For every rupee of the equity piece, 19.00 rupees have to be met before that rupee is reached, and for every rupee of the senior piece the figure is 0.00. Both pieces sit in the same arrangement, funded by the same receivables, exposed to the same collections. The label first and the label last do not carry that difference. The two amounts do.

There is one more thing hiding in that table, and it is worth pulling out because it looks like a shortcut and is only sometimes one. The equity piece is 5.0 per cent of the pool. One divided by 5.0 per cent is 20, and less that piece itself is 19.00. The table prints exactly that figure. The match is not a coincidence: for the claim at the very back of the queue, everything that is not it stands ahead of it, so its share of the whole is enough on its own to say what it is waiting on.

Try the same shortcut on the mezzanine piece and watch it fail. The mezzanine piece is 15.0 per cent of the pool, so one divided by 15.0 per cent, less one, gives 5.67. The table says 5.33. The shortcut counted the equity piece as standing ahead of the mezzanine piece, and the equity piece stands behind it. Everything that is not a given claim is not therefore ahead of that claim, and a shortcut that assumes so quietly moves a piece from one side of it to the other.

The gap taken in rupees rather than in multiples has no rounding anywhere in it. The amount the shortcut wrongly added is the equity piece, Rs 60 crore, and Rs 60 crore over the Rs 180 crore mezzanine piece is 0.3333 per rupee. The lazy route instead subtracts the two printed multiples, 5.67 less 5.33, and lands on 0.34. Neither figure is a typing error and both are printed correctly. A printed multiple is a rounded display and not a number to compute with. So the two figures part, and a reader who checks the table by subtracting the column will land two ten thousandths away from the arithmetic and blame themselves.

Where is a rank actually written, and what makes it hold?

Ranks do not all come from the same place, and the place they come from decides how they behave under pressure. There are three sources worth separating, and only the first two are written down anywhere.

The first is an agreement between lenders. One lender signs a document saying that it will wait until another has been met, and that promise is the rank. The promise sits as a term in a borrowing agreementThe signed document between a borrower and the people lending to it. It sets out what is owed, what is promised, and what happens if a promise is not kept. or in a separate arrangement alongside one, and it exists because somebody agreed to it in exchange for something, usually a higher rate.

The second is a charge over a specific named asset. Here the rank does not come from a promise between lenders at all. The rank comes instead from the claim being attached to a particular asset. The claim then reaches that asset before anybody who has no charge on it. A charge is not a promise about order; it is a link between one claim and one asset, and the order falls out of the link.

The third source is neither, and it is the reason the next block exists. Some claims stand behind others because of where they sit in an arrangement of companies, with nobody having written anything at all.

The useful question is never the name given to the rank. The useful question is what makes the rank hold on the one day it is tested, and a rank is tested exactly once: at the moment somebody has to sort out an unpaid claim. Up to that moment a rank is an expectation shared by people who mostly agree with each other. At that moment it becomes an instruction that has to survive a process, and the three sources survive it in three different ways. A promise between lenders holds if the promise binds the people it needs to bind. A charge holds if the charge was created and registered properly over an asset that is still there. A position in an arrangement of companies holds by itself, because nobody has to enforce a fact about where money physically sits.

How that resolutionThe process that runs once a claim has gone unpaid and somebody has to decide what happens next. Its order and its timetable are fixed by an authority rather than by any lender in the queue. runs, and in what order claims are actually met in law, is set by an authority. The published order is revised from time to time, and the live wording governs.

What is structural subordination, and why does no document mention it?

Picture two companies. One is a parent company that signs borrowing agreements and holds shares in the other. The other is a subsidiaryA company that another company holds. It keeps its own accounts, borrows in its own name, and pays its own lenders out of its own money before anything travels upward. that holds nothing exciting on paper but is where the plant sits, where the customers pay in, and where the cash is actually earned. A loan to the parent company has the parent company as its borrower. The money reaches the operations one level down, but the claim does not.

Now follow the money on a bad day. Collections arrive in the subsidiary. The subsidiary meets its own lenders out of its own money, because they lent to the company that holds the assets. Whatever is left over, and only whatever is left over, can travel up to the parent company. The parent company is where its lender's claim is waiting. The parent company lender stands behind every lender to the subsidiary, and not one line of the signed agreement says so. The ranking was never made by language.

Structural subordination is the hardest item here and it is worth saying twice in different words. A reader can obtain the full borrowing agreement, read every clause, find the word senior sitting there exactly as promised, and still be behind lenders they have never seen and could not have found in that document. The rank came from how the companies are arranged, not from any term inside the borrowing agreement. Nothing was hidden and nothing was breached. The word senior was accurate. The word was simply answering a question about one queue while the reader was standing in another.

Here is the household version. Somebody sends money every month to a cousin who runs a small workshop. The workshop has its own suppliers, and they are paid out of the workshop takings first, every time, because that is where the takings are. Only the surplus travels back. Nobody wrote a contract putting the person sending the money behind those suppliers. The geography did it.

What must be established before a rank means anything at all?

Six things, and a lender holding none of them is holding a label. None of the six is difficult. The six are worth listing because each one is usually assumed rather than checked, and the assumption is invisible until the day it is wrong.

The first thing to establish is which company in the arrangement is actually the borrower, and whether that company is where the assets sit and the cash is earned. The second is what ranks ahead of the claim, in amounts rather than in adjectives. The third is what ranks equally with it, in amounts, because that is the figure it will share with. The fourth is what the rank rests on: a promise from other lenders, a charge over a named asset, or nothing at all beyond where the claim happens to sit. The fifth is whether anything can be put ahead of it later without the lender's agreement, since a queue joined at the front is not necessarily a queue that stays that shape. And the sixth is whether the rank held is the one that governs when an unpaid claim is being sorted out, rather than the one described in the offering materialThe document a prospective holder is handed when an instrument is being sold to them. It describes what is on offer rather than creating it, and the two can come apart..

Notice that the fourth item changes what the other five are asking, and that is why it is worth establishing early rather than late. A rank resting on a promise sends the analyst to look at who signed and who did not. A rank resting on a charge sends the analyst to a register and to an asset. A rank resting on nothing but position sends the analyst to a structure chart, and to which company in it actually receives money from customers. Same word on the term sheet, three completely different afternoons of work.

What does one loss do to three claims standing at different positions?

Every claim made so far needs one worked instance, and the two invented objects already named settle the choice. Palash Cements Limited has exactly one bond here. Its term runs five years. The rate written into it is 9.10 per cent a year, compounding once a year. The bond repays Rs 1,000.00/- of face amount at the end. And nothing whatever is recorded above it or below it. One claim is not a queue, so no ranking for that issuer can be worked at all.

The invented pool can be worked instead. A pool of pieces is precisely an order. Take the three pieces already set out and apply a single loss of Rs 120 crore, an amount which set against the Rs 1,200 crore pool reads 10.0 per cent. Now hold on to the word single. The word carries the block. The loss is one event. The loss happens once, to the pool, and all three pieces are inside it at the same moment. Nobody rolled a dice three times.

The walk runs like this. The equity piece is met last, so it absorbs first: Rs 60 crore, the whole of it. Rs 60 crore of the loss is still unallocated, and the mezzanine piece is next, so it absorbs Rs 60 crore, one third of its Rs 180 crore. Nothing is left, so the senior piece absorbs Rs 0 crore. Added back, Rs 60 crore plus Rs 60 crore plus Rs 0 crore gives the Rs 120 crore the walk started with.

Run it the other way as a check. A walk that only closes in one direction has not been checked at all. Left afterwards are Rs 0 crore of equity, Rs 120 crore of mezzanine and Rs 960 crore of senior, and those three add to Rs 1,080 crore. The pool less the loss is Rs 1,200 crore less Rs 120 crore, which is also Rs 1,080 crore. The two routes agree, and they agree because nothing was created or destroyed by the walk. The walk only decided where the loss landed.

The middle row is printed as a fraction on purpose. Rs 60 crore out of Rs 180 crore is exactly one third, and one third does not terminate as a percentage, so writing it to two places and multiplying it back would land below Rs 60 crore. The fraction is exact and the decimal is a display, and on this row the difference is visible enough to be worth naming.

Now the point the walk exists to make. Same event, one date, three answers: everything, a third, nothing. The only thing that differs between those three answers is position, so the loss did not change because of rank, only its landing place did. Moving the landing place is the whole of what a rank does, shown rather than argued. The limit is exactly as wide. A walk of this kind settles where a loss lands; what a lender finally collects on a claim of any rank is a separate figure, and that figure comes from recorded recoveries rather than from an order of payment.

What does a rank still not say?

Four things. An account that ends on comfort misleads its reader in the last paragraph after being careful for the whole of the rest.

A rank cannot say whether there will be anything to collect. A rank divides a total that it plays no part in creating. First place in a queue in front of an empty till collects exactly what last place collects, and the arithmetic of the queue is the same in both cases. Whether the till has anything in it is a question about the borrower and its assets, and it was settled long before the queue formed.

A rank cannot say when. Once a claim has gone unpaid, the sorting out runs on a timetable that no lender in the queue sets and that a rank has no influence over. Being met first is not the same as being met soon, and a lender who needs the money on a particular date has a problem that no position solves.

A rank cannot be compared across borrowers. Comparing ranks across borrowers was the first block and it is the last one too. The mistake survives everything else. Two positions in two different queues are not two points on one scale.

And a rank cannot be turned into a collection figure here. A collection figure comes from recorded recoveries and not from a position in a queue, and no recovery record accompanies the two invented objects worked above. No historical study, no series, no single instance. So the cell where the number beside senior would sit is empty, with the reason printed inside it, and the reason is the teaching rather than an apology. A figure invented for that cell would be the most damaging line of the lot. A reader would carry it away and use it.

Why is seniority asked last rather than first?

Seniority answers the fifth of the five questions a lender works through, and the position is deliberate rather than a matter of taste. The four before it ask what is owed. The same four ask what pays it. Together they set the size of the obligation against that source, then price what carrying it costs to run. All four are about the borrower and about whether payment continues. Only the fifth asks what happens if it does not.

Ask the fifth question first and its comfort leaks backwards into the four that come before it. A lender who begins with a rank has begun on the far side of a failure that has not been examined yet, and every judgement afterwards is made by somebody already half reassured. The rank has not done anything wrong. The rank has simply been used to answer four questions it was never asked.

Asked in its own place, it does exactly the job it is for. The first four questions form a view on how likely the bad case is. The fifth says how bad the bad case is once it has arrived. Two different questions, two different answers, and neither one substitutes for the other.

Where the moving picture for this subject sits

The one relationship on this subject worth watching move is a loss travelling up an order until it reaches a given position, and that motion is available on this same pool, where the order of a structure is worked through step by step.

Motion is not what matters here. The distinction is what matters: that a rank belongs to a claim rather than to a borrower, that it moves the recovery and not the failure, and that some of it is never written down at all. None of those three moves with a dragged control. All three are settled by holding two questions apart, and that is work a reader does in their head rather than with a finger. The quiz below turns on exactly that, on a case with nothing to compute.