Lending is the fuel that powers the real estate industry. Therefore, anything that threatens lenders’ interests can have a negative impact on commercial and residential real estate. An intercreditor agreement (IA) is a tool lenders use to safeguard their rights and help keep loans flowing. In this article, we’ll discuss “What is an intercreditor agreement?” and examine various legal aspects of intercreditor deeds. Then, we’ll link to a sample intercreditor agreement and examine the ABA model intercreditor agreement. Finally, we’ll weigh whether an IA is right for you and answer some frequently asked questions.
What Is an Intercreditor Agreement?
One job of an intercreditor agreement is to protect the interests of senior lenders in case of default. That is, it ensures that senior lenders receive repayment with interest ahead of junior creditors after liquidation. Commonly, lenders use IAs when the borrower adds mezzanine debt to the capital stack for a property. The IA also protects junior lenders by pledging ownership of the borrower’s holding company should default occur.
Mezzanine financing is a form of secondary, or subordinate, debt. Developers turn to mezzanine financing to reduce the amount of their equity tied up in a project. Indeed, with a mezzanine loan, a developer can increase their leverage while freeing cash for other uses. Typically, mezzanine financing is available as a subordinate loan or as preferred stock. Specifically, there are two main types of mezzanine debt subordination:
- Payment Subordination: The mezzanine lender holds shares in the property-owning entity. The shares serve as collateral for the mezzanine loan. Typically, the property-owning entity is a holdings LLC that owns the project LLC, which in turn owns the property.
- Lien Subordination: Rarely, mezzanine lenders are able to place a second lien on the project property. This gives the mezzanine lender the right to use the property as collateral. In addition, a second lien gives the mezzanine lenders a right to collect liquidation proceeds after senior lenders.
Mezzanine Loan Key Documents
You’ll find most of the following documents associated with an intercreditor agreement for a mezzanine loan.
- Loan Agreement: Typically, the senior lender first negotiates the property mortgage. After that, the mezzanine lender will draft a mezzanine loan agreement. Typically, the mezzanine loan agreement will differentiate the property owner from the mezzanine loan borrower — the holding company. Also, the mezzanine loan agreement may contain covenants causing the mortgage lender to comply with the mortgage loan agreement. Additionally, It may allow the mezzanine lender to protect the mezzanine borrower should a mortgage default occur. Importantly, look for cross-default language in the mezzanine loan agreement.
- Pledge Agreement: The pledge agreement demonstrates the mezzanine lender’s equity interests in the property owner (the holding company). Additionally, the mezzanine lender will perfect and certificate its equity interests in the collateral entity. The process is “opting in” under UCC Article 8.
- Recourse Guaranty: The recourse guaranty consists of carve-outs that address risks relating to the collateral entity (the holding company). Basically, it protects the mezzanine lender’s interests from actions that the mortgage lender might take.
- Assignment of Management Agreement: This is an estoppel and recognition agreement that benefits a foreclosing lender. Specifically, the agreement gives the mezzanine lender the same foreclosure rights as those of the mortgage lender.
- Recognition Agreement: This is a subordination, non-disturbance and attornment agreement (SNDA) for a mezzanine loan.
- Non-Consolidation Opinion: This is a legal opinion stating that the mezzanine borrower will not consolidate assets into the bankruptcy estate of affiliated entities. Specifically, the opinion applies to affiliates who own more than 49% of the borrower.
- Title Insurance Policy: This is the basic UCC title insurance policy, which the mezzanine lender should obtain.
Legal Aspects of Intercreditor Deeds
Intercreditor agreements (AKA intercreditor deeds) can become quite complex. In this section, we’ll delve into some legal aspects of intercreditor deeds.
IA Bankruptcy Protection
Naturally, senior lenders prefer payment subordination, as lien subordination interferes with their repayments after default. In payment subordination, the mezzanine lender assumes ownership of the borrower’s ownership entity. Normally, the mezzanine lender then continues to pay the senior lender(s). However, a mezzanine lender might try to declare the borrower bankrupt and halt further payments. Clearly, this could threaten and/or delay senior lender repayment. Therefore, senior lenders often insist that IAs bar junior lenders from assuming borrower control and declaring bankruptcy.
An intercreditor agreement can also protect the mezzanine lender in case the borrower defaults on its loans. To that end, mezzanine lenders often push for protection against early foreclosure by the senior lender. Therefore, the mezzanine lender will preserve its right to foreclose on the property after taking control of the borrowing entity.
These are provisions that block junior creditors from seeking payments from senior creditors. Obviously, this favors the senior lender. However, junior lenders often try to put limits on IA blockage provisions. Indeed, these limits include blockages per year, number of blocked days each year, and other carveouts.
Sample Intercreditor Agreements
USEC Intercreditor Agreement
The U.S. Securities and Exchange Commission publishes a sample intercreditor agreement.
ABA Model Intercreditor Agreement
The American Bar Association also publishes a sample ABA intercreditor agreement.
Is an Intercreditor Deed Right for Me?
An intercreditor deed makes sense when two or more facilities lend money to a borrower. It is in everyone’s interests to clarify the relationship between lenders should the borrower default. Assets America® can arrange commercial financing in which intercreditor deeds are involved. We can arrange financing starting at a bare minimum of $5 million for borrowers seeking senior and/or junior loans. However, we prefer loans starting at $20 million and larger.
Frequently Asked Questions – Intercreditor Agreements
What is an intercreditor and subordination agreement?
The agreement preserves certain rights of senior and subordinate lenders who provide financing on the exact same project. On the one hand, it assures the senior lender that it will receive repayment first if the borrower defaults. On the other hand, it guarantees the junior lender’s collateral, which is the holding company of the borrower.
How should I read an intercreditor agreement?
An IA is part of a package of legal documents that mezzanine lenders typically use for multiparty financing. These are complex and highly situational agreements that lawyers carefully draft. You should rely on competent legal counsel to write and understand IAs on your behalf.
What is a pari passu intercreditor agreement?
Pari passu is Latin for “equal footing.” In a pari passu intercreditor agreement, each creditor receives a pro rata share of liquidation assets from a bankrupt borrower. Note how this differs from the standard subordination language of an IA.
When should I use an intercreditor agreement?
Use an IA when you are one of multiple lenders to a real estate project. For example, you want an IA if you are a senior lender looking to subordinate other lenders default repayments. Alternatively, a junior lender wants an IA to confirm its claims to collateral should the borrower default.