What is an intercreditor agreement?

Why two lenders need a contract with each other

A company with one lender has one set of loan documents. Add a second lender, and each loan agreement on its own would let its lender demand payment, accelerate and seize collateral after a default. Two lenders doing that at once would destroy the value both are trying to recover. The intercreditor agreement sets the order in advance: which lender comes first, what the other gives up, and for how long.

The senior lender usually drafts it, because it is lending more at a lower price and will not do so without knowing the junior lender cannot get in its way. The junior lender negotiates for limits on that control: a cap on how much senior debt can rank ahead of it, a defined end to any standstill, and consent over changes that make its position worse. The borrower typically signs only an acknowledgment. That means the company is bound by how the agreement works but, in most cases, has no rights under it and cannot enforce it.

The credit agreement tells you what each lender can do to the company. The intercreditor agreement tells you what each lender can do when the other one objects.

The provisions, and what each one means in a bad year

Most of these terms never touch the company in a good year. Junior interest is paid on schedule, nobody sends a notice, and the agreement sits in a closing binder. The exceptions are the senior debt cap and the amendment consents, which can get in the way of a healthy company that wants to borrow more or reset a covenant. The rest start to matter the first quarter a covenant is missed, which is exactly when the company has the least room to renegotiate them.

Lien priority is not the same as payment subordination

Owners often hear "subordinated" and assume it means one thing. There are two kinds, and the difference decides how much the junior lender can do.

• Lien subordination ranks the two lenders' claims on the collateral. A second-lien lender agrees that the first-lien lender is paid first from the proceeds of the collateral. It does not, on its own, stop the second-lien lender from receiving scheduled interest and principal from the company's ordinary cash flow.
• Payment subordination ranks the right to be paid at all. A mezzanine lender or a seller holding a subordinated note agrees that the senior debt is paid first from every source, and that its own payments are allowed only on the conditions the agreement sets. It is the deeper form of subordination, and it is why mezzanine and seller notes are priced and negotiated differently from a second lien.

A first-lien and second-lien structure usually uses a lien-only intercreditor agreement. Mezzanine and seller notes usually sit under a subordination agreement that does both. In a unitranche, the lenders inside the one facility sign an agreement among lenders that splits the loan into first-out and last-out pieces; the company often never sees it, but it works the same way. And where an asset-based line and a term loan each take first priority on different assets, a split-lien agreement divides the collateral between them.

Payment blockage: when the junior lender stops being paid

Blockage is the provision a company feels first. The usual pattern has two triggers.

• A senior payment default blocks every payment to the junior lender until the default is cured or waived. There is no time limit.
• Any other senior default, such as a missed coverage or leverage covenant, lets the senior lender send a blockage notice. Payments to the junior lender then stop for a set period, and the agreement limits how many notices the senior lender can send in a year and bars a second notice for the same default.

When a blockage period ends without the senior lender accelerating, the company can usually pay the junior lender what was missed. Interest that could not be paid in cash normally keeps accruing, and on mezzanine it may compound as PIK interest. So a blockage does not reduce what the company owes; it moves the junior lender's cash to the back of the line while the senior lender decides what to do.

Seller notes are often blocked more broadly: no principal at all while senior debt is outstanding unless the company passes a covenant test on a pro forma basis, and no payment of any kind during any senior default. Seller note terms in conventional deals covers how those conditions are negotiated.

Standstill and turnover: the queue for enforcement

Once a default happens, the junior lender would normally have the right to accelerate its loan and pursue the company. The standstill takes that right away for a period set in the agreement. During it the junior lender cannot sue, foreclose on collateral or push the company into bankruptcy. If the senior lender starts enforcing during the standstill, the junior lender usually stays stopped for as long as the senior lender is diligently pursuing its remedies.

Standstills end when the period expires, when the senior loan is repaid, or when the company files for bankruptcy, at which point the agreement's bankruptcy terms take over. A long standstill protects the senior lender's control of the workout. A short one gives the junior lender real leverage in any negotiation, because it can threaten to act on its own once the clock runs out.

Turnover backs up the whole structure. If the junior lender receives a payment it was not entitled to, or proceeds of collateral that belonged to the senior lender first, it holds that money in trust and must hand it over. The junior lender therefore gains nothing by trying to be paid first, which is what makes the senior lender comfortable lending alongside it.

Consents, caps and the right to buy out the senior loan

The terms that most often affect a healthy company are the ones about change.

• Changes to the senior loan. The senior lender can usually amend its own loan freely, except for listed changes the junior lender must approve: raising the rate beyond an agreed margin, shortening the maturity, adding scheduled principal or increasing the balance above the cap.
• Changes to the junior loan. The junior lender usually cannot raise its rate, bring forward its maturity, add amortization or take new collateral without the senior lender's consent.
• The senior debt cap. The junior lender limits the senior debt that ranks ahead of it, typically at the closing amount plus a cushion. Senior debt above the cap still exists, but loses its priority over the junior lender. A company planning a larger line or an add-on acquisition should check whether the cap leaves room.
• The purchase option. After a senior default or acceleration, the junior lender can often buy the senior loan at its balance plus accrued interest. The company can then find itself working out a problem with a lender it chose as a minority partner in the structure.

Here is how these combine. The company misses a senior coverage covenant, and the senior lender will waive it in exchange for a higher rate. If that increase exceeds what the intercreditor agreement allows without junior consent, the junior lender now has a veto over the fix and will want something for its signature: a fee, a higher rate of its own or a paydown. A fix that took one negotiation now takes two, and the options after a covenant breach narrow.

Bankruptcy: what the junior lender gives up in advance

Intercreditor agreements also settle, before anyone is in trouble, how the lenders will behave if the company files. The junior lender typically agrees not to challenge the senior lender's liens, not to oppose financing the senior lender provides during the case within agreed limits, and not to object to a sale of the collateral the senior lender supports. Its lien is released automatically when the senior lender releases its own on a permitted sale.

For an owner, the practical point is that a restructuring will usually be steered by the senior lender. The junior lender traded those rights away at closing for its higher return.

What a borrower should check before signing

The borrower is not a full party, but its leverage is real before closing: both lenders want the deal and neither wants to be the reason it fails. Read the draft alongside both loan agreements, not only the term sheet or commitment letter, and check:

• How long a blockage lasts, how many notices the senior lender can send in a year, and whether missed junior payments can be made up when it ends.
• Whether the senior debt cap leaves room for the line increase, equipment financing or acquisition the business plan assumes.
• Which ordinary amendments, such as a covenant reset, need the junior lender's consent.
• Whether the junior lender's covenants are set with enough cushion below the senior lender's that a small miss does not trigger both at once.
• Whether the agreement allows the company to refinance either loan without the other lender's consent, and on what terms.

Transparent's lender package models the whole stack — senior and junior payments, blockage scenarios and covenant headroom on each loan — so the terms are negotiated against the company's real numbers rather than a template. Of the 1,800+ lenders in the book, 1,148 write term and private credit.