What is an Intercreditor Agreement?
An Intercreditor Agreement, commonly referred to as an inter-creditor deed, is a document signed between two or more creditors, stipulating in advance how their competing interests are resolved and how to work in tandem in service to their mutual borrower. In a typical scenario, there are two creditors involved in a given agreement – a senior(s) and subordinate (junior) lender(s). However, in some circumstances, there may be more than two senior lenders. In such instances, there needs to be another agreement defined among themselves.
A Practical Example of an Intercreditor Agreement
Company X may be in a contract with government agency Y for constructing a housing development plan for Army veterans. The cost of the project is estimated to run to about $125 million, of which the company finances only $25 million. As a result, the company seeks an advancement from the government and another third-party financier(s). As a means to convince both the government agency and the financier(s) to fund the project, the company uses a high-value asset as a guarantee.
In such a scenario, the government agency may serve as a junior lender, the financier(s) as a senior lender(s), and the company (Y) is the borrower. Because the company secures the loan from both financiers with the same property, the senior creditor will definitely want to enter into an intercreditor agreement with the government agency to protect its interests.
Significance of an Intercreditor Agreement
The intercreditor agreement plays a pivotal role in the right to lien. It is, therefore, crucial to both lenders to lay a solid foundation regarding their rights and priorities in case a borrower’s financial capabilities erode and it defaults. In the absence of such a document, each party may exercise its own resolutions at the same time and be inconsistent. The entire process may be unethical and uneconomical and may quickly turn into a legal mess in court.
Challenges of Intercreditor Agreements
It is often the norm in many intercreditor agreements to see the senior lender dictating the terms of lien. However, in instances where a junior lender fails to negotiate the deed strongly, the senior lender may disadvantage a junior lender. In some instances, a junior lender may face artificial delays from the senior lender on a quest to seek approval to finalize an agreement or claim. Such a move may frustrate the process, forcing the junior lender to capitulate.
Caution to Junior Lenders
Junior lenders should exercise caution in evaluating an intercreditor deed before signing on to it. One way to accomplish this objective is by negotiating over an equitable edge and laying actionable plans. However, if efforts to establish such terms are futile, it is advisable that the junior lender foregoes the arrangement or seeks alternative options.
The junior lender should consider putting into the agreement conditions for taking over the project if the borrower defaults. If such a situation occurs, the junior lender should know that there are usually only two options available: either to inject finances into the project with the intention of curing monetary defaults under the senior lender, or paying off the senior lender. The latter is often close to impossible in cases where the senior lender has provided very large amounts of financing.
Common Areas of Negotiation and Remedies in an Intercreditor Agreement
Generally, in any deed signed by two or more parties, each party should be aware of critical elements within the agreement. So, it is necessary for a junior lender to achieve a clear ground and identify fundamental issues before the commencement of the transaction, as follows:
Check limitations of scheduled payments to a junior lender
Junior lenders must pay attention to how and when the scheduled payments of interest are made. It should also ensure that there are no staggering blockages instituted by the senior lender in case a borrower defaults. Therefore, a junior lender must negotiate for treatments such as limiting the number of blockages on defaults, protection to accelerate debts and perfect remedies, and a clear guideline on when a blockage should begin.
Clarify the definition of “senior debt” and assess its amendment
A “senior debt” terms of credit agreement consists of sensitive matters such as interest fees, costs, and indemnity payments that gives the senior lender preference over the junior lenders. It is also usual that a senior lender can amend it without the consent of a junior lender. Therefore, a junior lender should negotiate for a cap on the amount of senior debt and ensure there is a clause to stop the senior lender from amending terms of the senior loan.
Clarify the definition of “junior debt” and assess its amendment
A senior lender will usually want a junior lender to carry the burden of the debt owed by the borrower. In such a case, a junior lender may shield himself by seeking exemptions in short-term and limited purpose loans. He should also negotiate an acceptance to exercise fundamental equity rights, such as owning a shareholder vote in case a blockage arises.
Clarify the collateral subject to a subordination agreement
A junior lender should seek an exemption to a particular class of collateral that a senior lender has not included in his assets base. Once agreed that there is a personal guarantee from the principal of the borrower or a guarantee in favor of the junior lender, the junior lender should ensure that the stipulated rights are reflected accurately in the intercreditor agreement and that they are not subject to a standstill.
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