44. "Subordination"—What It Is and How It Works

One way for the syndicator to be paid for his work and efforts is to obtain a certain number of partnership units in the syndicate as his "cut". As a rule, he does not pay cash for these units. Very often he ends up with these free units and a substantial share in the growth of the syndicate without investing any money of his own.

In many cases, the agreement will provide that month­ly payments on the units owned by the syndicator will be subordinated to payments on the other units. This means that the monthly distributions must be made first to the cash investors. If there is enough left, monthly distribu­tions will be made on the units owned by the syndicator.

You benefit from subordination. Suppose that $500,000 worth of units are outstanding. The investors have put up cash for $450,000 worth of units. The syndicator has received $50,000 worth of units, but did not have to pay for these units. In order to pay 10% distribution on $500,000, the income must amount to $50,000. If, in a given year, the income amounts to only $45,000, you would only get 9% instead of a 10% distribution. How­ever, the subordination clause gives the cash investors priority. In our case, the investors will get their 10% and the syndicator nothing during the year in which the in­come of the property is only $45,000.

The syndicate is set up to provide a certain yearly dis­tribution to all who have units, including the syndicator. The subordination of the syndicator's interest provides a true cushion. If there is not enough money to make the projected distributions, the syndicator will receive none. The syndicator is under no obligation to subordinate his units, and they are only subordinated if it is specifically stated in the brochure. The brochure will also state whether the syndicator's units are permanently subordi­nated, or subordinated just for one or more years. The longer they are subordinated, the better for you.

We examined subordination of income on the syndi­cator's shares. The agreement could further provide that in case of a sale the investment of the cash investors must be repaid first, before the syndicator will receive any money for his share. Such a clause is also beneficial for you. If the property in our last example were sold for $450,000 above the mortgage, there would not be enough money to pay $500,000, the full value for all the units outstanding. If the syndicator had subordinated his units as to principal, the cash investors would get all their money back, and the syndicator would get nothing.

The subordination clause is usually easy to find and offers no difficulties. Sometimes such a clause is worded as follows:

For a period of three years after the date of the ac­quisition of the property, the limited partners (invest­ors) will have priority both as to distributions and as to proceeds of liquidation over the general partner (the syndicator).   (The words in parentheses were added by us to make the clause clearer). Giving to the investors priority amounts to the same thing as subordinating the syndicator. The effect of the above clause is to subordinate the syndicator's interest in distributions and proceeds of sale for a period of only three years.

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