Intercreditor agreement: Overview, definition, and example
What is an intercreditor agreement?
An intercreditor agreement is a legal document that outlines the rights and priorities of multiple creditors involved in a single debtor's financial arrangement. This agreement typically governs the relationship between creditors, specifying how they will share the debtor’s assets or repayments in the event of a default, bankruptcy, or other financial events.
Intercreditor agreements are often used when there are multiple lenders or creditors (e.g., senior lenders, subordinated lenders, bondholders) involved in the same debt structure, ensuring clarity about who has priority in receiving payments or assets. These agreements help manage the complexities of debt structures where different creditors may have different levels of seniority or different security interests.
Why is an intercreditor agreement important?
An intercreditor agreement is important because it establishes clear guidelines about how creditors will be treated in relation to each other, especially in the event of a default or liquidation. Without such an agreement, creditors might have conflicting interests, leading to disputes over the order in which they are repaid, which could delay or complicate the resolution of the debtor’s financial issues.
For businesses, an intercreditor agreement ensures that debt obligations are managed in a structured way, reducing the risk of litigation and helping maintain business relationships. For creditors, it provides a clear understanding of their rights, priorities, and how they are likely to be treated in the event of financial distress.
Understanding intercreditor agreement through an example
Imagine a company, Company A, takes out a large loan from two lenders: Lender 1 (a senior lender) and Lender 2 (a subordinated lender). Lender 1 is the primary lender and holds a higher priority for repayment, while Lender 2 has agreed to take on more risk by accepting a subordinate position.
An intercreditor agreement between Lender 1 and Lender 2 clearly defines the repayment hierarchy in the event of Company A defaulting. It specifies that Lender 1 has the right to receive payment first from any recovery of assets, and only after Lender 1 is fully paid will Lender 2 be entitled to any remaining funds. The agreement also includes provisions for other aspects, such as restrictions on Lender 2 taking legal action or enforcing security interests until Lender 1’s debt is fully satisfied.
In another example, a real estate project involves several creditors providing funding, with one group of creditors providing senior debt and another providing mezzanine financing. An intercreditor agreement will be necessary to determine the distribution of proceeds from the sale of the property or any debt recovery, establishing that the senior creditors are paid first, and the mezzanine creditors are paid after the senior debt is fully satisfied.
An example of intercreditor agreement clause
Here’s how an intercreditor agreement clause might appear in a contract:
“In the event of a default or liquidation of the Borrower, the Senior Lender shall have priority over the Subordinated Lender in the repayment of the debt. The Subordinated Lender agrees not to take any enforcement action or initiate any claim until all obligations to the Senior Lender have been fully satisfied. Any proceeds from the liquidation of the Borrower’s assets will first be allocated to the Senior Lender, and any remaining proceeds will then be distributed to the Subordinated Lender according to the terms of this Agreement.”
Conclusion
An intercreditor agreement is a crucial legal document that ensures fair treatment and clear prioritization among multiple creditors involved in a debtor's financial arrangement. By defining the rights and obligations of each creditor, this agreement helps prevent disputes, ensures smooth repayment processes, and provides a structured approach in the event of financial distress or default. Whether used in corporate finance, real estate projects, or other complex financial structures, intercreditor agreements are essential for maintaining order and clarity in creditor relationships.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.