Intercreditor Agreement

An intercreditor agreement is a contract between two or more creditors of the same borrower governing their respective rights, priorities, and remedies vis-à-vis each other. Intercreditor agreements are most common in multi-tier capital structures, senior secured lender plus junior or mezzanine lender, or first-lien plus second-lien lenders. The agreement allocates rights regarding the borrower's collateral, the timing and order of payment, enforcement actions, voting in restructurings, and behavior in bankruptcy. Although the borrower is typically a party (or signs an acknowledgment), the agreement's principal economic effect is between the creditors.

Lien priority and lien subordination

The core function of most intercreditor agreements is establishing lien priority, which creditor's security interest in the collateral is senior. Two principal models: (1) first-lien/second-lien structure, both creditors have liens on the same collateral, with the second-lien creditor expressly subordinated; (2) senior/mezzanine structure, senior creditor has lien on operating company assets, mezzanine creditor has lien on holding company equity (not on operating-company assets). In a first-lien/second-lien structure, the agreement ranks the liens and the application of collateral proceeds. Lien subordination does not by itself subordinate the junior debt in right of payment. That requires separate payment-subordination terms.

Payment subordination

Payment subordination provisions govern when junior creditor may receive payments. Two principal models: (1) deep payment subordination, junior receives no payments until senior is paid in full; (2) limited payment subordination, junior receives ordinary scheduled payments while no senior default exists, but junior payments are blocked during specified default conditions. Modern intercreditor agreements typically use limited payment subordination with payment blocks triggered by senior payment defaults or financial-covenant defaults.

Enforcement standstills

Enforcement standstills prohibit the junior creditor from taking enforcement action (foreclosure, lawsuit, exercise of remedies) against the borrower or collateral for a specified period after the senior creditor has been notified of a default. The length of the standstill period is negotiated. The senior lender uses the standstill period to formulate its enforcement strategy without competing junior-creditor actions undermining its position. Standstill expiration restores the junior's enforcement rights but typically still subject to senior priority.

Bankruptcy provisions

Intercreditor agreements address several bankruptcy issues: (1) cash collateral and DIP financing, junior creditor's agreement to support or not oppose senior's cash collateral and DIP financing positions; (2) plan voting, junior creditor's voting on plans of reorganization may be governed by intercreditor terms; (3) section 1111(b) elections, coordinating the parties' bankruptcy elections; (4) relief from stay, agreements about which creditor will pursue stay relief; (5) turnover, junior agrees to turn over to senior any payments received in violation of subordination. Section 510(a) of the Bankruptcy Code enforces subordination agreements in bankruptcy to the same extent they are enforceable under nonbankruptcy law.

Buy-out rights and amendments

Many intercreditor agreements grant the junior creditor a "buy-out right", the right to purchase the senior debt at par after a stated default period, putting the junior in the senior position. This can be an attractive option when the junior wants to control the workout. Senior creditors often include "no-amendment" provisions limiting junior's right to amend its own loan documents in ways adverse to senior (extending maturity, increasing principal, increasing payment terms beyond defined parameters).