What is an Intercreditor Agreement?

Example of Intercreditor Agreement

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XYZ Co. is planning to raise $100 million, the bank has agreed to pay $20 million, so $80 million will have to be raised from outside. Two external creditors have agreed to pay $50 million and $30 million, respectively. Who will have the first claim on the borrower’s property if the borrower defaults, and how much can each lender recover?

All this confusion is sorted by an agreement signed between the two lenders. The deal is called the intercreditor agreement. That is because it will help the creditors distribute the collateral from the borrower in case of default. So, the agreement prevents lenders from engaging in uncalled disagreements over collateral distribution. All this confusion is sorted by an agreement signed between the two lenders. The deal is called the intercreditor agreement. That is because it will help the creditors distribute the collateral from the borrower in case of default. So, the agreement prevents lenders from engaging in uncalled disagreements over collateral distribution.

Issues with Intercreditor Agreement

  • It is challenging to set an order regarding the claim on individual assets in case of default. So, if the property is limited to cover the entire liability, which creditor will be placed first in the claim is tough to decide.Assets are of different values and liquidity, so it is not easy to determine which one will use the asset to cater to their needs. Therefore, the agreement is tough to draft, considering all the issues.

Need Of Intercreditor Agreement

This agreement deals with discrepancies and confusion that may arise in case of default in payment by the borrower. For example, if multiple parties give a loan to a borrower, the collateral is challenging to distribute as the assets are not of the same liquidity and value. So, it is essential to draft an agreement regarding the proper allocation of assetsAllocation Of AssetsAsset Allocation is the process of investing your money in various asset classes such as debt, equity, mutual funds, and real estate, depending on your return expectations and risk tolerance. This makes it easier to achieve your long-term financial goals.read more and rights. Therefore, this agreement helps deal with the appropriate collateral distribution in default. In addition, it prevents unnecessary harassment of collateral distribution.

Intercreditor Agreement vs. Subordination Agreement

An Intercreditor Agreement is a collateral distribution once a borrower defaults in case the lenders are both superior. In the case of the subordination agreement, the loans are ranked in order of priority. It means a rank is given regarding which debt is to be paid first compared to other debts. So this ranking clears doubts in the minds of the lenders as they know who will pay all as per ranking.

Benefits

  • It helps avoid confusion after the default of payment by the borrower, as the payoff after bankruptcy is already decided. Hence, it helps eradicate confusion and helps in the smooth running of settlement.Junior creditor gains confidence and agrees to give borrowers loans as they know superior lenders will not ignore their rights.

Disadvantages

  • If the junior creditor fails to draft favorable terms, they must abide by the unfavorable terms throughout the agreement.As superior lenders are considered more powerful than subordinate lenders, they might bend justice in a dispute.

Conclusion

An Intercreditor Agreement is extremely beneficial for subordinate lenders in case of default by the borrower as the terms are already drafted beforehand. Hence, it removes the confusion that may arise in case of default. In addition, a well-drafted agreement will help properly distribute collateral. Therefore, it is always advisable to form an Intercreditor Agreement.

This article is a guide to Intercreditor Agreement. We discuss examples, issues, and the need for an inter-creditor agreement, benefits, and disadvantages. Also, you may learn more about financing from the following articles: –

  • Subordinated DebtCovenantsSecured LoansDebt Default