Intercreditor Agreements

An intercreditor agreement is an agreement between two creditors agreeing in advance how their competing interests in their common borrower will be dealt with.

Lenders are often required to address the priority of their loans and security in relation to another lender to the same borrower. In some cases, both lenders may simply want an acknowledgement that each of them is entitled to security of a specific priority over specific assets of the borrower, to the exclusion of the other lender. In other cases, additional restrictions on the rights of one of the lenders may be required.

In a senior lender/junior lender scenario, the lenders will customarily enter into an intercreditor agreement to establish their respective rights. The intercreditor agreement will usually provide a restriction on the payments that the borrower can make to the junior lenders upon the occurrence of certain events of default under the senior lender credit agreement. These provisions are referred to as “payment blockage” provisions. If a payment blockage provision is triggered, all payments to the junior lenders will usually be blocked, even the payments the junior lenders may otherwise be entitled to receive, such as scheduled interest or ordinary course fees and expenses

Debt vs. Security Subordination

Not all intercreditor arrangements contemplate that both the debt and the security of a “junior” lender will be postponed to the debt and security of a “senior” lender. Consideration should always be given to whether the subordination should extend not just to the security, but to the underlying debt obligation as well.

Subordination Agreements

In situations where a senior lender seeks the agreement of a junior lender to subordinate both the junior lender’s debt and its security, the nature and extent of the restrictions placed upon the junior lender (i.e., the “level” of subordination) are determined by the requirements and relative bargaining power of the parties. Matters which may be addressed in the subordination agreement include the following:

1. Standstill

The junior lender may be prohibited from taking any action to enforce the junior debt (including declaring a default, accelerating the debt, making demands for payment, taking legal action, etc.) for a specified period of time after notice has been given by the senior lender. Alternatively, the standstill period may continue until the senior lender has commenced its own enforcement proceedings, or even until the senior debt is repaid in full.

2. Restrictions on Repayment

Prior to a default under the senior debt, the junior lender may agree that, as long as any portion of the senior debt is outstanding, the junior lender will not accept or require repayments of the junior debt except for interest and regularly scheduled repayments of principal, or some other agreed amount. After a default under the senior debt, the junior lender may be prohibited from accepting any repayment of the junior debt until the default is remedied or the senior debt is repaid in full. If the junior lender is related to the borrower, the senior lender may require that no repayment of the junior debt whatsoever be made at any time until the senior debt is repaid in full.

3. Borrower Covenants

The borrower may be made a party to the agreement for the purpose of acknowledging the subordination, and to covenant not to make payments to the junior lender in prohibition of the agreement.