Peru: Subordination agreements in insolvency

Lisbeth Benavides K

Subordination agreements are frequently used in financing operations as a way to allow the debtor to obtain a subordinated financing from a junior creditor (usually a related party) without deteriorating the senior creditors' position. However, one of the problems faced when structuring subordination agreements in which the debtor is a Peruvian entity, is that – although these agreements are valid, legal and binding under Peruvian Law – the Peruvian Insolvency Law (PIL) does not contain any specific provision recognising and allowing the enforcement of subordination agreements within insolvency proceedings (procedimientos concursales).

Moreover, according to the PIL, the payment of related-party creditors is not subordinated to the payment of non-related parties' claims; the participation of each creditor in the creditors' meeting is determined by the percentage that its allowed claims represent in the aggregate amount of allowed debt (disregarding whether the claims represent subordinated or non-subordinated debt); and, in a reorganisation scenario, payments must be made under the reorganisation plan approved by the creditors' meeting. Therefore, unless the senior creditor has control over the creditors' meeting, it would not be able to ensure that the reorganisation plan reflects the subordination of the junior debt.

Further, under the PIL, in a liquidation scenario, the liquidator of the insolvent debtor must mandatorily pay the allowed claims in the following priority order: (i) labour claims; (ii) alimony claims (in case the insolvent is an individual); (iii) secured claims; (iv) tax claims; and, (v) non-secured claims. Except for secured claims (which are paid with the proceeds of the sale of the assets granted as collateral), payments within each order are made on a pro rata basis. So in cases where the claims of the senior and the junior creditor have the same priority in payment under the PIL, the junior and senior creditor would have the same right to receive payment on a pro rata basis.

Although certain contractual arrangements can be made in order to enhance the senior creditor's position to enforce the subordination agreement within an insolvency proceeding, these arrangements have not been tested in practice and it is still unclear whether the Peruvian Insolvency Authority, the administrator or the liquidator of the debtor would recognise them for purposes of the insolvency proceeding.

As debt subordination agreements become more and more frequent in Peru, the PIL should be amended to expressly regulate this type of arrangement.

Lisbeth Benavides K

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