Vol 7 (2010) - Issue 4

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The Intercreditor Debate: Six Months On

Whilst the revised LMA recommended form of intercreditor agreement, circulated in November 2009, is gaining recognition as a starting point for negotiations between the senior and mezzanine debt providers on leveraged finance transactions, it does not provide a market standard on all issues and leaves room for further discussion.

In particular, it has become apparent that intercreditor agreements have not always afforded the mezzanine lenders the desired level of protection. In recent new leveraged financings in the market there has been significantly more involvement and negotiation between the senior lenders and mezzanine lenders as the latter seek to improve their protections and ensure that such provisions are meaningful.

The LMA recommended form of intercreditor agreement is emerging as the precedent base document for discussions on intercreditor arrangements. It was first circulated in March 2009 at a time when the market was unsettled and prior to any post-credit crunch set of market norms having been established. Many mezzanine lenders expressed the view that the March 2009 recommended form favoured the position of the senior lenders and the hedge counterparties and failed to adequately address mezzanine concerns. Following discussions with mezzanine lender representatives, the LMA subsequently updated their recommended form of intercreditor agreement to include additional drafting or footnotes for issues to consider when acting for the mezzanine lenders (or conversely, items to consider removing if acting for the senior lenders). Relatively few leveraged buy outs have occurred since the revised recommended form was circulated in November 2009 and it is not yet clear therefore whether a market precedent has been set on the relevant issues. The LMA intercreditor agreement does however provide a useful starting point for negotiations.

Set out below is a high level list of some of the protections the mezzanine lenders have sought to strike a balance between the rights of the mezzanine lenders and the senior lenders and, where applicable, the grounds upon which senior lenders have relied in order to decline the inclusion of such rights:

Release of mezzanine claims
Perhaps the most contentious mezzanine lender issue of all is the ability of the security agent to release or transfer mezzanine lender claims upon enforcement without their prior consent (or a majority thereof). This has resulted in the mezzanine lenders having little bargaining power in recent restructurings. Many mezzanine lenders are pushing for their consent to be deemed automatic only where a disposal or transfer of assets (i) is made for cash and the proceeds thereof are applied in accordance with the intercreditor waterfall (to limit the ability of the sponsor and senior lenders to agree to a pre-pack arrangement and to roll the senior debt across to a newco vehicle), (ii) results in a release of all senior lender claims and (iii) is made via a public auction process or for fair market value as certified by an independent internationally recognised investment bank or through a court governed process where the court acts in the interests of the secured creditors of the borrower group as a whole. In respect of a public auction the senior lenders would argue, amongst other things, that as soon as one makes public the fact that the borrower group is in difficulty, further financial deterioration is likely to follow and it is an inappropriate forum to sell the shares of a private company. Further, senior lenders may be reluctant to incur the extra cost or delay that obtaining a fairness opinion will require during which the credit of the borrower group could further deteriorate although it is noted that this provision is often a feature of an intercreditor agreement involving senior bank debt and high yield bonds.