Unlike a subordination agreement, the waiver would be risky, as it could have undesirable tax consequences. The total removal of the debt from the balance sheet could be considered by the tax authorities as an exceptional taxable benefit. Legal advisors must try to achieve the impossible by removing debts from the balance sheet of over-indebtedness while remaining on the tax balance sheet. On the basis of decisions of the Bundesfinanzhof, legal practice has developed relatively safe formulations to cover this tax risk. However, there are still a number of unresolved questions as to the correct wording of subordination: this does not necessarily require giving up the respective debts. German law provides that debts in an over-indebtedness balance sheet can be left out without giving up if the parties declare that liability is subordinated (Article 19 of the Insolvency Code). The subordination agreement should stipulate that the debt can only be met in the insolvency procedure when all other creditors – including creditors who are automatically subordinated – have fully recovered their claims. In a subordination agreement, the second loan is considered inferior and considered a „junior“ debt. It thus becomes a subordinated debt, which means that the first lender receives the repayment before the second lender does so. Mortgagor pays him for the most part and gets a new credit when a first mortgage is refinanced, so that the new last loan now comes in second.
The second existing loan becomes the first loan. The lender of the first mortgage will now require the second mortgage lender to sign a subordination agreement to reposition it as a priority for debt repayment. Each creditor`s priority interests are changed by mutual agreement in relation to what they would otherwise have become. A subordination agreement is a legal document that classifies one debt as less than another, which is a priority in recovering repayment from a debtor. Debt priority can become extremely important when a debtor becomes insolvent or declares bankruptcy. A subordination agreement shows that the priority debt lender has the right to be fully repaid to the lender of the second division. The primary lender also has a higher right to property or assets.