Arrangements with third-party creditors: Inter-creditor and priorities agreements

Hi my name is Richard Dusome and I'm a Financial Services lawyer at Gowling WLG. This video is part of our Arrangements with Third Party Creditors video series.

In our earlier videos in this series, we have talked about the use of Subordination Agreements and Postponement Agreements to protect a senior creditor from vendor take-back lenders (otherwise known as VTB lenders) and other third party creditors.  In many situations, using a simple form of Subordination Agreement will be sufficient.  However, there will be other deals and more complicated transactions where that just won't be enough to address all of the special features of the deal. 

The same is true when one lender is providing an operating credit facility secured primarily on accounts receivable and inventory, and another  lender is providing a separate term credit facility secured on real estate or specific equipment. 

In both of those situations, the business deal may require that one lender will enjoy first priority over certain identified assets, while another lender might have first priority over other assets.  Part of that arrangement will also see each lender have second ranking priority on the other lender's bundle of first priority assets. 

Alternatively, the business deal may be that one lender's priority is intended to be capped at a maximum amount of indebtedness, or both lenders wish to share priority to assets on a pro rata basis based upon their respective debt levels.

In those cases, properly documenting those arrangements will require a more fulsome Priorities Agreement or an Inter-creditor Agreement  entered into by all the lenders as well as the borrower and any guarantors. In other words, you don't want to use a shovel where a backhoe or a front-end loader is needed to build the road to a successful deal.

There are really no limits to the complexities that might be involved when you are involved with imaginative and deal-making bankers and other lenders. Once again there is no One Size Fits All Inter-Creditor Agreement.  It's not a document you just pull off the shelf.  And you should never quickly sign an Inter-creditor Agreement presented by another lender without a full review of the document by legal counsel to make sure it fits your deal.

The content of any inter-creditor agreement is deal specific and dependent upon the type of facilities offered by each lender, the security held by each lender and the overall business deal, that is, who is intended to have priority over which bundles of assets.  However, there are some common threads seen in most documents:

1.  Reciprocal Covenants.  As we have said before, many subordination agreements are one-sided arrangements on favour of a senior creditor.  However, you can expect an inter-creditor agreement to contain reciprocal covenants resulting in benefits and burdens for each creditor that evidence some give and take and compromise between the lenders. Provisions relating to notices of the borrower's default and a lender's right to amend its documents often fall into this category.

2.  Payment and Enforcement Standstills.  As we have outlined in more fulsome detail in a separate video session, an inter-creditor agreement will often include standstill terms and other restrictions on each lender's right to receive payments on its debt and the right to enforce its security over certain assets in the event of non-payment.

3.   Focus on Defined Terms and their Scope/Limits.  Defined terms created for each lender's collateral bundle over which it is to have first priority security and the description of each lender's indebtedness will be key terms of an inter-creditor agreement.  Carve-outs from the defined terms and restrictions and limits on those terms require careful review.

4.  Proceeds Waterfall.  You should expect to find a Proceeds Waterfall in most inter-creditor agreements  A Proceeds Waterfall is simply a clause which sets out the relative order of payment to the lenders of the proceeds of realization of certain assets.  Generally it is structured so that certain costs of enforcement are paid first, followed by payments of the senior debt associated with an asset or group of assets. 

Where you have distinct bundles of assets over which different lenders have priority, there can be a Proceeds Waterfall for each asset bundle.  In some cases there may be a limit on the maximum amount of indebtedness eligible for being secured under a first ranking priority position so as to discourage lending in excess of agreed upon limits.

5.  Access to Remove Collateral.  If the inter-creditor agreement is between an operating lender and a term lender with real property security, the operating lender will want to ensure it has access to the real property to be able to remove inventory or other assets of the debtor for realization purposes.  The operating lender may also want the ability to occupy the premises for a period of time after a borrower default to complete the manufacture of work-in-progress or WIP inventory into finished goods inventory.

This list is by no means exhaustive and there are a number of other terms that can make their way into an inter-creditor agreement.  So be prepared for negotiation and compromise when dealing with one.

Should you have any questions about the content of this video, please feel free to reach out to me directly, or any one of the Gowling WLG lending team. Thank you so much for watching this video.