Intercreditor Agreements
Definition
Intercreditor agreements establish the relative rights, priorities, and remedies between different classes of lenders in the same capital structure—typically between first lien/senior secured lenders and second lien/mezzanine/subordinated lenders. Key provisions include: (1) Payment subordination defining when junior payments are blocked, (2) Lien priority establishing collateral recovery order, (3) Standstill periods (90-180 days) preventing junior enforcement after senior default, (4) Amendment restrictions limiting senior lenders' ability to prejudice junior position, and (5) Bankruptcy coordination specifying joint vs separate representation. These agreements are critical in leveraged buyouts where multiple debt tranches secure different risk-return profiles while sharing common borrower and collateral pool.
Why it matters
Intercreditor agreements determine actual recovery outcomes during defaults and restructurings—not just contractual lien priorities. During 2008-2009 defaults, second lien lenders recovered 30-50 cents on dollar despite 'secured' status because intercreditor standstill periods and payment subordination gave senior lenders time to control restructuring process. Senior lenders often forced out-of-court exchanges where second lien holders received equity worth 20-30% of par rather than cash recoveries. Understanding intercreditor mechanics explains why second lien debt trades at 60-70% of par during stress while senior secured trades at 90-95%—not just leverage difference but structural subordination enforced through intercreditor rights. For investors, these agreements aren't boilerplate—specific provisions around payment blockage triggers, permitted debt, and amendment baskets can mean 20-30 point difference in recovery values.
Common misconceptions
- •Second lien isn't just 'junior first lien'—it's structurally subordinated through intercreditor agreement even though both have liens on same collateral. Recovery rights fundamentally different.
- •Intercreditor agreements can't be easily amended once signed. Requires consent of majority or supermajority of both senior and junior lenders—creates gridlock during stress when interests diverge.
- •Payment subordination doesn't mean zero payments forever. Junior debt receives payments until senior default occurs—often years of cash flow before payment blockage triggers.
Technical details
Payment subordination mechanics
Payment blockage triggers: Junior debt payments automatically cease upon: (1) Payment default on senior debt (missed interest/principal), (2) Bankruptcy filing by borrower, (3) Acceleration of senior debt following event of default, (4) Senior debt outstanding exceeding permitted amounts. Example: Senior facility allows $50M second lien. If second lien grows to $60M (covenant breach), payment blockage triggers even without senior default.
Permitted payments: During normal operations (no senior defaults), junior lenders receive: scheduled interest payments, scheduled principal amortization, optional prepayments from excess cash flow (if permitted), and refinancing proceeds. Cannot receive: dividends on equity-like instruments, payments funded by asset sales without senior consent, or payments violating senior debt covenants.
Payment reinstatement: If senior default cured (waivers obtained, payments made, borrower exits bankruptcy), payment blockage terminates. Junior payments resume, typically including any accrued but unpaid amounts during blockage period. However, if blockage lasted 12+ months, junior lenders may agree to PIK accumulated interest rather than cash payment (preserving liquidity).
Turnover provisions: Any payments received by junior lenders during blockage period (even if received in error) must be immediately turned over to senior lenders. Creates strict liability—junior lenders can't claim ignorance of default. Monitoring obligations require junior lenders to track senior debt compliance continuously.
Lien priority and collateral sharing
First priority lien mechanics: Senior lenders have first-priority perfected security interest in all collateral (typically all assets of borrower). Junior lenders have second-priority security interest in same collateral. Both liens perfected through UCC filings—senior lender files first, junior lender files second noting subordination to senior. In foreclosure, senior lenders receive 100% of proceeds until repaid in full, then junior receives remainder.
Silent second liens: Some structures use 'silent second lien' where junior lender has contractual second lien but doesn't file UCC (avoiding public record of subordination). Relies on intercreditor agreement rather than public filing for priority. Benefit: cleaner cap table appearance. Risk: If junior lender doesn't file, third-party creditors could potentially achieve priority over unfiled junior lien.
Carve-outs and excepted liens: Certain liens can prime both senior and junior lenders: (1) Landlord liens for unpaid rent, (2) Mechanic's liens for unpaid contractors, (3) Tax liens for unpaid payroll/sales taxes, (4) Superpriority DIP financing in bankruptcy. Intercreditor agreements specify maximum permitted amounts of these priming liens (often aggregate cap of $10-25M).
Collateral release provisions: If borrower sells assets (with lender consent), both senior and junior lenders must release liens. Proceeds flow to senior lenders first, then junior per priority. If sale generates $20M, senior debt $60M, junior debt $40M → all $20M goes to senior lenders reducing their debt to $40M. Junior receives nothing but benefits from senior debt reduction (improving junior coverage ratio).
Standstill and enforcement restrictions
Standstill period duration: Upon senior default, junior lenders subject to standstill preventing enforcement actions for 90-180 days (180 days most common). During standstill, junior cannot: file bankruptcy petition, accelerate junior debt, foreclose on collateral, exercise control rights, or commence litigation. Senior lenders have exclusive enforcement rights.
Senior lender enforcement options: During standstill, senior lenders can: (1) Negotiate out-of-court restructuring, (2) File bankruptcy and seek DIP financing, (3) Commence foreclosure proceedings, (4) Sell debt position to distressed investors, or (5) Do nothing (betting on recovery). Junior lenders are sidelined during this period watching senior control process.
Post-standstill junior rights: After standstill expires (and if senior lenders haven't resolved default), junior lenders can enforce independently. However, intercreditor agreement ensures senior priority in any recovery—even if junior forces bankruptcy, proceeds go to senior first. Practical result: junior enforcement rarely beneficial since recovery goes to senior anyway. Better to negotiate participation in senior-led process.
Purchase option rights: Some intercreditor agreements give junior lenders right to purchase senior debt at par during standstill. Allows junior to take control by buying out senior position. Example: Senior debt trading at 90 cents, junior at 30 cents. Junior exercises purchase right, pays par ($100M on $100M senior debt), eliminates senior layer, junior becomes first lien. Expensive but provides control. Uncommon—typically only in structures where junior is large sophisticated fund.
Amendment rights and voting control
Permitted senior amendments: Senior lenders can amend their credit agreement without junior consent for: interest rate changes, fee adjustments, covenant levels (if changes don't increase junior subordination), and administrative provisions. Cannot amend: maturity dates extending beyond junior maturity, principal amounts, mandatory prepayment provisions prejudicing junior, or definitions affecting shared concepts.
Junior protective provisions: Material changes require junior consent: (1) Increasing senior debt beyond permitted amounts, (2) Adding new liens priming both senior and junior, (3) Changing payment waterfall priorities, (4) Modifying definitions of 'senior debt' or 'junior debt', (5) Amending intercreditor agreement itself. Typically requires majority or supermajority (66-75%) of junior lenders to approve.
Prohibited amendments: Intercreditor agreements strictly prohibit certain amendments without unanimous lender consent: (1) Releasing collateral (other than permitted asset sales), (2) Subordinating senior debt to new obligations, (3) Modifying payment blockage triggers, (4) Changing standstill periods, (5) Altering lien priority. These protections prevent senior-junior collusion or hold-out situations.
Affiliate voting restrictions: If senior and junior debt held by same fund family or affiliates, intercreditor may restrict voting rights. Example: Distressed fund owns 30% of senior and 40% of junior. Intercreditor prohibits 'cross-class' voting preventing single investor from controlling both classes and engineering advantageous amendments. Ensures arm's-length negotiations between classes.