A Senior Secured Lender's Guide to the Risks Posed By Junior Secured Debt

In theory, a borrower's issuance of junior secured debt is a boon for its senior secured lender. The borrower obtains additional capital, and the claims of the junior lender against shared collateral, since “subordinated,” don't diminish the senior lender's prospects for repayment. In practice, however, a senior secured lender should view proposed junior secured financing skeptically because the existence of such debt can become highly problematic for the senior lender. The key to protecting the senior lender lies in properly negotiating and documenting the intercreditor agreement with the junior lender to eliminate, or at least minimize, the myriad ways in which the junior lender's rights may, in practice, limit ' or even trump ' those of the senior lender.

This article describes the key elements of an intercreditor agreement that should be carefully negotiated by the business principals structuring the deal. In addition, the article outlines a senior secured lender's options for protecting its interests in transactions involving junior secured debt. Many of these elements might appear to be arcane or rarely relevant. However, when financial distress strikes the borrower, these devilish “details” in the intercreditor agreement can make all the difference in the senior lender's ultimate recoveries.