Definition
An Intercreditor Agreement, in finance, is a contract established among different lenders that details their rank and how they will be repaid in case of a borrower’s bankruptcy or liquidation. It includes provisions on how the common borrower’s assets will be divided, as priority of repayment often goes to the senior lenders first. The agreement serves to define rights, interests, and priorities of each creditor, reducing potential disputes between them.
Key Takeaways
- An Intercreditor Agreement is a contract entered into between two or more creditors, outlining their rank and privileges in relation to the debt owned by a common debtor. It clearly defines the terms of their relationship, hence minimizing potential conflicts.
- This agreement is often implemented in complex finance structures where multiple lenders are involved. It ensures all parties understand their respective positions, particularly in cases where the debtor can’t meet their obligations, detailing which lender has priority for repayment.
- Intercreditor Agreements contain several key components, including payment waterfalls, standstill provisions, voting rights, and buy-out rights. These elements establish the order of priority, limit certain actions a creditor can take, regulate decision-making processes, and give possibilities for a creditor to buy out another’s interest in a loan.
Importance
The Intercreditor Agreement is a crucial finance term as it provides a clear structure of priority and rights among different creditors who have extended loans to the same borrower.
This agreement is particularly important in instances where the borrower defaults, ensuring that senior creditors are paid prior to subordinate creditors.
By delineating each creditor’s rank in the repayment hierarchy, it minimizes disputes during any financial distress.
Beyond outlining repayment hierarchy, it also governs the relationship between creditors, including detailing circumstances when a subordinate creditor can or cannot enforce its rights.
Thus, an Intercreditor Agreement is key for risk management and operational clarity among lenders.
Explanation
The purpose of an Intercreditor Agreement is to set the framework within which multiple creditors, lending to the same borrower, agree to operate. These agreements are absolutely essential in project finance agreements, corporate loans, and in situations where a company has multiple sources of debt from different lenders.
They are particularly helpful in bankruptcy, insolvency, or default situations because they present a predefined pecking order concerning who gets paid first and how much one can recover. Essentially, they lay down the rules of engagement between the spoken creditors.
Another significant usage of Intercreditor Agreement is to resolve potential disputes between senior and subordinated creditors. In most cases, the senior lender has the whip hand in the agreement and the junior lenders often have only limited voting rights.
Typically, this restricts junior creditors from taking any enforcement action against the debtor without the senior lender’s approval. By setting clear rules, an Intercreditor Agreement ensures that all parties know their rights and obligations, which provides a level of predictability and stability in the financial arrangement.
Examples of Intercreditor Agreement
Real Estate Development: In a real estate development project, multiple banks or financial entities might provide financing to the developer. One bank could provide a loan for the initial purchase of the property, while another helps finance the actual construction of the building. To protect their respective interests and establish who would have the priority on the repayment, these lenders enter into an intercreditor agreement. This ensures that, should the developer default on their payments, there’s a clear hierarchy in place to determine who gets paid back first.
Corporate Restructuring: In situations where a corporation is going through a restructuring or bankruptcy, there may be multiple creditors involved – regular lenders, bondholders, suppliers etc. In this complex scenario, an intercreditor agreement is put in place to dictate the ranking of creditors and what they will receive in repayment.
Mergers and Acquisitions: When a company is acquiring or merging with another company, it can often involve multiple parties lending the funds (banks, private equity, etc.). An intercreditor agreement would be utilized to clarify the ranking of debt and how the newly merged or acquired company’s cash flow will be applied to repay each debt.
Frequently Asked Questions about Intercreditor Agreement
1. What is an Intercreditor Agreement?
Intercreditor Agreement is a contract between two or more lenders, establishing the terms and conditions for their relationship, when they are both lending to the same borrower. It determines the priority of their claims in the event of a borrower’s bankruptcy or other default.
2. Why is an Intercreditor Agreement necessary?
An Intercreditor Agreement is necessary to manage the relationships between lenders. It eliminates the potential disputes between different lenders in the case of a borrower’s default by establishing a clear hierarchy of claims.
3. Who are the parties involved in an Intercreditor Agreement?
The parties involved in an Intercreditor Agreement are typically two or more lenders who are offering loans to the same borrower. The borrower may also be a party to the agreement.
4. What rights does an Intercreditor Agreement provide to the lenders?
An Intercreditor Agreement provides rights such as determining who has the first right to the borrower’s assets in case of default, who takes decisions regarding enforcement of security, and when can a lender take action against the borrower without other lenders’ consent.
5. How is an Intercreditor Agreement different from a Subordination Agreement?
An Intercreditor Agreement and a Subordination Agreement are both used to determine priority in claims in case of default, but they are used in different contexts. While an Intercreditor Agreement is a contract between two or more lenders, a Subordination Agreement is a contract between a lender and a borrower, where the borrower agrees to repay the loan to a subsequent lender before paying off an earlier loan.
Related Entrepreneurship Terms
- Security Interest
- Subordination
- Debt Re-structuring
- Collateral
- Covenant Compliance
Sources for More Information
- Investopedia – Most commonly used source for financial information, it includes a wide range of finance terms including Intercreditor Agreement.
- Law Insider – This provides legal context and examples for a variety of terms including Intercreditor Agreement.
- Corporate Finance Institute – A professional resource for finance information that should have information on Intercreditor Agreement.
- Bloomberg – A top source for finance news and information including details on Intercreditor Agreement.
