Beware of Provisions in Intercreditor Agreements

Any first-lien lenders that permit a borrower to obtain second-lien financing will try to ensure that their interests are primary to those of the second-lien lender should the borrower file for bankruptcy or default. The relative positions of first and second-lien lenders are typically described in intercreditor, or subordination, agreements that generally subordinate the rights of the second-lien lender regarding the collateral and payments from the borrower. These agreements often feature stipulations restricting the second-lien lender’s rights in the event of borrower bankruptcy.

The bankruptcy-related provisions might state that the first-lien lender may vote the claims of the second lien lender against the borrower’s assets to accept or reject the Chapter 11 plan of reorganization. Such a provision is intended to protect the primary position of the first-lien lender, making the second-lien lender a silent party to the plan-voting process. However, the limited case law interpreting this provision has shown that it is uncertain whether a court would conclude it is enforceable.