Intercreditor Arrangements - well worth the negotiation
SOURCE: CHARTERED BANKER, DECEMBER 2009 / JANUARY 2010
As banks and borrowers are keen to establish their negotiating position in connection with refinancing and/or the recovery of funds, banking documents and arrangements are being carefully examined. In this article, we shall consider some of the issues that arise in connection with Intercreditor Agreements.
An Intercreditor Agreement governs the relationship between 2 or more lenders, and will determine the powers of each lender in various circumstances, and ought to be carefully negotiated. Where there is a surplus of funds, the Intercreditor Agreement is seldom referred to. However, where there is a shortfall, those who have been well advised on the intercreditor arrangements are likely to recover at least their commercial entitlement, and sometimes even more than that.
We have seen Junior Lenders for example, take advantage of the situation where the documentation provides that they must consent to debt restructuring, often to ensure that they have an enhanced priority in the new arrangements. This was not envisaged by the Senior Lender, who had not been advised of this possibility when the documentation was negotiated. Therefore, it is essential that the advisor properly identifies all implications of the documentation, and ensures that the relevant lender understands its position.
Conversely, the recent case of Bluebrook has confirmed that Junior Lenders can, in some circumstances, be ignored, all to the benefit of the Senior Lenders.
In this case, a borrower sought Court approval to enter into schemes of arrangement with the Senior Lenders, which would leave the original borrower companies with no assets, and the Junior Lenders with no prospect of recovering any monies. Contrary to the previous example, the Intercreditor Agreement contained the more conventional wording whereby the Senior Lenders could insist that the Junior Lenders security would be released in certain circumstances.
The Junior Lenders challenged this and argued that they could recover part of their debt as they had a valuation (although not on a going concern basis) that valued the borrower group in excess of the senior debt; and they also sought to be included in the equity stake in the new borrower structure, but recognised that their subordinated status would require to be preserved.
The argument against was that the Junior Lenders had no economic interest in the scheme as the value of the borrower group as a going concern was less than the senior debt, and so the Junior Lenders would not be entitled to any recovery.
The Court cast doubt on the valuation submitted by the Junior Lenders as it was not on a going concern basis, and partly also because the Junior Lenders passed on their entitlement to buy out the senior debt and carry out a sale and restructuring themselves, which implied that they were not so confident in their valuation.
The Court decided that a company is free to enter into a scheme of arrangement with only one class of creditors, and is not compelled to include those whose rights will not be altered by the scheme. Likewise, consultation with those with no economic interest in the scheme is not necessary. Therefore, the scheme should be sanctioned as it did not affect the rights of the Junior Lenders, nor were they unfairly prejudiced by them.
The judgement strengthens the “no economic interest” argument commonly levied against Junior Lenders in negotiations between the borrower and senior lenders.
Therefore both Senior and Junior Lenders need to carefully negotiate the terms of an Intercreditor Agreement; and be aware of the consequences if the going concern valuation of the Borrower is less than the value of the senior debt. In particular Junior Lenders may wish to carefully consider (and negotiate) their right to enforce a purchase of the senior debt, and at what price (the lower of full price or the valuation of the Borrower?) as that may be their only hope of recovering any value for their investment.
author: alex innes
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