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Intercreditor Agreement in Commercial Real Estate
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.
- What is an Intercreditor Agreement?
- Lien Subordination vs. Payment Subordination
- Standstill Provisions and Payment Blockages in Intercreditor Agreements
- Bankruptcy and Intercreditor Agreements
- Foreclosure and Intercreditor Agreements
- Intercreditor Agreements and Commercial Real Estate Borrowers
- Questions? Fill out the form below to speak with a commercial real estate loan specialist.
- Related Questions
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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.
Questions? Fill out the form below to speak with a commercial real estate loan specialist.
Related Questions
What is an intercreditor agreement in commercial real estate?
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.
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.
What are the benefits of an intercreditor agreement in commercial real estate?
An intercreditor agreement in commercial real estate can provide a variety of benefits to both senior and mezzanine lenders. For senior lenders, an intercreditor agreement can provide additional security and protection in the event of a loan default. It can also ensure that the senior lender will be fully repaid before the mezzanine lender can begin to get their share of proceeds from the sale of a property. For mezzanine lenders, an intercreditor agreement can provide additional assurance that they will be able to recoup their losses in the event of a loan default.
For borrowers, an intercreditor agreement can provide additional 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.
What are the risks associated with an intercreditor agreement in commercial real estate?
The primary risk associated with an intercreditor agreement in commercial real estate is that the agreement may contain unreasonable or unfair provisions that could negatively impact the borrower. For example, a longer standstill provision could allow a senior lender to recoup their losses before the mezzanine lender can begin to get their share of proceeds from the sale of a property. For this reason, borrowers should always closely read intercreditor agreements when possible and 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.
How does an intercreditor agreement affect small business financing?
An intercreditor agreement can have a significant impact on small business financing, especially in the case of a loan default. The agreement can contain provisions that allow the 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. In addition, the agreement can prevent the junior lender from taking control of a borrowing entity and declaring bankruptcy, which 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, small business borrowers should always closely read intercreditor agreements when possible and 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.
What are the key elements of an intercreditor agreement in commercial real estate?
The key elements of an intercreditor agreement in commercial real estate are:
- The rights and responsibilities of each party
- Safeguards that protect the senior lender’s interest in the property should the borrower default on their loan
- The exact nature of the subordination agreement between the two parties
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What are the common mistakes to avoid when drafting an intercreditor agreement in commercial real estate?
Common mistakes to avoid when drafting an intercreditor agreement in commercial real estate include:
- Not reading the agreement closely and seeking the advice of an experienced real estate attorney or advisor.
- Not understanding the rights and obligations of senior and mezzanine lenders.
- Not understanding the potential impact of the agreement on borrower outcomes.
- Not understanding the provisions that prevent a senior lender from foreclosing on the property immediately.
Source: www.commercialrealestate.loans/commercial-real-estate-glossary/intercreditor-agreement