July 21, 2023 - On Wednesday, July 19th, the LSTA hosted, as part of its Summer Series, a webinar, An Introduction to Intercreditor Agreements, presented by Brian Rock, Partner of Latham & Watkins. When there are two or more secured parties with a security interest in the collateral of the same borrower, the parties will enter into an intercreditor agreement that establishes the relative priorities in that collateral. Intercreditor agreements are complex instruments that govern the relationship between those parties and will primarily address relative priorities in that collateral, enforcement of that collateral, any issues that may arise in a bankruptcy proceeding, the releases of collateral, as well as other ancillary matters.
The secured party’s rights with respect to the collateral (other than real property) are governed by Article 9 of the Uniform Commercial Code which is uniform across all 50 states. The default rule which governs with respect to the collateral where there is more than one party is the first to file or perfect rule. In other words, the first secured party to file a financing statement will have priority over later filing secured parties. But that general rule has exceptions and the UCC also recognises that parties may alter that rule by contract. Thus, the intercreditor agreement can specifically override what would otherwise be established by Article 9 and reset the priorities according to the contract. All the principles of contract law will apply, however, and as such any party that is not party to the intercreditor agreement will not be impacted by the terms of that contract. Thus, even though you may be titled as first lien for the purposes of the loan documentation it may not establish your priority as to all possible secured parties. There may be a tax lien, a judgment lien, or even a secured party that is not a party to the intercreditor agreement and their priority will be established by Article 9.
In most cases intercreditor agreements effectuate lien subordination only and expressly provide that they do not create debt subordination. Lien subordination alters secured parties’ priorities with respect to collateral and collection with respect to that collateral. By contrast, debt subordination alters debtholders’ priorities with respect to payments or collection on the debt. A contract can govern both, of course, so parties drafting must be fully aware of the contours of their particular intercreditor arrangement and how they need to document them in the intercreditor agreement – will your intercreditor agreement govern only lien or only debt or both? The general rule stands, however, that intercreditor agreements effectuate lien subordination only.
Another high-level concept is to work out whether you have a shared lien structure or a multiple liens intercreditor structure. The LMA style intercreditor agreement is typically an example of the shared lien structure. Under this structure, even if you have a first and second lien structure there is only one lien in favor of a single party – a single collateral agent where there is one set of security documents in favor of that one agent. Both structures work well to secure multiple facilities, and there may be different reasons why a deal chooses one structure over the other. Again, it will be critical for the draftsperson to understand which one you have and ensure it properly flows through all the loan documentation.
The intercreditor agreement has adapted to developments in the US loan market in recent years. In the past, if you had a single series first lien and second lien it would be between one first lien collateral agent representing its own secured parties and a second collateral agent. Now, however, with the ability of a borrower to incur incremental debt that can be secured through a separate facility the intercreditor documentation has had to follow suit to allow for more than one credit facility at any given priority level. As such, most intercreditor arrangements in the US today are drafted as a multi series style intercreditor agreement. Unlike a “single series” which is a bilateral agreement between two series of secured parties (typically, their agents), the “multi series” contemplates any number of series of secured debt (theoretically this can be infinite). Multi series features include mechanics to add additional series of secured debt, typically via a joinder and/or debt designation. The intercreditor agreement will typically not cover whether the additional debt is permitted. That will be governed by the debt documents themselves, and, of course, any additional debt must be permitted under each existing debt document. However, the intercreditor agreement may include a debt cap because an intercreditor agreement puts you in direct privity with other secured parties, and thus you are not simply relying on covenants with the borrower.
There are different types of intercreditor agreements and structures which may be found. For example, you may have a single series intercreditor agreement between one senior credit facility and one junior credit facility (a first lien / second lien structure). Another example is the equal priority intercreditor agreement where one or more different series are secured on an equal priority basis referred to as the pari passu structure. The third type of intercreditor agreement drafted in US deals is the split collateral intercreditor. This is also referred to as the ABL intercreditor because it is common for those deals. There can be combinations of these in any capital structure to create the capital structure you want for the borrowing facility. Most are drafted in complicated ways to achieve different structures, but fortunately they do all “plug and play” together nicely.
The matters that an intercreditor agreement will cover are varied. First, of course, it will cover priority with respect to the collateral. As noted above, priorities established by the intercreditor agreement intentionally override the priorities that would apply under applicable law. Most commonly, such contractual priorities apply notwithstanding the date, time, method, manner or order of grant, attachment or perfection; any provision of the UCC or any other applicable law; any defect or deficiencies, or failure to perfect or lapse in perfection; or any avoidance as a fraudulent conveyance or otherwise. It will also address the waterfall and, therefore, provides for pro rata payment in full of each senior class before any value is applied to any junior class (subject to any debt caps). It will also address the control of remedies and typically provides for the control of remedies to senior class, either permanently or for a limited period referred to as the “standstill period” which is commonly 180 days but may range from 90-270 days. It should be noted that the expiration of the standstill does not override the waterfall. Importantly, gaining control of enforcement does not mean gaining waterfall priority. An enforcing junior lien still hands over all proceeds to pay off the senior class. Matters typically covered in the bankruptcy section of the intercreditor agreement are ability to provide for DIP Financing, adequate protection, ability to get post-petition interest, ability to control asset sales, voting, and release of collateral. Other ancillary matters that are typically covered include an agreement not to challenge liens, the purchase right, ie, junior class has the option to purchase senior obligations at par following negotiated trigger events (e.g., payment default, enforcement on collateral, bankruptcy), and the proceeds of insurance (the senior class controls insurance awards and settlements).
Members may recall that Brian Rock is our external counsel on the creation of the LSTA’s new Form of Intercreditor Agreement Project on which we are collaborating jointly with the American Bar Association. There is also a very helpful article, Intercreditor Agreements Between First and Second Lien Lenders: Overview, by Practical Law on the LSTA University webpage on this topic. Please let me know if you would like to join that project.
