Intercreditor agreements, deeds of priorities, subordination agreements… we see many terms for documents which all seek, in different ways, to regulate the relationships between different creditors and their borrower group. So, what is an intercreditor agreement and when might you need to use one?
What is an intercreditor agreement?
Like a deed of priority, an intercreditor agreement aims to determine the order of priority of debts and security interests of senior and junior lenders to a borrower group. And like a subordination deed, an intercreditor agreement will usually seek to rank the priority of unsecured creditors who would otherwise compete for distributions in a liquidation. An intercreditor agreement will be used where there is a more complex capital structure or more complicated relationships between different creditors and the borrower group, each of which will need to be a party to the document. In addition to setting out the order of payments and security interests and ranking the unsecured creditors, the intercreditor agreement may also specify when the borrower group can make payments to particular groups of creditors or set out the specific circumstances in which particular lenders can enforce their security interests.
Commercial objectives dictate the drafting
When drafting an intercreditor agreement, keep in mind each party’s commercial objectives. Institutional lenders generally want as much certainty (of repayment and control in the event of stress and distress) as possible. They will seek to tightly regulate when a borrower makes payments, particularly to other creditors and between other entities in the borrower group: to ensure that enough funds remain within the lender’s ‘net’ of control. In contrast, the borrower will want the flexibility to run its business free from unnecessary interference. The relationship between an existing lender and an incoming lender providing additional funding will need to be carefully balanced, as both will want to protect their own repayment streams and argue for a priority position.
So where do intercreditor agreements come into play?
Picture a company with an existing loan that experiences a squeeze on cashflow. Unless addressed, the company may face a decline, with worsening credit terms from suppliers, nervous staff and directors, and ultimately the prospect of an insolvency process. The lender faces the risk of disruption to the payment of interest, the possible write-off of debt, and perhaps a drawn-out security enforcement or debt recovery process. A fresh injection of funds may resolve the issue, but the existing lender may not want to increase its exposure.
Bringing in an additional lender could be the solution, but this lender will want to ensure that its repayment is prioritised over payment to the existing creditors, including the existing bank lender. While the existing lender may be happy with the borrower drawing the new funding, it will be reluctant to cede its priority position to the new lender. Both lenders will want their debts to rank higher than those owed between the borrower and group entities or to any investors.
This is where an intercreditor agreement comes in. In this situation, the new lender may want, among other things, provisions to:
(a) subordinate other debts owed by the borrower and any guarantors (other than amounts owed to trade creditors, which are essential for the continued operation of the business);
(b) prevent payments by the borrower to other creditors other than in specific circumstances and provide that any amounts received by other creditors are turned over to the new lender;
(c) limit other creditors from enforcing their security interests or commencing enforcement proceedings against the borrower and any guarantors; and
(d) prevent the borrower from increasing their exposure to any other creditor.
The existing lender, on the other hand, will want to:
(a) prevent the incoming lender from increasing the size of its facility or taking additional security or guarantees from the borrower; and
(b) protect its ability to take action in respect of its debt (including to enforce security interests) if any key event of default occurs.
The negotiation of these positions will often result in an agreement that gives preferential treatment to the incoming lender, whilst giving the existing lender a path to repayment and some, limited, control.
We’ve given a relatively simple example – as the number of parties and relationships to be governed increases so does the complexity of the arrangement. But the key remains to put in place a regime which properly and clearly regulates the relationships across the financing structure of the borrower group whilst allowing the business the space to thrive.
Trailing thoughts
It should be understood, however, that putting any intercreditor agreement in place can add complication to any financing transaction – in terms of both time and fees – particularly where there is no visible benefit to an existing lender. Existing debt and security documentation will likely restrict further lending and security without the lender’s consent, so what could at first appear to be a straightforward standalone loan financing can morph into a much more involved exercise, with unexpected negotiations, costs and delays.
Matthew Padian
Luke Fahy-Spada