Subordination vs Subrogation



If you are involved in any aspect of the real estate business, sooner or later you will come across the term "subrogation". If you are subrogated to someone's claim, it sounds as though you are somehow subordinated to it, which is where the confusion comes in—you are not subordinate at all. So let's go over both.

You may find subrogation in leases, mortgages, insurance policies, guarantees, and other agreements. The phrase may appear in a document where a party agrees to "waive his right of subrogation", or where it is stated that one party is "subrogated to the claims of another".

Simply stated, the right of subrogation is the right to pursue someone else's claim.

Remember when the bully at school gave you trouble and broke your bike, and your big brother stepped in to handle the situation for you? That is subrogation! He pursued the conflict as if it was his own.

This can arise by the express agreement of the parties or automatically, by operation of law.

Let's look at a few examples.

Insurance

Suppose you own a building that burns down due to the negligence of a third party. Your fire insurance company can pay off your claim, but the insurance company is then subrogated to your claim against the negligent third party. This means that your claim against the negligent third party is treated as having been assigned to the insurance company, which may sue him to recover the amount it paid you on account of the fire loss. Kind of like your big brother did with the bully.

Guarantees

Speaking of brothers, suppose you guarantee your brother's loan so that he can buy a property. If you are forced to make good on the loan, you are subrogated to the lender's claim against your brother.

Interest in Real Property

Suppose you hold an interest in someone else's real property. It might be an easement, a leasehold estate, or a lien or encumbrance of some sort. If the owner allows the property taxes to go into default, you might decide to pay the taxes in order to protect your own interest. By doing so, however, you also protect the interest of the owner by paying off an obligation the owner should be paying. In this situation, you are subrogated to the rights of the taxing authority and may proceed against the fee owner in order to obtain reimbursement for the taxes you paid.

Subordination is very different. It will come up regarding loans.

Subordination is a legal agreement which establishes one debt as ranking behind another debt in the priority for collecting repayment from a debtor. The priority of debts is extremely important if the debtor defaults on payments or declares bankruptcy.

Remember your big brother? Now a kid at school wants to borrow 10 dollars from your brother. But your brother only wants to lend $5. So the kid goes to you for the other $5. Clearly, he is going to pay back your brother first, therefore making it riskier that you won't get paid back. You are in a subordinate position to your brother.

Debts that have a higher priority have a legal right to be repaid in full before lower priority debts receive any repayments. Often, the debtor does not have enough funds to pay all debts, and lower priority debts may receive little or no repayment.

Therefore, subordinated debts are much riskier, and lenders will require a higher interest rate as compensation.