An Intercreditor Agreement (or inter-creditor deed) is a contract between two or more creditors. Such an agreement comes into effect when the borrower has two (or more) lenders. The lenders sign a contract among themselves stipulating all the needed points. The contract includes details like dispute resolution, various lien positions, responsibilities of the creditors, liabilities of each creditor, impact on the other creditors, etc.
Usually, there are two creditors in an inter-creditor agreement – one senior and the other subordinate or junior lender. For example, Company A takes a loan from Bank A for a big project. Later, Company A also takes a relatively smaller loan from Bank B for further expansion of the same project. In this case, Bank A is the senior lender, and Bank B is the junior lender.
In some cases, however, there are more than two lenders. Or even more than two senior lenders as well. In such a case, the senior lenders sign a separate agreement defining the authorities of each.
Lenders have to establish the right to the loan and the security in case of the borrower has more than one lender for the same loan and security. In the majority of the cases, the lenders are ok with an acknowledgment that each of them is entitled to a specific claim on the assets of the borrower.
But, in the case where there is a senior/junior lender thing, the lenders enter into an inter-creditor agreement. Such an agreement helps them define their respective rights.
Importance: Intercreditor Agreement
Such an agreement plays a vital role in the right to lien. Thus, the agreement is important to all the lenders as it lays the foundation for the rights and priorities in case the borrower is unable to pay properly or defaults.
If one doesn’t enter into such an agreement, each lender will proceed in its own way. Such a process could prove uneconomical and, at the same time, turn into a legal mess.
Intercreditor Agreement – What does it Include?
Usually, such an agreement limits the payment that a borrower can make to the junior lenders if the borrower defaults based on terms specified under the agreement with the junior lenders. Such provisions are called “payment blockage.” This provision even limits the payments that the junior lenders are entitled to in the normal course of their working from the borrower, like interest or the usual fees and expenses.
Such an agreement also includes a provision for the buy-out rights. This right allows a lender to buy the other lenders’ claims and liens. Such an option triggers after specified events, like filing a bankruptcy case.
Another provision in the inter-creditor agreement could be Standstill. Under this, the junior lender is restricted from taking any action against the borrower to enforce its debt. Usually, the restriction to take any action (demanding the payment, taking legal action, etc.) is for a specific period. Also, the standstill period continues until the commencement of the enforcement proceedings from the senior lender. Sometimes, the period stretches up to the full repayment of the senior debt.
The agreement could also include restrictions on the repayment. A junior lender could agree that it would not ask for any repayment until the senior debt is repaid in full, except for the interest or any other payment as agreed upon.
In certain cases, the borrower is also a party to the agreement. The borrower acknowledges the terms of the agreement, like not to make any payment to the junior lender until the borrower pays the debt in full to the senior lender.
Usually, a senior lender dictates the term of the agreement. So, if the junior lender fails to negotiate properly, it may be at a disadvantage.
Further, it may also happen that the senior lender intentionally delays the approval of the agreement, which may be fair to the junior lender. This could prove frustrating for the junior lender.
Before signing the agreement, the junior lender must also clarify the definition of the ‘senior debt’ and ‘junior debt.’ Also, it is common for a senior lender to edit the terms of the agreement without getting approval from the junior lender. So, the junior lender must keep an eye on this as well.
To overcome such issues, it is important that the junior lender evaluates the deed thoroughly before agreeing to it. Also, the junior lender must negotiate the agreement equitably. If the efforts didn’t pay off, then the junior lender may not consent to the agreement and seek other options.
The junior lender must try to put a clause of it taking over the project in case of the default. To make the maximum of it, it will have two options. First, to re-finance the borrower to ensure the project continues, and second, to repay the senior lender in full. The second option could prove impossible if the senior lender has given a big amount of loan.