Two priority issues arise between creditors of a common debtor:
- Payments - What are the priorities between the creditors to payments made to them by the debtor?
- Security Interests - What are the priorities between the creditors in relation to security interests granted to them by the debtor?
As to payments, creditors are free to agree as between themselves as to who is paid when[1]. As to security interests, the Personal Property Security Act[2] (the "Act") has complex priorities rules that determine the priority between competing security interests to the same collateral. However, creditors can enter into agreements to confirm or change the priority that their security interests would have under the Act[3]. Those agreements can, and usually do, also deal with priority of payments[4]. The agreements go by a number of different names, such as subordination agreements, priority agreements or intercreditor agreements. While there are no firmly established rules as to what each type of agreement does, there are typical terms in each agreement that differ from the terms in other agreements. This article looks at the various kinds of agreements dealing with priority issues, the typical terms they have and the differences between them.
Postponement agreement
A postponement agreement deals only with the issue of payments to be made by a debtor to its creditor, and not with any security interests granted by it. Under a postponement agreement the postponing creditor agrees that it will postpone receipt of payments from the debtor on specified terms, such as until the senior creditor is paid in full. While a postponement does give one creditor priority to payments from the common debtor, it does not usually subordinate any security interest that a creditor might have[5].
Subordination agreement
A subordination agreement (sometimes called a priority agreement or a priorities agreement) is given by one creditor in favour of another, and typically deals with subordination by the granting creditor of both security interests governed by the Act and of the right to payment. Under a subordination agreement, the subordinated secured creditor:
- subordinates to the senior secured creditor the security interests granted to it by the debtor; and
- agrees to postpone payments to it by the debtor until the senior secured creditor is paid in full[6].
An agreement on those terms constitutes a full or deep subordination by one secured creditor to another[7]. A subordination agreement can limit the extent of subordination, for example to a limited dollar amount, for a certain period of time or while other conditions exist, and can contain some of the more complex provisions of an intercreditor agreement, as discussed below. But the typical subordination agreement is a one-way subordination by a subordinated creditor in favour of a senior creditor.
Intercreditor agreement
An intercreditor agreement usually provides for mutual subordination of security interests and division of payment between secured creditors. It can also deal with matters not strictly related to priority, such as enforcement of rights and remedies and access to collateral.
Rather than a simple subordination by a subordinated creditor in favour of a senior creditor, an intercreditor agreement is usually a more complex agreement between two or more secured creditors, setting out the details of the relationship between them in relation to their common debtor. An intercreditor agreement could include provisions dealing with:
- The relative priority of the security interests of each secured creditor to the other. This could take the form of subordination by each secured creditor of its security interest to certain classes of collateral. For example, one secured creditor might take priority over the debtor's operating assets, such as inventory, cash and receivables, and the other could take priority over the debtor's fixed assets, or over all other personal property.
- Payments by the debtor to each secured creditor. These provisions could include payment blockage notices (to be given by a senior secured creditor upon a default or other occurrence) and payment blockage periods (relating to payments to a junior creditor). Or the parties could agree to pari passu[8] sharing of payments between them, calculated on the amount of the indebtedness owing by the debtor to any one of them to the amount of the debtor's indebtedness to all parties to the agreement.
- The rights and remedies of each secured creditor on default. For example, a secured creditor could be required to give notice to the other secured creditor before enforcing its security. The parties could also agree to an enforcement standby (sometimes called a standstill), setting out when a junior creditor may and may not enforce its security interest.
What about no interest letters?
A no interest letter (sometimes called an estoppel letter) or similar agreement is not strictly an agreement affecting priority to payments or to collateral, although it does affect rights to collateral[9]. Under a no interest letter one secured creditor acknowledges to another that it does not have a security interest in specified collateral, or that its security interest is limited only to specified collateral. This differs from a subordination agreement in that the creditor giving the letter is disclaiming or narrowing any interest in the collateral, rather than maintaining a subordinated security interest in it. For the secured creditor receiving the no interest letter, however, the effect is the same as a subordination agreement. The benefitting secured creditor can rely on the no interest letter to assert its priority to the collateral over the secured creditor granting the letter.
The hybrid
The terms of agreements dealing with priorities and the issues they address are limited only by the requirements of the parties and the imaginations of creditors and their counsel. While this article has dealt with each type of agreement as separate and distinct, some or all of the elements in each type of agreement may be combined in a single agreement. That is sometimes done in an intercreditor agreement, or it may be in an agreement called a "Postponement, Subordination and Standstill Agreement", or a similar name that describes the effect of the provisions in the agreement.
As to "what's in a name", it turns out quite a lot. Although there are no fixed rules as to what terms any given agreement dealing with priorities contains, the name of the agreement can give a pretty good indication of the nature of the agreement and the provisions in it. Just don't forget to read the fine print.
[1] Such as in a postponement agreement, as discussed below.
[2] In this article a reference to the PPSA means the Personal Property Security Act in each of British Columbia, Alberta and Ontario.
[3] See s.40(1) of the British Columbia PPSA, s.40 of the Alberta PPSA and s.38 of the Ontario PPSA.
[4] The agreements can also deal with other issues, such as enforcement of rights under security on default, but this article focuses on the issue of priority of payments and security interests.
[5] The postponing creditor may not hold any security interest which requires subordination, or it may have agreed to postponement of payment but not to subordination of its security interest.
[6] There could be some other agreement on payments to the subordinated creditor, such as allowing certain defined "Permitted Payments" to it as long as the debtor is not in default to the senior creditor.
[7] For example, a shareholder that has made loans to and taken security from a company will usually fully subordinate its security interests and right to payment to an institutional lender to the company.
[8] Pari passu means "at the same rate" or (in general) "equally". Other terminology sometimes used to describe the equitable division of payments or proceeds among secured creditors is "proportionately" or "pro rata". The meaning of these terms can vary depending on whether they are defined in the agreement and how they are used in context.
[9] No interest/estoppel letters are most common in Ontario, where the "check the box" system used for financing statements can make it difficult to determine the scope of a security interest and the collateral charged by it. For example, checking the box "equipment" would include all equipment, not just equipment supplied or financed by the secured party, even though the security interest may only extend to equipment that is supplied or financed.