Introduction to Intercreditor Agreement
Intercreditor Agreement is a legal document that is accepted and signed between two or more creditors when they lend money to the same borrower. This document will state the interests and rights of the creditors. It also states who will be the first lender (Senior) and Subsequent lender (Junior).
Purpose of Intercreditor Agreement
An intercreditor agreement is a deed that regulates the interests and rights of the lenders when more than one lender funds for the same borrower. The deed will clearly state the rights to receive payments (Principal, interest, etc.) and the rights to impose security cover over the lender’s assets. In addition, it clearly mentions the ranking of the lenders and who will be first paid. Suppose there is a situation of more than one senior lender (i.e.) borrower with the same ranking. In that case, there could be one more agreement known as “deed of priority” between multiple senior lenders to define their priority and rights.
Example of Intercreditor Agreement
ABC Corporation needs money for the expansion of business. Therefore, it has planned to take a bank loan for the same. It has approached Zen Bank for the major part of the financial requirement, which can directly fund the project, and it planned to take a small working capital loan from XYZ Bank. So, Zen Bank and XYZ Bank planned to enter into an Intercreditor Agreement to decide on the rights and priorities. In the given case, since Zen Bank has funded a major part for the project, it will be the senior lender, it will have more rights and stay higher in rank, whereas XYZ bank, which has funded for the working capital requirement, will be the subordinate or junior lender.
Need for Intercreditor Agreement
Creditors always want to secure the money lent by them; when multiple creditors have lent money to the same borrower, it becomes challenging to claim over the assets if the borrower defaults to make a payment or becomes bankrupt. In order to overcome this challenge and confusion, the creditors enter into an Intercreditor Agreement.
Intercreditor Agreement is much needed to decide the priorities and rights among them. It states the senior lender and junior lender basis the money lent and security. The senior lender has the edge over the agreement and can limit the payments to junior lenders. The senior lenders can restrict the rights of the junior lender to act against the borrower to enforce its debt. The agreement also includes the buy-out rights where one lender can buy the other lender’s claims and rights. Usually, the buyout is used in case of bankruptcy of the borrower.
Issues of Intercreditor Agreement
In Intercreditor Agreement, the junior lender has to be very careful in finalizing the agreement as the senior lender always has superiority in the agreement, and improper understanding of the terms can be a disadvantage to the junior lender. In addition, senior leaders can intentionally delay the payment to the junior lender, and it can lead to disputes between them.
The Junior lender must have complete clarity about the agreement, and the senior lender can change the terms of the agreement without the permission of the junior lender. So junior lenders should always stay alert to avoid issues in the future that may lead to their own disadvantage. A junior lender should not agree to the terms unless evaluating the agreement completely and also can negotiate with the senior lender to get better terms. If the agreement is not favorable junior lenders can look out for other options like refinancing the borrower or by completely paying out the senior lender. If the sum lent by the senior lender is huge, it may be tough for the junior lender to repay them in complete.
Challenges of Intercreditor Agreement
In the Intercreditor agreement, there is always a senior lender who enjoys more priorities and rights. So often, it can so happen that the senior lender dictates the terms and puts the junior lender at a disadvantage. A senior creditor can restrict the repayment to the junior lender by the standstill option in the agreement and make sure the senior lender can get paid first. The junior lender has to negotiate the terms clearly and strongly to hold their position and rights. Considering the strong position of the senior lender, they may unnecessarily delay the process of finalization of the agreement and terms. So junior lenders need to be more cautious and place in their strong hold while entering into Intercreditor Agreement.
The Intercreditor Agreement is very important as it clearly states the position and rights of the creditors. It also states the priorities which are very much needed to incase the borrower goes bankrupt or defaults on the payments. In the absence of an Intercreditor Agreement, there won’t be a clear alignment between the creditors, and they may act on their own will, and it may lead to disagreement and confusion between the parties. So, to have a fair process, it’s better to have an agreement between creditors; else it may lead to legal issues.
The junior lender should be aware of all critical terms before agreeing to the terms. The following aspects can be evaluated once before entering into the agreement.
- Check for the payment clause and also if the senior lender has imposed any limitations/blockage of payment to the junior lender.
- Amendment of terms and conditions without the consent and approval of junior lenders.
- Considering the amount lent, the senior lender enjoys more rights and priorities, so the junior lender should make sure that the agreement is fair and just to all parties.
- A junior lender can check for any collateral option specifically available for the loan/ principal lent to protect their interest and also clearly state in the agreement that the standstill option is not applicable for the same.
Intercreditor agreement is much needed when there are multiple lenders to the same borrower. It helps in a smooth flow of transactions and can avoid confusion between creditors as their rights and priorities are clearly stated in the agreement. Many times, it helps in avoiding misunderstandings and legal issues between the parties. As the senior lender controls, this arrangement the junior lender should evaluate the agreement on all aspects and accept it.
This is a guide to Intercreditor Agreement. Here we also discuss the definition, purpose, example, needs, issues, and challenges of the Intercreditor Agreement along with importance. You may also have a look at the following articles to learn more –