Clarification of equitable subordination risks by Swiss Federal Supreme Court

In a recent decision, the Swiss Federal Supreme Court has clarified equitable subordination risks in connection with shareholder loans. The key takeaways are as follows:

• A re-characterization of loans into equity has been dismissed by the Swiss Federal Supreme Court, confirming previous decisions on this topic.
• The concept of equitable subordination is recognized for the first time by the Swiss Federal Supreme Court on the basis of the abuse of rights doctrine.
• Over-indebtedness (i.e. balance sheet insolvency) has been identified as the relevant trigger event for equitable subordination.
• Other tests with earlier and less objective trigger events suggested in doctrine, such as the third party test and the recovery test, have been dismissed.

By identifying an objective trigger (namely, over-indebtedness) for equitable subordination, the decision may make rescue debt financing more attractive from a shareholders’ perspective. Among other scenarios, this may be particularly helpful in a start-up or private equity context.

Wider context

Under Swiss insolvency and corporate law, loans made available to a subsidiary by its direct or indirect shareholders are not per se re-characterized into equity or subject to statutory or equitable subordination. Rather, the general rule is that such shareholder loans are treated as a regular debt position of the subsidiary and that they rank pari passu with other unsecured debt.

While the re-characterization of shareholder loans into equity has been dismissed by the Swiss Federal Supreme Court in earlier decisions, it has previously left open whether statutory or equitable subordination may apply in exceptional circumstances. Doctrine has been largely supportive of such concept but requirements and consequences have been discussed controversially. In particular, the required level of financial distress of the subsidiary has been debated heavily, resulting in significant uncertainties when it comes to rescue debt financing by shareholders. Two main concepts are discussed:

• A pure balance sheet test. According to this view, shareholder loans may be subject to subordination if, at the time of the granting or subsequent extension of the loan, the borrower suffered from over-indebtedness (balance sheet insolvency; assets no longer cover liabilities of the entity on a standalone basis and applying statutory accounting rules) or capital loss situation (assets no longer cover liabilities and half of the stated share capital and protected legal reserves on a standalone basis and applying statutory accounting rules).
• A third party or market test: According to this view, a shareholder loan may be subject to subordination if it has been extended in a situation where a recapitalization with debt would not have been obtainable from the markets (third party test) or where only a recapitalization with equity would have been sufficient to successfully restructure the company (recovery test).

In its most recent decision 5A_440/2024 of March 31, 2025, published on May 15, 2025, the Swiss Federal Supreme Court provides much awaited clarity on the topic. After re-confirming the inadmissibility of a re-characterization of loans into equity in line with previous decisions, it recognizes for the first time the concept of equitable or statutory subordination on the basis of the abuse of rights doctrine.

When discussing the relevant trigger, the Swiss Federal Supreme Court adopts a pure balance sheet perspective and holds that only loans which are granted to an over-indebted subsidiary are exposed to the risk of equitable or statutory subordination. The more vague third party and recovery tests have been dismissed by the Swiss Federal Supreme Court.

In our assessment, the more objective standard adopted by the court is appropriate and will reduce uncertainty for shareholders. This may make rescue debt financing from shareholders a more controllable risk. That said, the over-indebtedness analysis will typically depend on the going concern assessment (i.e. whether assets and liabilities may still be valued at going concern values) which still brings some level of discretion (and uncertainty) into the equation.

The Swiss Federal Supreme Court has also considered whether implied subordination may be admitted in the specific case. As opposed to equitable or statutory subordination, the court holds that implied subordination is to be determined on the basis of the well-established rules on contract interpretation. The court concludes that no implied subordination could be inferred from the relevant circumstances prevailing at the time the specific loan agreements were entered into.

Please do not hesitate to contact us in case of any questions.

Legal Note: The information contained in this Smart Insight newsletter is of general nature and does not constitute legal advice.