With more and more lenders sharing risk it is important for us at CRL to understand what is under the hood of those intercreditor agreements and what to look for during times of corporate stress. It is better to have spent time and money writing the agreement than trying to protect your interest when you pull it out of the dusty draw in time of need. In our role we often are looked upon to assist in the negotiations to hopefully keep the waters calm as we look for a financial solution to the challenges at hand. That said what you will find below is a short summary and thoughts on what we learned that evening.
“Who” is in the first position and “what” needs to move into the first position to get repaid. It is the intercreditor agreement that outlines who is on first and what “what’s” rights are and what precludes “what” from moving to “who’s” first position. When the second lien holder made the loan he looked to excess value in the assets or future cash flows and as time marches on the matrix changes. It is the change in values and more importantly cash flow that can create a “CEO” opportunity.
While most second lien holders prefer not to hear, read or otherwise use the word subordination it is in fact what is occurring.
It is important that the document be tight from the first lien holder’s point of view and the second lien holder may prefer a slightly ambiguous agreement to leave their attorney’s room to negotiate quoting various legal opinions in their corner. Never fun to be in hostel waters over legal documents and it can be costly.
You may wish to focus on certain key areas of the agreement:
- Priority of Liens (lien subordination) – simple – I need to be first!
- Statutory provisions
- Intercreditor provisions
- Lien Subordination vs Payment Subordination
- Priority of Payments (payment subordination)
- Look to limit proceeds of collateral or amounts in liquidation vs payment subordination
- Limit actions of second and third lien holders until all remedies have been exercised or certain defaults take place
- The Subordination agreement should reflect that all payments to second lien holder are subordinated
- Payment blockage to second lien holders based upon a senior default trigger for a specific duration
- Simple – if the second lien holder receives any payments related to the collateral it must be remitted to the first lien holder
- Exercise of Remedies and Lien Releases
- The agreement must be tight relative to the senior lenders rights to control and liquidate the collateral
- Standstill Periods (remedies block)
- The senior lender will want to have rights and remedies against collateral and debtor which is usually triggered by borrower’s default on junior debt.
- Trigger- Important – notice must be given to senior lender of junior debt default as you want x days beyond notice for it to be the trigger of the default not the actual default itself. If no notice the junior secured could be out there impairing your collateral and repayment.
- Loan Document Amendments, Senior Debt Cap
- Control when loan documents can be changed
- Control on senior debt extensions, increases, rates, and maturity dates
- No amendments by junior lenders that would impact senior lender. I would think you would want to restrict any changes not approved by senior lender. Always difficult to get but it might be a great starting point in the negotiations.
- Junior lenders will want a cap on senior lenders debt. This would be a negotiated number as loans rise because of asset increases and overall growth of a business. Unless you are lending to own, growth and profits are a good thing. At the same time the junior lender does not want any deterioration in their position. So the negotiations begin.
- Senior lender may wish to have an out on the loan for a new senior lender. Talk about red lights going off, but then again everyone appetite is different.
- In some situations the junior lender may wish to be able to buy out the senior lender either to buy, imagine that, or in a bankruptcy to protect their position. Most of my banking clients frown upon putting up more cash to protect what is already out. A hedge fund on the other hand might have a different look at the situation.
- Senior lender would want a provision to be made whole. Nice provision to start the negotiations.
- Waivers and Consents
- An import issue was lien priority. While every lender I have met always asserted their liens were perfected. It may or may not be true. The document really needs to clearly state that the senior lender has first priority lien.
- Senior lender may want waivers in case of bankruptcy
- Junior lenders will want a number of rights outlined in a bankruptcy for now their collateral is really up for grabs.
•Right to Challenge the Validity of Liens;
•Right to Object to DIP Financing and Use of Cash Collateral;
•Right to Seek Relief from the Automatic Stay;
•Right to Adequate Protection and Post-petition Interest;
•Right to Object to Section 363 Sales of Collateral; and
•Voting Rights and Plan Proposals.
My analogy is lending is like owning a boat. The best two days of your life are when you book the loan and get repaid. Nothing matters once you are repaid but it is those old dusty loan documents that can cost you a “CEO” opportunity and sleepless nights.
Lastly, be sure to contact an expert attorney in the area of intercreditor agreements when the need arises.