Intercreditor Agreements

This is the sixth (and final) article in a series covering various aspects of intercreditor agreements.

Now that the holiday season is receding in the rear-view mirror, we in the finance industry have the privilege of taking a deep breath, looking back and taking stock. Of course, in the “normal” world, people generally don their “year-in-review” glasses during the month of December (especially the last week thereof). However, those working in finance do not have the luxury of engaging in such (non-billable/non-revenue-generating) qualitative examinations when deals need to be closed and goals need to be attained. Rather, we defer such our introspection for the first few weeks of the first quarter (once the lassitude of the fourth quarter rush has lifted).

This is by no means intended to be a comprehensive practice guide covering all things intercreditor. Each situation will be different, and the type of intercreditor agreement needed will depend on a variety of factual, legal and business considerations. However, I would like to think that I have gained some insights during the 15 years or so I have been practicing in the commercial finance arena, so I thought it would be helpful to cover a few practice-oriented thoughts, including some that do not appear to receive much consideration in literature or during CLE seminars.

Some Thoughts

First, intercreditor agreements are an unavoidable aspect of the broader finance landscape. Following the Great Financial Reset of 2007 and 2008, banks, commercial finance companies and other lenders have become extremely sensitive to the concept of concentration. That is, finance providers are wary of too much exposure to one obligor or one consolidated group of obligors. Similarly, finance providers are wary of excessive exposure to a particular asset class or a particular industry. The end result is that a greater number of finance providers will be doing business with a given company. Accordingly, the chances of having to deal with a prior perfected lender via an intercreditor agreement (or for a prior perfected lender having to deal with requests for intercreditor agreements) have increased as well.

Second, as a corollary to the preceding point, precedent is persuasive but not necessarily determinative. In some instances, an existing intercreditor agreement between Lender A and Lender B with respect to Borrower X will serve as a template for a subsequent intercreditor agreement among the same parties operating similar circumstances. For example, Lender A has a blanket lien on all assets by virtue of being the senior credit facility provider to Borrower X. Lender B wishes to finance specific assets for Borrower X, so Lender A and Lender B enter into an intercreditor agreement whereby Lender A agrees to subordinate any lien on and security interest in those specific assets to the lien and security interest of Lender B, and Lender A also agrees to standstill provisions with respect to those specific assets. Should Lender B wish to finance additional specific assets in the future, Lender B (and Borrower X) would expect Lender A to agree to a similar intercreditor agreement. However, should Lender B desire to enter into a qualitatively different transaction, such as a revolving line of credit secured by raw materials, inventory and accounts, Lender B (and Borrower X) should not be surprised when Lender A requires a qualitatively different intercreditor agreement. Remember, just like a law school hypothetical, changes in facts will likely result in changes in results.

Third, also related somewhat to the reality of practicing in the post-Great Financial Reset era, intercreditor agreements can take time and can cost money. In this instance, I am not even speaking of the time and expense related to negotiating the intercreditor agreement itself. Rather, I am referring to the fact that senior lenders, especially in syndicated loan facilities, do not seem to do many things quickly or for free. While there is little the party seeking an intercreditor agreement can do to eliminate the time or expense associated with a borrower obtaining a waiver, consent or approval from a senior lender, there are a few things which can be done to manage the process. For example, the parties should identify and finalize the collateral list as quickly as possible, as a senior lender is often reluctant to agree to vague, generic or incomplete descriptions (or a senior lender may require a second consent/waiver/approval, together with the requisite fee). Similarly, lien searches should be run as soon as possible in a transaction. The sooner a borrower is able to approach a senior lender about the need for an intercreditor agreement (or UCC amendment or other accommodation), the sooner the senior lender will be able to tell the borrower what will be required in exchange for the same.

Fourth, when in doubt, get something into the record. As between the parties to the intercreditor agreement, the terms and conditions of the intercreditor agreement will be binding. However, to third parties, not only is the intercreditor agreement not binding (or at least such was the thinking prior to the case of Southern Fidelity Managing Agency, LLC v. Citizens Bank & Trust Co., 2014 WL 129336 (D. Kan. 2014), as discussed in a prior issue), but third parties also do not have notice of an intercreditor agreement or the effect of such intercreditor agreement on certain collateral. While the typical intercreditor agreement charges each party with the duty to notify any successor or assign of such party of the intercreditor agreement and its effect on certain collateral, a promise is only as good as the party making (and charged with keeping) the promise. As an alternative, and to eliminate any uncertainty, the parties to an intercreditor agreement may agree to make filings in the applicable records evidencing the additional interest in the affected collateral. For example, a UCC financing statement in favor of Lender A could be amended to indicate that Lender B has a senior interest in certain collateral described in the amendment (or to add Lender B as a secured party with respect to such collateral). Similarly, subordination agreements can be filed in other filing offices such as the Surface Transportation Board or the National Vessel Documentation Center. By making a filing in the applicable public records systems, a new lender can mitigate the risk of an existing lender failing to perform its notice obligations in the intercreditor agreement.

Fifth, beware the pitfalls of bankruptcy. As discussed in prior articles, the result that would otherwise be expected outside of a bankruptcy proceeding may be vastly different when reached within a bankruptcy proceeding. Similarly, the bankruptcy landscape is constantly in flux (remember that bankruptcy courts sit in equity), so results will vary depending on the United States Bankruptcy Court (or the United States District Court or the United States Court of Appeals) having jurisdiction over the case. Also, results may vary in the same court over time. Accordingly, you will need to review the provisions of your “form” intercreditor agreements ' especially the bankruptcy-related provisions ' regularly with colleagues specializing in UCC and bankruptcy matters.

Finally (and I am sure I will be pursued with pitchforks and torches for saying this), do not be afraid to say “no” to an intercreditor agreement that does not make business or legal sense. If the counterparty to an intercreditor agreement is asking for accommodations or concessions which are truly beyond the pale, a lender may be better served by passing on the transaction altogether. For example, a working capital lender frequently requires an access agreement from a real estate and equipment lender as the working capital lender needs assurance that it will have access to the means necessary to convert raw materials into inventory and inventory into proceeds (namely, cash).

However, if the working capital demands an abnormally long access period, refuses to pay rent for its access period, refuses to provide evidence of liability and property insurance prior to entering and using the facility and refuses to allow the real estate and equipment lender to show the facility to prospective purchasers, the real estate and equipment lender may determine that the risks associated with such an arrangement far outweigh the rewards of providing the financing. Sometimes the best deals are the ones a lender declines to do.

Conclusion

As stated previously, intercreditor agreements can be both an important and a frustrating aspect of a commercial finance transaction. However, with a little bit of practice, a little bit of situational awareness, a little bit of planning and a little bit of patience, attorneys should be able to integrate intercreditor agreements into their practice.

Sean M. Gillen is a partner in the Omaha, NE, office of Kutak Rock LLP. Gillen is a member of the firm's Corporate Department, representing borrowers, lessees, lenders, lessors and credit enhancers in asset acquisitions, dispositions and financings, including loan and lease financings, syndications, securitizations, restructurings, workouts and bankruptcies. He can be reached at [email protected].

This is the sixth (and final) article in a series covering various aspects of intercreditor agreements.

Now that the holiday season is receding in the rear-view mirror, we in the finance industry have the privilege of taking a deep breath, looking back and taking stock. Of course, in the “normal” world, people generally don their “year-in-review” glasses during the month of December (especially the last week thereof). However, those working in finance do not have the luxury of engaging in such (non-billable/non-revenue-generating) qualitative examinations when deals need to be closed and goals need to be attained. Rather, we defer such our introspection for the first few weeks of the first quarter (once the lassitude of the fourth quarter rush has lifted).

This is by no means intended to be a comprehensive practice guide covering all things intercreditor. Each situation will be different, and the type of intercreditor agreement needed will depend on a variety of factual, legal and business considerations. However, I would like to think that I have gained some insights during the 15 years or so I have been practicing in the commercial finance arena, so I thought it would be helpful to cover a few practice-oriented thoughts, including some that do not appear to receive much consideration in literature or during CLE seminars.

Some Thoughts

First, intercreditor agreements are an unavoidable aspect of the broader finance landscape. Following the Great Financial Reset of 2007 and 2008, banks, commercial finance companies and other lenders have become extremely sensitive to the concept of concentration. That is, finance providers are wary of too much exposure to one obligor or one consolidated group of obligors. Similarly, finance providers are wary of excessive exposure to a particular asset class or a particular industry. The end result is that a greater number of finance providers will be doing business with a given company. Accordingly, the chances of having to deal with a prior perfected lender via an intercreditor agreement (or for a prior perfected lender having to deal with requests for intercreditor agreements) have increased as well.

Second, as a corollary to the preceding point, precedent is persuasive but not necessarily determinative. In some instances, an existing intercreditor agreement between Lender A and Lender B with respect to Borrower X will serve as a template for a subsequent intercreditor agreement among the same parties operating similar circumstances. For example, Lender A has a blanket lien on all assets by virtue of being the senior credit facility provider to Borrower X. Lender B wishes to finance specific assets for Borrower X, so Lender A and Lender B enter into an intercreditor agreement whereby Lender A agrees to subordinate any lien on and security interest in those specific assets to the lien and security interest of Lender B, and Lender A also agrees to standstill provisions with respect to those specific assets. Should Lender B wish to finance additional specific assets in the future, Lender B (and Borrower X) would expect Lender A to agree to a similar intercreditor agreement. However, should Lender B desire to enter into a qualitatively different transaction, such as a revolving line of credit secured by raw materials, inventory and accounts, Lender B (and Borrower X) should not be surprised when Lender A requires a qualitatively different intercreditor agreement. Remember, just like a law school hypothetical, changes in facts will likely result in changes in results.

Third, also related somewhat to the reality of practicing in the post-Great Financial Reset era, intercreditor agreements can take time and can cost money. In this instance, I am not even speaking of the time and expense related to negotiating the intercreditor agreement itself. Rather, I am referring to the fact that senior lenders, especially in syndicated loan facilities, do not seem to do many things quickly or for free. While there is little the party seeking an intercreditor agreement can do to eliminate the time or expense associated with a borrower obtaining a waiver, consent or approval from a senior lender, there are a few things which can be done to manage the process. For example, the parties should identify and finalize the collateral list as quickly as possible, as a senior lender is often reluctant to agree to vague, generic or incomplete descriptions (or a senior lender may require a second consent/waiver/approval, together with the requisite fee). Similarly, lien searches should be run as soon as possible in a transaction. The sooner a borrower is able to approach a senior lender about the need for an intercreditor agreement (or UCC amendment or other accommodation), the sooner the senior lender will be able to tell the borrower what will be required in exchange for the same.

Fourth, when in doubt, get something into the record. As between the parties to the intercreditor agreement, the terms and conditions of the intercreditor agreement will be binding. However, to third parties, not only is the intercreditor agreement not binding (or at least such was the thinking prior to the case of Southern Fidelity Managing Agency, LLC v. Citizens Bank & Trust Co., 2014 WL 129336 (D. Kan. 2014), as discussed in a prior issue), but third parties also do not have notice of an intercreditor agreement or the effect of such intercreditor agreement on certain collateral. While the typical intercreditor agreement charges each party with the duty to notify any successor or assign of such party of the intercreditor agreement and its effect on certain collateral, a promise is only as good as the party making (and charged with keeping) the promise. As an alternative, and to eliminate any uncertainty, the parties to an intercreditor agreement may agree to make filings in the applicable records evidencing the additional interest in the affected collateral. For example, a UCC financing statement in favor of Lender A could be amended to indicate that Lender B has a senior interest in certain collateral described in the amendment (or to add Lender B as a secured party with respect to such collateral). Similarly, subordination agreements can be filed in other filing offices such as the Surface Transportation Board or the National Vessel Documentation Center. By making a filing in the applicable public records systems, a new lender can mitigate the risk of an existing lender failing to perform its notice obligations in the intercreditor agreement.

Fifth, beware the pitfalls of bankruptcy. As discussed in prior articles, the result that would otherwise be expected outside of a bankruptcy proceeding may be vastly different when reached within a bankruptcy proceeding. Similarly, the bankruptcy landscape is constantly in flux (remember that bankruptcy courts sit in equity), so results will vary depending on the United States Bankruptcy Court (or the United States District Court or the United States Court of Appeals) having jurisdiction over the case. Also, results may vary in the same court over time. Accordingly, you will need to review the provisions of your “form” intercreditor agreements ' especially the bankruptcy-related provisions ' regularly with colleagues specializing in UCC and bankruptcy matters.

Finally (and I am sure I will be pursued with pitchforks and torches for saying this), do not be afraid to say “no” to an intercreditor agreement that does not make business or legal sense. If the counterparty to an intercreditor agreement is asking for accommodations or concessions which are truly beyond the pale, a lender may be better served by passing on the transaction altogether. For example, a working capital lender frequently requires an access agreement from a real estate and equipment lender as the working capital lender needs assurance that it will have access to the means necessary to convert raw materials into inventory and inventory into proceeds (namely, cash).

However, if the working capital demands an abnormally long access period, refuses to pay rent for its access period, refuses to provide evidence of liability and property insurance prior to entering and using the facility and refuses to allow the real estate and equipment lender to show the facility to prospective purchasers, the real estate and equipment lender may determine that the risks associated with such an arrangement far outweigh the rewards of providing the financing. Sometimes the best deals are the ones a lender declines to do.

Conclusion

As stated previously, intercreditor agreements can be both an important and a frustrating aspect of a commercial finance transaction. However, with a little bit of practice, a little bit of situational awareness, a little bit of planning and a little bit of patience, attorneys should be able to integrate intercreditor agreements into their practice.

Sean M. Gillen is a partner in the Omaha, NE, office of Kutak Rock LLP. Gillen is a member of the firm's Corporate Department, representing borrowers, lessees, lenders, lessors and credit enhancers in asset acquisitions, dispositions and financings, including loan and lease financings, syndications, securitizations, restructurings, workouts and bankruptcies. He can be reached at [email protected].