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 some of our earlier sessions we have talked about subordination agreements that may be entered into between a senior creditor with various other creditors of a debtor. This would include any agreement you as a senior lender might require from a junior creditor of your debtor or a vendor holding vendor take-back security from your debtor.
Subordination agreements are frequently one-sided documents in favour of the senior creditor. They are designed to provide it comfort that the existence of the package of junior debt and security is being managed, and does not have the potential to force the senior lender's hand to an early enforcement following a default.
Today we are going to focus on two of the most significant clauses typically included in a Subordination Agreement, namely the Payment Standstill and Enforcement Standstill Arrangements.
So what exactly are Payment and Enforcement Standstill Arrangements?
Generally speaking each secured creditor of a debtor will have certain rights under its security agreement and under the applicable legislation to take action to demand payment and enforce its security against the debtor in the event of a default under the loan. Any junior creditor will have that bundle of rights.
A standstill arrangement imposes certain restrictions and limitations on the exercise of those rights. It gives the senior lender control over the actions of the junior creditor, and can make the junior creditor standstill and not take any action for an agreed period of time.
First let's take a closer look at what constitutes an Enforcement Standstill.
An Enforcement Standstill is a prohibition or limit on the junior creditor's rights to enforce its security generally against all of the debtor's assets, or against a specific bundle of the debtor's assets. Its purposes is to minimize the disruption to the debtor's operations after a default and to allow the Senior Lender to control the enforcement.
Typically this restriction is pegged at a certain number of days, for example 120 or 180 days and is known as the Standstill Period. During that time a junior creditor cannot take action to enforce its security even though the junior creditor's loan may be in default. The Standstill Period is designed to give the senior lender time to consider its options and to determine if it wishes to make demand on the debtor and enforce its own security, or whether it wishes to do a restructuring. The Enforcement Standstill gives the senior lender time to think through the whole process and to consider how to best protect its interests.
If the senior creditor chooses not to commence its own enforcement by the end of the Standstill Period, then the junior creditor will be free to proceed with the enforcement on its security. However, the senior creditor's choice does not reverse or change the relative priorities of the junior creditor and the senior creditor. If the junior creditor realizes any proceeds from its own enforcement, those proceeds must still be paid to the senior lender until its debt is paid in full.
This naturally discourages the junior creditor from proceeding with any enforcement. It would have to be comfortable that the expected amount to be realized on the security will cover the full amount of the senior loan and the junior loan in order to make the process worthwhile for the junior lender.
An Enforcement Standstill is also useful even when dealing with a secured party who only has security over a single asset, but that asset is of key importance to running the debtor's business as a going concern, like Intellectual Property. If the realization on that Intellectual Property security is not delayed or restricted, it could lead to major disruptions in the debtor's business and accelerate the decline in value of the other assets subject to the senior creditor's security.
The terms of every Enforcement Standstill are unique and deal specific.
Now let's consider what constitutes a Payment Standstill or a Payment Block
A Payment Standstill or a Payment Block is a prohibition or restriction on regularly scheduled payments that may be accepted by a VTB lender or a junior creditor for a specific period of time.
It is typically triggered by the occurrence of an event of default under the senior debt or the junior debt, or by the commencement of enforcement proceeding by the senior creditor. In these situations the senior creditor will want the debtor to be preserving its cash flow for operations and not disbursing funds to paydown subordinate debt.
The payment prohibition generally lasts for a specific limited period of time (known as the Standstill Period or the Block Period) usually until the event of default has been cured or waived by the applicable lender. At the end of the Standstill Period, payments can be resumed provided a new or further event of default has not occurred.
Certain aspects of the Standstill Period will be the subject of negotiation, including :
(1) the number of times the period can be triggered over a period of time in situations where defaults occur and are cured frequently, and
(2) whether there are any special Permitted Payments (perhaps interest only) that can flow to the junior creditor despite the prohibition on general payments.
Like Enforcement Standstills, the terms of every Payment Standstill are unique and deal specific. Be prepared and make sure all details and expectations of the intended business deal as you understand them make their way into the drafting.
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.