The intercreditor frameworks applicable to a given financing structure in a particular market are often fairly settled, but in cross-border financings for European borrowers or other financings involving practitioners and business people in different parts of the world, deal parties may have different expectations as to the key intercreditor terms that ought to apply.
In this chapter, we will compare and contrast the key terms in U.S. second lien and European second lien intercreditors and discuss the blended approach taken in some recent intercreditor agreements for financings of European companies in the U.S. syndicated bank loan markets. Similar dynamics may be involved when documenting intercreditor agreements involving other non-U.S. jurisdictions as well, but for ease of reference, we will refer to these intercreditor agreements as "Transatlantic Intercreditor Agreements".
U.S. second lien intercreditors are predicated on two key assumptions: first, that the business will be reorganised pursuant to Chapter 11 of the United States Bankruptcy Code (Chapter 11); and second, that the first lien lenders will receive the benefits of a comprehensive guarantee and collateral package (including shares, cash, receivables and tangible assets) pursuant to secured transactions laws that effectively provide creditors with the ability to take a security interest in "all assets" of the borrower and guarantors. European second lien intercreditors, in contrast, (i) assume that it is unlikely that the borrower and guarantors will be reorganised in an orderly court-approved process and indeed more likely that, since there is no pan-European insolvency regime (and thus no pan-European automatic stay on enforcement of claims), the intercreditor terms will have to function in the context of potentially multiple and disparate insolvency proceedings (ideally outside of insolvency proceedings altogether), and (ii) contemplate that not all assets of the borrower and guarantors will be subject to the liens of the first lien and second lien secured parties. As a result, one of the key goals that European second lien intercreditors seek to facilitate is a swift out-of-court, out-of-bankruptcy, enforcement sale (or "pre-pack") resulting in a financial restructuring where the business is sold as a going concern on a "debt-free basis", with "out of the money" junior creditors' claims being released and so removed from the financing structure.
The first lien/second lien relationship in the U.S. closely resembles the senior/second lien relationship in Europe; however, for the reasons stated above, the key terms of U.S. second lien and European second lien intercreditors have been constructed on the basis of different assumptions, which therefore results in significant intercreditor differences.
European second lien intercreditor agreements typically combine claim subordination, payment blockages, lien subordination, broad enforcement standstill provisions restricting the junior lien creditors' ability to take enforcement action (not only with respect to collateral but also with respect to debt and guarantee claims) and extensive release mechanics. U.S. second lien intercreditors establish lien subordination, which regulates the rights of the U.S. second lien creditors with respect to collateral only, and include an enforcement standstill with respect to actions against collateral only, although there are generally protections against junior lien creditors receiving value in their capacity as an unsecured creditor that would be prohibited by the terms of the lien subordination (such as take-back equity that is not otherwise first issued to senior lien creditors). U.S. second lien intercreditors do not generally include payment or claim subordination and they rely heavily on waivers of the junior lien creditors' rights as secured creditors under Chapter 11.
European second lien intercreditors often have their original genesis in the Loan Market Association's form (the "LMA"), but are negotiated on a deal-by-deal basis. By contrast, there is no market standard first lien/second lien intercreditor agreement in the U.S., although the American Bar Association published a model first lien/second lien intercreditor agreement in May 2010 intended as guidance for secured creditor constituencies in the U.S. market.
As discussed below, recent intercreditors for financings of European companies in the U.S. syndicated bank loan markets vary even more significantly.
Key Terms of U.S. Second Lien Intercreditor Agreements and European Second Lien Intercreditor Agreements
1. Parties to the Intercreditor Agreement
U.S. second lien intercreditors are generally executed by the first lien agent and the second lien agent and executed or acknowledged by the borrower and, sometimes, the guarantors. In the current market, intercreditor agreements frequently allow for representatives of future classes of first lien and second lien debt permitted by the debt documentation to accede to the intercreditor agreement. U.S. second lien intercreditors also typically allow for refinancings of the first lien and second lien debt.
By contrast, the parties to European second lien intercreditors generally include a longer list of signatories. In addition to the first lien agent and initial lenders, the second lien agent and initial lenders and the obligors, the obligors' hedge providers, ancillary facility lenders, the lenders of intra-group loans, the lenders of shareholder loans and the security agent will execute a European-style intercreditor agreement. The longer list of parties to European second lien intercreditors is largely driven by the senior creditors' desire to ensure that, after giving effect to the senior lenders' enforcement, the borrower group is free and clear of all claims (both secured and unsecured) against the borrower and guarantors coupled with a preference to ensure that any enforcement action by creditors is choreographed in a manner which maximises recoveries for the senior secured creditors (and thus indirectly for all creditors). It has become common for refinancing and incremental structural debt to be permitted in European deals. European intercreditors typically require such debt to be subject to the intercreditor agreement, although the treatment of unsecured debt can be subject to negotiation.
Hedge obligations are generally included as first lien obligations under U.S. second lien intercreditors, but hedge counterparties are not directly party to U.S. second lien intercreditors. By accepting the benefits of the first priority lien of the first lien agent, the hedge counterparties receive the benefits of the first priority lien granted to the first lien agent on behalf of all first lien secured parties (including the hedge counterparties) and the hedge counterparties are deemed to agree that the first lien security interests are regulated by the intercreditor agreement and other loan documents. The hedge counterparties under U.S. intercreditors in syndicated bank financings generally have neither the ability to direct enforcement actions nor the right to vote their outstanding claims (including any votes in respect of enforcement decisions). Hedge counterparties protect their interests through the terms of their swap agreements with the borrower or guarantors such that a swap termination event occurs upon certain events (e.g., amendments to the hedge status under the intercreditor agreement, changes to distribution of collateral proceeds or termination of security).
Cash management obligations (e.g., treasury, depository, overdraft, credit or debit card, electronic funds transfer and other cash management arrangements) are often included as first lien obligations under U.S. second lien intercreditors on terms similar to the terms relating to the hedge obligations. Historically, European second lien intercreditors typically did not expressly contemplate cash management obligations, although this position is increasingly negotiated. In European financings, the cash management providers that are initial lenders would typically provide the cash management services through ancillary facilities - bilateral facilities provided by a lender in place of all or part of that lender's unutilised revolving facility commitment. Ancillary facilities are not a traditional feature of U.S. credit facilities, although increasingly common. The providers of ancillary facilities would be direct signatories of a European second lien intercreditor.
a. Enforcement Instructions
The first lien agent under a U.S. second lien intercreditor takes instructions from the lenders holding a majority of the loans and unfunded commitments under the first lien credit agreement, which follows the standard formulation of required lenders in U.S. first lien credit agreements. (Note, however, that the vote required to confirm a plan of reorganisation in a Chapter 11 proceeding is a higher threshold - at least two thirds in amount and more than one half in number of the claims actually voting on the plan.) Where there are multiple first lien facilities, typically the agent for the facility representing the greatest amount of loans and unfunded commitments is the "controlling" agent acting for the first lien class, though in most cases the agent for the bank facilities (as opposed to a notes trustee) will be the controlling agent even if the bank facilities are smaller than outstanding senior secured notes.
The security agent under European second lien intercreditors, however, takes instructions from creditors holding 66?% of the sum of (i) the drawn and undrawn amounts under the senior credit agreement, and (ii) any actual outstanding liabilities (plus any mark to market value if the senior credit agreement has been discharged) under any hedging arrangements.
b. Enforcement Standstill Periods
U.S. second lien financings involve lien subordination as opposed to payment (also referred to as debt or claim) and lien subordination. The result of lien subordination is that only the proceeds of shared collateral subject to the liens for the benefit of both the first lien secured parties and second lien secured parties are applied to repayment in full of the first lien obligations before the second lien secured parties are entitled to receive any distribution of the proceeds of the shared collateral, but the second lien secured parties may receive other payments (such as payments of principal and interest and payments from other sources, e.g., unencumbered property) prior to the first lien obligations being paid in full. In the context of U.S. obligors, it is unlikely, in practice, that there would be substantial property that is unencumbered since the security granted would likely pick up substantially all assets - in contrast to a number of European obligors whose unencumbered assets may be significant due to local law limitations.
Payment subordination requires the junior lien creditors to turnover to the first lien secured parties all proceeds of enforcement received from any source (including the proceeds of any unencumbered property) until the first lien obligations are paid in full. In consequence, the difference in recoveries between lien subordination and payment subordination could be significant in a financing where material assets are left unencumbered, as is likely in a financing in which much of the credit support is outside the U.S.
U.S. second lien intercreditors prohibit the second lien agent from exercising any of its rights or remedies with respect to the shared collateral until expiration of a standstill period (typically 90 to 180 days after notice delivered by the second lien agent to the first lien agent of a second lien event of default or, in some cases, if earlier, second lien acceleration). The standstill period becomes permanent to the extent the first lien agent is diligently pursuing in good faith an enforcement action against a material portion of the shared collateral or upon a bankruptcy proceeding filing. An exercise of collateral remedies generally includes any action (including commencing legal proceedings) to foreclose on the second lien agent's lien in any shared collateral, to take possession of or sell any shared collateral or to exercise any right of set-off with respect to any shared collateral, but the acceleration of credit facility obligations, filing a proof of claim in a bankruptcy proceeding or ensuring continued perfection on collateral are generally not considered an exercise of collateral remedies.
European second lien intercreditors typically contain a much broader enforcement standstill provision than U.S. second lien intercreditors, principally because there is no pan-European equivalent of the Chapter 11 automatic stay. The scope of the restricted enforcement actions typically prohibits any acceleration of the second lien debt, any enforcement of payment of, or action to collect, the second lien debt, and any commencement or joining in with others to commence any insolvency proceeding, any commencement by the second lien agent or second lien creditors of any judicial enforcement of any of the rights and remedies under the second lien documents or applicable law, whether as a secured or an unsecured creditor. The enforcement standstill period has traditionally run for (i) a period of 90 days following notice of payment default under the senior credit agreement, (ii) a period of 120 days following notice of financial covenant default under the senior credit agreement (although this is much less common since the introduction of cov-lite financings in the European market), and (iii) a period of 150 days following notice of any other event of default under the senior credit agreement. However, the enforcement standstill period is now often subject to negotiation and in some deals, for example, it is 120 days following notice of the relevant event of default. In European second lien intercreditors, the senior creditors firmly control enforcement (other than in some exceptional circumstances). In addition, the senior agent is generally entitled to override the junior agent's instructions to the security agent, leaving the second lien lenders only able to influence the timing of enforcement action after the standstill period.
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Originally Published by ICLG - Lending & Secured Finance 2021.
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.