Subordination Agreements
Investors sometimes invest directly in a broker-dealer. This kind of investment usually takes the form of a subordination agreement in which the investor agrees to lend money or securities to the brokerage firm in the form of subordinated debt. Hence, a subordination agreement is a type of formal contract between the investor and the broker-dealer in which the investor’s claim is junior or subordinate to other claims on the broker-dealer should the broker-dealer go out of business. Subordinated liabilities rank beneath senior debt in priority for collecting repayment. Because of their subordinated nature, subordinated agreements are often risky, and are not suitable for many investors. The risks of subordinated agreements are described later in the section.
All subordination agreements must follow certain minimum requirements, which include:
• The loan must have a minimum term of one year, except for temporary subordinated loans.
• The agreement must be in written form and binding to all parties.
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