What is an Intercreditor Agreement?
In commercial real estate, an intercreditor agreement is an agreement between two lenders that stipulates the rights and responsibilities of each party. Intercreditor agreements are most commonly used when mezzanine debt is layered on top of a senior commercial real estate loan. Typically, the agreement creates a variety of safeguards that protect that senior lender’s interest in the property should the borrower default on their loan.
In many cases, an intercreditor agreement ensures that the senior lender will fully recoup their losses, plus interest, before the junior lender can begin to get their share of proceeds from the sale of a property. However, this is determined by the exact nature of the subordination agreement between the two parties.
Lien Subordination vs. Payment Subordination
Junior/mezzanine debt comes in two main varieties, at least when it comes to subordination. In most cases, mezzanine lenders hold shares in the entity that owns the property as collateral for their loan. In rarer cases, a junior/mezzanine lender will actually have a second lien on the property; however, most senior lenders do not allow this, as it could interfere with their ability be repaid in the case of loan default. If a junior/mezzanine lender has a second lien, they will be able to use the property as collateral (just like the senior lender), and will be able to collect proceeds from the property after the senior lender.
Standstill Provisions and Payment Blockages in Intercreditor Agreements
In many cases, an intercreditor agreement stipulates that, if default-triggering events occur, the junior lender cannot accelerate the debt, take legal action, declare an official default, or demand that the borrower repay all or part of the loan. Instead, they will have to notify the senior lender and wait for a specific period, called a standstill period, before they can take any actions to claim repayment on any part of the loan. This generally results in what’s referred to as a payment blockage, and usually lasts between 90 -180 days, or until the senior lender has finished enforcing their remedies.
In some cases, standstill periods and their associated payment blockages can be triggered by violations of a loan agreement that are not related to a monetary default-- for instance, environmental issues or a violation of a loan’s special purpose entity (SPE) provisions. This is sometimes referred to as a non monetary default.
Bankruptcy and Intercreditor Agreements
In most cases, if a borrower defaults on a mezzanine loan, the mezzanine lender will take over the original borrower’s ownership entity (therefore taking the property for themselves) and will continue to make payments to the senior lender. However, a mezzanine lender could theoretically take over the ownership entity and, instead of making payments, could declare bankruptcy in an effort to recoup their losses faster. However, this could potentially cut the senior lender out of their portion of the property, or, at the very least, tie up the property in court proceedings that could last for months or even years. For this reason, many intercreditor agreements prevent the junior lender from taking control of a borrowing entity and declaring bankruptcy.
Foreclosure and Intercreditor Agreements
Just as a senior lender often will push for provisions that prevent a mezzanine lender from declaring bankruptcy, a mezzanine lender will often push for provisions that prevent a senior lender from foreclosing on the property immediately. Generally, a mezzanine lender will want to be able to take advantage of its ability to ‘foreclose’ on the property itself, typically by taking control of the borrowing entity (as mentioned above).
Intercreditor Agreements and Commercial Real Estate Borrowers
Intercreditor agreements primarily discuss the rights and obligations of senior and mezzanine lenders, not borrowers. However, the agreements that these parties make can have a significant impact on borrower outcomes, especially in the case of a loan default. For example, a longer standstill provision could allow a borrower more time to become current on their loan, potentially allowing them to cure their default before their mezzanine lender took control of the borrowing entity. For this reason, borrowers should always closely read intercreditor agreements when possible. In addition, they should generally seek the advice of an experienced real estate attorney or advisor to make sure that the agreement does not contain any unreasonable or unfair provisions.