Subordination agreements and intercreditor agreements are often utilized to establish priority and rights when two or more lenders have liens in the same borrower’s collateral. Although these agreements are referenced interchangeably, a subordination agreement is an agreement between two or more lenders to address priority in specific liens and repayment priority, while an intercreditor agreement is an agreement between lenders to address lien priority and other rights in the event the borrower defaults on its obligations owed to a lender or files for bankruptcy. This article summarizes some of the key elements lenders should consider when negotiating subordination agreements and intercreditor agreements.

Key Elements To Consider

Defining the Scope of First Lender and Second Lender Obligations
One of the first elements lenders should consider when negotiating subordination agreements and intercreditor agreements is the scope of the obligations of the borrower to each lender. Each lender should carefully consider how the borrower’s obligations are defined and which of those obligations also fall within the scope of the obligations owed to the other lender. If the senior obligations include amounts that a subordinate lender did not anticipate, such as increases to the senior loan amount, the subordinate lender could recover less than expected under the subordination provisions. Depending on negotiating power, subordinate lenders may consider negotiating a cap on the senior loan amount and/or a borrowing base limit applicable to the senior loan. Senior lenders, on the other hand, should seek flexibility in how its obligations are defined so that it may increase such obligations without needing the other lender’s consent should the borrower have additional financing needs.

Standstill Provisions Payment Blockage
Most intercreditor agreements contain standstill provisions that dictate the enforcement actions a subordinate lender can take against collateral that both lenders have a security interest in (referred to as “common collateral”) during a specified standstill period. During a standstill period, senior lenders have an opportunity to consider whether to take enforcement action against the collateral without interference from the subordinate lender. When negotiating a standstill provision, lenders will want to consider and define (i) the events that trigger a standstill period, (ii) the duration of a standstill period and (iii) what occurs after the standstill period has expired. Standstill provisions may be triggered by a borrower’s failure to make timely payments or otherwise comply with its obligations under the loan documents. Senior lenders often negotiate for the standstill period to be as long as possible, while subordinate lenders try to limit the length, especially if the value of the collateral may decline during such period. After a standstill period expires, the subordinate lender can then exercise its rights against the collateral under the terms of the subordination and intercreditor agreement.

Payment Blockage
Payment blockage provisions are another key element lenders should consider when entering into subordination and intercreditor agreements. These provisions allow a senior lender to block payments to a subordinate lender under certain conditions, usually when there is a default on the senior lender’s debt. Payment blockage provisions generally require that a borrower’s available funds are used to satisfy senior debt obligations before payments are made to subordinate lenders. The parties should clearly outline the specific conditions triggering a payment blockage, the duration of the blockage period, any exceptions to the payment blockage, and whether missed payments to the subordinate creditor can be made after the triggering condition has been cleared.

Amendment Restrictions
Amendment restrictions within subordination and intercreditor agreements govern the ability of the borrower and lenders to amend the terms of the underlying credit facility. Typically, subordination and intercreditor agreements provide that material amendments to the senior facility, such as increasing the principal amount beyond any applicable cap, increasing the interest rate, increasing fees owed to the senior lender, and maturity date extensions require the consent of the subordinate lender. These provisions protect subordinate lenders from unexpected changes that could negatively affect their ability to collect debt payments or collateral proceeds in the event of a default.

Conclusion

Subordination and intercreditor agreements are essential tools used in financing transactions involving multiple lenders to facilitate and manage each lender’s rights and expectations with respect to security interests and the borrower’s payment obligations. By understanding key elements, including the scope of the senior and subordinate obligations, payment blockage provisions, standstill provisions and amendment restrictions, lenders are better positioned to effectively protect their interests and navigate the complexities of subordination and intercreditor agreements, particularly in the event of a borrower default or bankruptcy filing.

Taylor Chase and Heather Morris are members of the Spencer Fane Banking and Financial Services team. They can be reached at tchase@spencerfane.com or (816) 292-8801 and hmorris@spencerfane.com or (816) 292-8387, respectively.