An Intercreditor agreement is used by lenders to establish their rights and security to a loan taken by a borrower when the borrower has more than one creditor for the same loan. Normally, the lenders simply acknowledge that each of them is entitled to a specific claim on the assets of the borrower. In cases where there is a senior and junior debt, the lenders enter into an intercreditor agreement in order to define their respective rights and security since junior debt is less of a priority than senior debt. Such an agreement plays an important role in the right to lien (right to possess borrower’s property/assets) since it lays the foundation for each creditor’s rights and priorities in case the borrower defaults or fails to pay back the loan in full.
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What is an Intercreditor Agreement
Also known as an intercreditor deed, an Intercreditor agreement is a contract between 2 or more creditors. Such an agreement normally comes into effect when there is a senior and junior lender. The lenders sign a contract among themselves stating the responsibilities of each creditor, the liabilities of each creditor and various lien positions among other issues. In cases where there are more than 2 creditors senior lenders sign an agreement among themselves stipulating the authorities of each. If an intercreditor agreement is not signed and each creditor decides to go his/her own way the process could become an expensive legal mess. In some cases, the borrower can be part of the intercreditor agreements.
A Practical Example
In this simplified example, suppose that a company needs to finance the building of a plant for manufacturing its products. It manages to secure a loan from creditor X and uses a high value asset as collateral. In the process the same company obtains a smaller loan from creditor Y. In this scenario creditor X (the senior lender) and Y (the junior lender) will enter into an intercreditor agreement in order to protect each other’s interests.
Common Intercreditor Agreements
- First lien/Second lien Intercreditor agreement
This agreement involves 2 separate credit facilities. Each credit facility is secured by its own lien on the same collateral. Meaning both credit facilities share the same collateral although one is prioritised more than the other. One credit facility is secured by the first priority lien and the other is secured by a second priority lien on the same collateral. This intercreditor agreement states the priorities of the liens in relation to each other and governs the rights and obligations of each lender in relation to each other.
- Split collateral intercreditor agreement
A split collateral intercreditor agreement involves 2 credit facilities as well. One credit facility is secured by a first priority lien on a pool of assets and the other credit facility is secured by a first priority lien on a different pool of assets. Split collateral intercreditor agreements are often entered into when one of the lenders is an asset-based credit facility. The structure of the split collateral intercreditor agreement is similar to that of the first lien/second lien intercreditor agreement but there are critical differences. The negotiations for each lender’s priority collateral need to be done carefully because unwary lenders can be easily trapped.
- Senior/Mezzanine intercreditor agreements
A senior mezzanine intercreditor agreement involves 2 separate credit facilities where one is secured by a lien on all of the borrower’s assets and the other is either unsecured or secured by a pledge on a controlling interest in the borrower. There are times when a mezzanine intercreditor agreement is secured by all assets on a silent second lien basis. Such an arrangement is similar to the first lien/second lien intercreditor agreement. The mezzanine lenders are subordinated when it comes to rights of payment in favour of senior lenders. Thus, the mezzanine lenders may be forced to defer interest payments. A subordinated agreement determines the rights and obligations of each group of lenders and when payments are permitted to be retained by the mezzanine lenders. Subordinated agreements are straight forward to negotiate especially when the mezzanine lenders are not secured.
- Unitranche Intercreditor Agreement
This intercreditor agreement involves only one credit facility secured by one lien on one pool of collateral. Debt is separated into a first out (FO) tranche and a last out tranche (LO) debt. This may be determined within the credit agreement or in a separate agreement among lenders (AAL). If any triggering events occur payments or proceeds are made to the first out tranche lenders before they can be made to the last out tranche lenders. With a unitranche intercreditor agreement the AAL governs the rights and obligations of the first out and last out group of lenders. Unitranche intercreditor agreements are seen by some lenders as riskier than other intercreditor agreements because they have not been fully tested when dealing with bankruptcy. In addition, unitranche intercreditor agreements involve possible interest deferral compared to two lien agreements that do not have payment subordination by way of interest deferral.
Provisions of an Intercreditor Agreement
- Payment Blockage
An intercreditor agreement limits the payments a borrower can make to junior lenders if the borrower defaults based on terms specified under the agreement with junior lenders. It may even go on to limit the payments that the junior lenders are entitled to such as interest and usual fees.
Buyout rights are another provision of the intercreditor agreement. The buyout allows a lender to buy another lender’s claims and liens. This option may be taken by some lenders after the borrower has filed for bankruptcy.
A standstill prohibits the junior lender from taking any legal action against the borrower to enforce its debt for a specific period of time. Sometimes the period may be as long as the senior debt is paid in full.
Challenges of an Intercreditor Agreement
- Often, senior lenders dictate the terms of the intercreditor agreement
- Junior lenders that fail to negotiate with the senior lender may be disadvantaged
- In some cases, the junior lender may face artificial delays from the senior lender in order to frustrate the process and get the junior lender to agree with the senior lender’s terms