Intercreditor Agreement: Importance, Provisions, and Issues

Introduction

In any working relationship financial agreements matter a lot as it outlines the expectation of both parties, and protect the dealer rights if the pre-decided expectations aren’t met.  Intercreditor agreement is one of the popular concessions in the field of finance. 

Definition

The intercreditor agreement is also known as an inter-creditor deal. In intercreditor contract process, the documentation is signed between two and more creditors. These real estate transactions include a combination of mezzanine capital and mortgage.

 The agreement involves details like the responsibility of each creditor, lien positions, liabilities of each creditor, dispute resolution, and impact on the other creditor, etc.

Mostly there are two creditors in an intercreditor contract:

  1. Senior Lender
  2. Junior or Subordinate Lender

A contract is signed among the creditors or class of creditors for financing companies that describe the respective obligations and rights regarding the borrower and its assets.  In some cases, there may be more than two senior creditors. On such occasions another agreement is settled among the lenders First lien/second lien, Split collateral, Senior/mezzanine, and Unitranche are the types of intercreditor agreements.

Practical Example of Intercreditor Agreement

A company ABC takes a mortgage from Bank X for a huge project. Later on company ABC again take a somewhat smaller loan from another Bank Y with the intention of further expanding the same project. In this scenario, Bank X is considered as senior creditor and Bank Y is the junior creditor.

What is the Importance of Intercreditor Agreement?

With the increased use of several layers of debits by a single company or group of companies, the significance of intercreditor agreement has grown. The intercreditor agreement is significant because it plays an integral role in the right to lien. The agreement on the terms of the  transaction, principal, interest, buyout right, bankruptcy provisions, and priorities of payment minimize the chances of any kind of dispute.

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It is pivotal for both parties to lay down a solid foundation with respect to their rights of borrowing financial capabilities.  It helps in understanding creditor how to handle the circumstance under which the contract can be ended.

Intercreditor Agreement – Provisions

Intercreditor contract comes up with the following provisions;

  1. Provision of which creditor has the authority to mention the defaults and collateral foreclose, and grant a dispensation.
  2. There is a restriction on junior creditors that they cannot take action against the recipient to impose its dues. This condition is known as the standstill provision.  
  3. Provision from buyout right that means the act of buying part in a company.    
  4. The limitation on payment to junior creditors.
  5. Revision or alternation to transaction document.
  6. Restrictions on taking reinforcement action.
  7. Authority of control enforcement strategy.
  8. The facility of making changes in security and loan agreement.
  9. Senior lenders have less risk in comparison to junior lenders.
  10. A turnover provision allows the junior lender to receive aggregate and then the amount is turned over to the senior lender to clear any outstanding debt.

Intercreditor Agreement – Issues

In every agreement, there might be a possibility that issues may occur due to a lack of understanding, dispute, or any sort of financial cheating. A complex financial transaction dispute leads to legal courts. There are also some common issues associated with intercreditor contract;

  • A junior creditor find it difficult to negotiate agreement terms with a senior creditor  
  • Poor understanding of the term by creditor leads to a quarrel between parties 
  • Intentional delay by the senior lender may also cause disputes
  • Issues might arise by junior creditors because mostly terms are finalized by senior lenders.
  • The agreement may lead to cancellation due to much negotiation
  • Setback in submitting the scheduled payments
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To overcome the issue in the agreement, a junior creditor must analyze the contract thoroughly before agreeing to it.  The junior creditor must efficiently negotiate the agreement process. In case of any disagreement, two options are needed to be considered.

First, to refinancing the borrowing party to make sure the project continues and the second option is to compensate the senior creditor with full but this alternative would not be implementable if the senior is designated a large amount of mortgage. Once the junior creditors have a checklist of major agreement issues, it would be easy for them to resolve it as early as possible.

Conclusion

Intercreditor Agreement sets forth several liens, rights, and liabilities for both junior and senior lenders. When financing companies and creditors establish priorities in payment it becomes convenient to fulfil the contract. The prior setting of financial agreement terms helps in minimizing the disputes

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