What is a subordination agreement?
Is a subordination agreement enforceable in South Africa?
“In the case of debt subordination, the creditor has no claim unless other creditors receive payment in full. … In my opinion, the liquidator of a company would be obliged to have regard to a subordination agreement which was valid and in force as at the date of winding-up.”
“For any purpose of this Act, a company satisfies the solvency and liquidity test at a particular time if, considering all reasonably foreseeable financial circumstances of the company at that time— (a) the assets of the company, as fairly valued, equal or exceed the liabilities of the company, as fairly valued; and … (b) it appears that the company will be able to pay its debts as they become due in the ordinary course of business for a period of— (i) 12 months after the date on which the test is considered”
“I therefore conclude that the matters mentioned in s 45(1)(a) are exhaustive of the meaning of ‘financial assistance’ and disagree with the high court’s contrary finding. In terms of s 45(2), however, s 45 applies to direct and indirect financial assistance.”
When you need a Subordination Agreement
- A company’s liabilities exceed its assets (factual / balance-sheet insolvency) and its auditors need a valid, in-force subordination of shareholder or related-party loans before they will sign off the financial statements on a going-concern basis rather than a break-up basis.
- A bank or new financier will only advance funds if the existing shareholder, holding-company or director loans are subordinated (postponed) behind the financier’s facility — an “upward” subordination as a condition of the new lending.
- A holding company or shareholder is funding a subsidiary or start-up and wants the funding recorded as a loan it can recover later, while still giving the directors comfort to keep trading and to satisfy the section 4 solvency and liquidity test.
- A group is restructuring intercompany loan accounts, or preparing for an audit, a sale of the business or due diligence, and needs the ranking and repayment of related-party debt put on a clear, enforceable footing.
- Directors are concerned about reckless or insolvent trading exposure and want a subordination in place so the company is not trading while factually insolvent on its balance sheet.
What a Subordination Agreement should contain
Identification of the subordinated debt
Define precisely which claim is being postponed — the specific loan account, capital, accrued interest and any future advances. A subordination that does not clearly fix the debt it covers is hard to apply when the auditors or a liquidator have to decide what ranks where.
The creditors ranked ahead (the senior class)
State who the subordinated creditor is postponed behind — all other creditors generally, or a named financier and its facility. “Upward” (financier-driven) and “general” (auditor / solvency-driven) subordinations are drafted differently, so the ranking must be explicit.
The condition that ends the subordination
Specify exactly when the postponement falls away — most commonly when the company’s assets, fairly valued, again exceed its liabilities, fairly valued (often certified by the auditors). This condition is what lets the debt be left out of account for solvency, so it must track the Companies Act section 4 test.
No demand, no payment, no set-off while subordinated
Bind the creditor not to claim, demand, sue for, accept payment of, cede or set off the subordinated debt while the subordination subsists, and bind the company not to repay it. Without this the postponement is illusory — the creditor could simply call up the loan.
Irrevocability and duration
Make the subordination irrevocable (or revocable only on stated conditions) and binding for as long as the solvency condition is unmet. A subordination the creditor can withdraw at will gives the auditors no comfort and cannot safely be relied on to support a going-concern view.
Effect in winding-up / business rescue
Record that the subordination remains in force if the company is wound up or placed in business rescue, and spell out what then happens to the debt. Carbon Developments held that a liquidator must have regard to a subordination valid and in force at winding-up, and that on the usual terms the creditor has no claim unless the other creditors are paid in full — where insolvency makes the repayment condition impossible to meet, the debt normally falls away and cannot be proved at all.
Governing terms, variation and the auditors’ role
Deal with how the agreement is varied or released (typically only with the senior creditors’ or auditors’ consent), South African governing law, and any annual confirmation the auditors require that the subordination is current and enforceable for the financial statements.
Subordination agreement vs cession / waiver of a loan in South Africa
| Feature | Subordination agreement | Out-and-out cession / waiver |
|---|---|---|
| What happens to the debt | Debt survives — the creditor keeps its claim but agrees to be paid last | Cession transfers the claim to another party; a waiver extinguishes it |
| Primary purpose | Keep the company solvent / a going concern; satisfy a financier or the auditors | Move the claim (cession) or give it up entirely (waiver / set-off arrangement) |
| Ranking on insolvency | Subordinated creditor is paid after the senior creditors, then on the balance | Cessionary stands in the original creditor’s shoes; a waived claim ranks nowhere |
| Reversible? | Falls away once the solvency condition is met — the creditor can be repaid | A waiver is generally final; a cession is permanent unless re-ceded |
| Typical signatory | Shareholder, holding company or director who lent money to the company | A creditor selling/securing its claim, or releasing the debtor |
Common South African pitfalls
- Relying on an oral or vague subordination. Auditors and a liquidator need a clear, written, in-force subordination that fixes the debt, the senior class and the condition for release. A loose “we won’t call the loan” understanding cannot safely support a going-concern view or be applied in a winding-up.
- Treating a subordination as solving solvency permanently. As the SAICA / auditing guidance stresses, a valid subordination does not by itself prove the company is a going concern — it must be current and enforceable each year, properly disclosed, and the directors must still assess liquidity (the ability to pay debts as they fall due) under section 4, not just the balance sheet.
- Subordinating too much or for too long. An open-ended subordination can leave the creditor unable ever to recover its loan and effectively converts the debt into quasi-equity; conversely a subordination drafted to lapse too easily gives the auditors and financier no real comfort.
- Ignoring voidable-disposition risk. A subordination given for no value while the company’s liabilities already exceed its assets can, in some circumstances, be attacked as a disposition without value under the Insolvency Act 24 of 1936 if the company is later liquidated — the agreement should be structured and timed with this in mind.
- Assuming section 45 never applies. Constantia Insurance held the section 45 “financial assistance” list exhaustive, but it also held that section 45 covers indirect assistance, and it did not decide whether a subordination is assistance. A subordination given to help a related company raise finance, or bundled with a guarantee, indemnity or loan to a director or related company, can engage section 45 — and getting that wrong renders the assistance void.
Frequently asked questions
Is a subordination agreement legally binding in South Africa?
Yes. A properly drafted subordination agreement is a valid and enforceable contract. In Ex parte De Villiers NNO: In re Carbon Developments (Pty) Ltd 1993 (1) SA 493 (A) the Appellate Division explained that a subordinated debt continues to exist but can be enforced only once the company’s assets exceed its liabilities, held that a subordination is “material and relevant” when a court asks whether those running the company incurred debts with a reasonable expectation of their being paid, and held that the subordination binds the liquidator if it is valid and in force at winding-up.
What is the purpose of a subordination agreement?
Its main purpose is to keep a company solvent and trading as a going concern. By having a shareholder or related-party creditor postpone its loan behind the other creditors, the company can leave that debt out of account when its assets are weighed against its liabilities, which can turn a balance-sheet-insolvent company back into a solvent one on paper and support going-concern financial statements. It is also used to give a new financier priority over existing creditors.
Does a subordination agreement cancel or write off the debt?
No. A subordination does not extinguish the debt — the creditor keeps its full claim. It only agrees not to demand or accept repayment, and to rank behind the other creditors, until the agreed condition is met (usually that the company’s assets again exceed its liabilities). Once that condition is satisfied the subordination falls away and the loan becomes repayable again, unlike a waiver, which gives the debt up permanently.
Does a subordinated loan count when applying the Companies Act solvency and liquidity test?
The Act does not say. Section 4 of the Companies Act 71 of 2008 makes no specific provision for subordinated loans: it requires a fair valuation of the company’s assets and liabilities, including reasonably foreseeable contingent liabilities (s 4(2)(b)), so how a subordinated loan is treated depends on its terms and should be agreed with the company’s auditors. The liquidity limb is separate — the company must also appear able to pay its debts as they become due in the ordinary course of business for the next 12 months (s 4(1)(b)).
Is a subordination agreement binding on a liquidator?
Yes, if it is valid and in force at the date of winding-up: Carbon Developments held that the liquidator “would be obliged to have regard to” it. On the usual terms the subordinated creditor “has no claim unless other creditors receive payment in full”, and the court added that where insolvency makes the repayment condition impossible to meet, the debt normally falls away and cannot be proved in the insolvency at all. The exact result depends on the agreement’s terms, so the insolvency position should be drafted expressly.
Does a subordination agreement need shareholder approval under section 45 of the Companies Act?
Probably not on its own, but Constantia did not decide the point. In Constantia Insurance Co Ltd v The Master [2022] ZASCA 179 the SCA held that the section 45 definition of “financial assistance” is exhaustive — lending money, guaranteeing a loan or other obligation, or securing a debt or obligation — which supports the argument that a bare subordination falls outside it. But the same judgment holds that section 45 covers indirect assistance, so where a subordination helps a related company obtain finance, or is combined with a loan, guarantee or indemnity to a director or related company, section 45 can apply — and many practitioners observe its formalities as a precaution.
Who signs a subordination agreement?
Typically the creditor whose claim is being postponed — most often a shareholder, holding company or director who has lent money to the company — together with the company itself. Where the subordination is required by a financier, the financier is also a party or its facility is named as the senior debt the existing creditors must rank behind.
Can a subordination agreement be challenged if the company is later liquidated?
It can be, in limited circumstances. If a subordination was given for no value at a time when the company’s liabilities already exceeded its assets, a liquidator may attack it as a disposition without value under the Insolvency Act 24 of 1936 (subject to the statutory time windows and proof requirements). Careful drafting, timing and commercial justification reduce this risk, which is why these agreements should be professionally prepared.
Sources & authority
- Ex parte De Villiers and Another NNO: In re Carbon Developments (Pty) Ltd (in liquidation) (720/91) [1992] ZASCA 220; 1993 (1) SA 493 (A); [1993] 1 All SA 441 (A)
- Companies Act 71 of 2008, s 4 (solvency and liquidity test) — with s 45 (financial assistance)
- Constantia Insurance Company Ltd v The Master of the High Court, Johannesburg [2022] ZASCA 179; 2023 (5) SA 88 (SCA)
This guide is general information, not legal advice. It reflects the law as at October 2026.