As the transition from an equity-investor bull market featuring seemingly endless liquidity to a market correction featuring more debt on company balance sheets continues, transaction lawyers are seeing the reemergence of the intercreditor agreement. 

Just as preferred shareholders meticulously negotiate their rights amongst each other, debt investors do just the same. In both cases, these negotiations have an impact, albeit sometimes unintended, on the company targeted by the investment.

A number of factors can influence creditor negotiations, including creditworthiness of the borrower, financing market conditions, creditor yield requirements, the identity and relationship of the parties involved, working capital assets of the borrower, willingness of the creditors to defer payment, relative sizes of the senior and junior debts, the borrower’s ability to attract equity investments in the transaction, the borrower’s outstanding leverage, and the experience and negotiating skills of the principals and their counsel in intercreditor arrangements and transactions. 

These factors are often impactful when negotiating key business and legal points such as lien priority, enforcement rights, payment rights, and purchase rights, as further described below.

Lien Priority

Generally, secured lenders in the U.S. market will want to be the first to file a Uniform Commercial Code financing statement to take priority over later filings. Despite this general rule, creditors still negotiate their rights through intercreditor arrangements. Specifically, creditors and their respective counsel must create a creditor lien structure that reflects the agreed-upon business terms of the relevant transaction. Today, we frequently see first lien/second lien arrangements and split collateral arrangements. 

First Lien/Second Lien Arrangement 

Under the first lien/second lien arrangement, all or substantially all of the borrower’s collateral is encumbered by a first-priority lien in favor of one or more senior creditors and a second priority lien in favor of one or more junior creditors. To reference a precedent of the simplest form of a first lien/second lien structure, parties in their negotiations may turn to the Model Intercreditor Agreement developed by the Business Law Section of the American Bar Association.

Split Collateral Arrangements 

Under a split collateral arrangement, an asset-based lender or other cash flow lender has a first-priority lien on a defined set of the borrower’s current assets (typically, receivables and inventory), and a term lender has a first-priority lien on a separately defined set of the borrower’s long-term assets (typically, fixed assets, investments, real property, and intellectual property). Each lender then takes a second-priority lien on the other lender’s defined set of first lien collateral, respectively.

Enforcement Rights

A senior creditor may seek to restrict a junior creditor from direct enforcement against a borrower upon a default or event of default with respect to shared collateral for a designated period of time–a “standstill period”–or for the entire term of the senior credit facility. The standstill period may be heavily negotiated by the creditor parties or be consistent with current market trends. The junior creditor may also negotiate carve-outs from the restriction on direct enforcement, based on the nature of the collateral or transaction-specific terms typically related to the size or nature of the junior subordinated debt. 

Payment Rights 

The senior creditor may seek to restrict the debtor from making any payments to junior creditors during a default or event of default until the senior creditor receives all principal and interest payments due and payable to it. These payment restrictions are often paired with provisions requiring the junior creditor to turn over to the senior creditor any proceeds received by the junior creditor in violation of payment restrictions. Negotiated exceptions to payment restrictions are typically made in very limited circumstances. 
Purchase Rights 

Junior creditors, with an eye to first-priority priming, may seek to obtain a purchase right option to “take out” the senior creditor’s position. If this right is agreed upon, in most instances senior creditors will want to narrow the time frame in which the junior creditor may exercise such right. A senior creditor will want to reduce any risk or negative impact on its senior enforcement rights that can occur through a proposed purchase of the senior creditor’s position. 

Bankruptcy Specific Rights

Sophisticated creditors may wish to carefully evaluate and negotiate the rights of creditors generally associated with the U.S. Bankruptcy Court. Creditors will negotiate what rights creditors may have to use collateral to secure debtor-in-possession financing and priming liens. Creditors may specifically negotiate limits on objections to use of cash collateral. Also, creditors often desire a negotiated understanding regarding junior creditors’ ability to file claims for adequate protection. In general, senior creditors will pay close attention to the ability of junior creditors to object to the actions of a senior creditor, including a plan of reorganization offered by the senior creditor. Senior creditors may want the ability to vote the junior creditors’ debt if they are in the same creditor class. 

In summary, intercreditor agreements are bespoke arrangements based on the creditors and borrowers at hand. In addition to the points discussed above, creditors will consider in their negotiations a number of other issues, such as refinancing, governing law, third-party beneficiaries’ impacts, waivers and amendments, and insolvency. 

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