A borrower today will often look to a wide variety of capital sources in order to finance its various operational and strategic needs. For example, a borrower may have an operating lender, a senior secured lender, a subordinate secured lender and any number of unsecured lenders, each with their own expectations and requirements. An intercreditor agreement between two or more of such lenders helps to set out the relative rights and priorities between these lenders. Such an agreement is critical in helping to achieve certainty as to the lenders' relative rights in the various circumstances that may arise over the course of the financing.
It is difficult to say that there is a "market" form of intercreditor agreement. Many of the same issues are dealt with in different intercreditor agreements, but the rights accorded to each of the lenders vary significantly and are often heavily negotiated. The final terms of such an agreement depend on a number of factors, including the nature of the debt and security held by the relevant lenders, the borrower's financial condition and the lenders' preferred exit strategies. A number of the matters typically addressed in an intercreditor agreement are set out below.
Matters Addressed in an Intercreditor Agreement
Many intercreditor agreements deal with the following matters:
- establishment of relative priorities (payment subordination and/or security subordination);
- if and when a lender is entitled to receive payments from the borrower (payment blockages);
- if and when a lender can enforce its rights against the borrower (standstill periods); and
- access to collateral.
Establishing relative priorities between lenders (with respect to rights to payment and security, for example) is a key component of an intercreditor agreement.
Payment subordination involves an agreement between lenders (whether secured or unsecured) as to the order in which payment will be made to the creditors on account of the obligations of each creditor. From a senior lender's perspective, one should consider what will constitute the senior ranking obligations. For example, will the senior obligations include prepayment premiums, default interest, protective advances, hedging obligations? A senior lender wants the broadest possible definition, and the junior lender wants a narrower definition so that it understands the maximum amount that ranks in priority to it.
Security subordination involves an agreement between secured lenders as to the priority of ranking with respect to the security for their debt. In some cases, lenders have security over different assets (i.e., the split collateral deal). For example, the working capital lenders may take a first lien on working capital assets (i.e., cash, receivables, inventory) and the enterprise value lenders may take a first lien on everything else (i.e., fixed assets, such as equipment and real estate). The key issues in split collateral deals involve access to collateral and are set out below.
In most cases, a senior lender will want to restrict the ability of the borrower to make payments to the junior lender and possibly to prohibit them altogether. Consequently, one of the most heavily negotiated provisions of the intercreditor agreement is that relating to payment blockages.
Generally, restrictions on the payment of principal prior to the repayment in full of the senior debt are not controversial. Restrictions on the payment of interest, however, vary significantly between agreements. The more equity-like the terms of the subordinate debt, the more restrictive the provisions.
Discussions centre around a number of issues, including:
- what is the triggering event for the payment blockage (e.g., a senior covenant default, a senior monetary default, demand, insolvency); and
- the frequency and length of payment blockages.
Where there is a senior monetary default, the payment blockage period is potentially infinite in duration based on the theory that, unless and until the senior lender is brought current, the junior lender should not be receiving any payments whatsoever. Where there is a senior covenant default, the length of a covenant blockage period is negotiated, and generally ranges from 120 to 180 days. Some junior lenders insist on a limit upon the aggregate term of covenant blockage periods in any one year, and request that catch-up payments by the borrower to the junior lender be permitted once the senior default is cured.
Another common feature of an intercreditor agreement is a standstill provision. The purpose of such a provision is to give the senior lender control over any enforcement process by ensuring that the junior lender cannot enforce its security after a junior event of default until the senior lender has been given some time to determine how it wishes to proceed.
Typically, the standstill period will be 180 to 365 days for mezzanine debt, and 90 to 180 days for second-lien debt (less if the collateral is particularly vulnerable to accelerated depreciation). If the junior debt is high-yield debt or non-arm's-length debt, the prohibition against any enforcement action should apply at all times.
Junior lenders will try to negotiate the ability to take the following steps during the standstill period:
- accelerate the debt and demand payment;
- issue statutorily required notices;
- undertake collateral reviews and appraisals; and
- file notices of claim in insolvency proceedings.
Access to Collateral
In realization proceedings, a lender may need access to collateral held by other lenders in order to operate the business or to conduct a sale of its collateral. For example, a fixed asset lender may grant access to an operating lender to occupy the real property and use the fixed assets for a specified period of time in order to sell the remaining inventory.
The lender granting access will typically want to consider what compensation, if any, it should receive for granting such access. Such lender will also want to ensure that the operating lender is responsible for the payment of taxes, utilities, insurance and other operating costs during the latter's occupancy period, together with the obligation to repair any damage caused to the fixed assets during such occupancy period.
While the foregoing are often common issues dealt with in many intercreditor agreements, each intercreditor agreement is unique and transaction specific. Understanding a lender's key concerns and requirements in any given deal is key so that appropriate protections can be negotiated in any such agreement.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.