We at Seward & Kissel have been seeing in the recent past an increasing number of financing transactions with multiple layers of debt in the maritime space. The hallmark of such a structure, of course, is the intercreditor agreement. This note covers some of the essential concepts that appear in U.S.-style intercreditor documentation and discusses the unique aspects of such documentation relevant to maritime transactions.
What is it and what does it do?
An intercreditor agreement (whether it’s styled as an intercreditor or subordination agreement or documented as part of a collateral trust agreement or in the case of a unitranche deal, an agreement among lenders) sets forth the relationship between the lenders having differing rights against the interests that they share (most notably, the payment rights against the borrower and the collateral granted by the borrower). Perhaps the most common intercreditor arrangement in commercial lending may be that of first and second lien lenders whereby two lenders agree to share common collateral but the first lien lender has priority against the second lien lender as relating to the proceeds of such collateral. Another common example of the intercreditor arrangement is that of a senior lender and a subordinated lender where the senior lender has priority against the subordinated lender as to its right to collect payments from the borrower; depending on the deal terms, that may mean that the subordinated lender cannot collect any payment from the borrower until the senior lender is paid in full (subject to certain limited exceptions as may be negotiated between the lenders).
What are some of the basic terms?
Some of the common provisions found in an intercreditor agreement include:
- Lien Subordination – As mentioned above, one lender will have priority over the other lender in lien rights against common collateral.
- Payment Subordination – Payment subordination is distinguished from lien subordination, in that a lien right relates to a property, whereas a payment right is asserted against a person. If all items of collateral are sold off but the senior lender is still not paid in full, a payment subordination provision would dictate whether the senior lender has the priority to go against the borrower to collect on the remaining debt.
- Right to Modify Transaction Documents – When two lenders agree to lend to the same borrower, they generally want to make sure that the other lender cannot change material terms of its transaction documents without the other lender’s consent. For example, a junior lender will not want the amount of the senior debt to increase substantially because that means the junior lender’s chance of recovery in a downside scenario may be reduced. Another example may be that a senior lender will not want a junior lender’s interest rate to increase significantly because that may affect the borrower’s cash flow position and ability to service the senior debt on an ongoing basis.
- Enforcement Right – An intercreditor agreement spells out what right each lender has in relation to any enforcement action to be taken in a downside scenario. A senior lender will not want a junior lender to hinder its right to foreclose on collateral but at the same time, a junior lender will not want to be shut out of the process permanently. Depending on the deal specifics, a so-called “standstill period” may be negotiated where the senior lender may have the exclusive right to take enforcement actions for a period of time only (for example, 180 days).
- Purchase Option – Many intercreditor agreements permit one lender (especially the junior lender) to purchase the claims of the other lender (most often at par), thereby obtaining the ability to drive the foreclosure process if it is in its best interest to do so.
- Bankruptcy Provisions – An intercreditor agreement may be most relevant when a borrower faces financial difficulties which may then lead to an insolvency proceeding. Depending on the jurisdiction of such proceeding, the applicable insolvency regime may afford creditors certain rights or require certain procedural steps. The intercreditor agreement needs to be sufficiently clear, so that lenders do not inadvertently waive their rights or are prevented from taking such procedural steps. For example, a junior lender needs to be able to file a “proof of claim” with the bankruptcy court in order to receive proceeds from the bankruptcy estate and may want to retain any rights it may have as an unsecured creditor. A senior lender may want to negotiate for a right to provide so-called “debtor-in-possession” financing to its (now insolvent) borrower, thereby facilitating the debtor’s business operations during the pendency of the insolvency proceeding in the hope for a better recovery.
Does an intercreditor agreement matter to Borrower?
While not always the case, a typical intercreditor agreement requires the borrower and other obligors to become party. This is mostly for the benefit of the lenders because it puts the borrower on notice of the agreement between the lenders. For example, a restriction on increasing the amount of the senior debt is within the control of the borrower because the loan amount cannot increase without the agreement of the borrower, and this affords the lenders extra protection.
On the flip side, understanding what is specified in the intercreditor may provide the borrower certain insights into the lender group dynamics and could be useful if there needs to be a change in deal terms. This is one of the differences between a traditional senior/junior lien debt structure and a unitranche, where typically an “agreement among lenders” is not signed by the borrower, so the borrower is unaware of the deal made between the lenders.
Considerations for the maritime financing lenders when negotiating an intercreditor agreement
There are some unique aspects of the maritime financing transactions that need to be kept in mind in negotiating an intercreditor agreement because of the uniqueness of the collateral and the borrower involved in such transactions.
- Enforcement – A primary item of collateral in most maritime financing transactions is the vessel. Arresting a vessel and eventually having it sold to satisfy the creditor’s debt is a complicated and lengthy process, which is jurisdiction-dependent. This has implications in what kinds of actions each lender should be permitted to take (or prohibited from taking) and for how long. In addition, shipping being a highly regulated industry can create issues when it comes to enforcement of collateral in general (for example, U.S.-flagged vessels with coastwise or fisheries endorsements that have citizenship restrictions on the owner), and the intercreditor terms may need to take into consideration such regulatory concerns.
- Governing Law – Challenges in maritime financing transactions often originate from their cross-border, multi-jurisdictional nature. For example, a financing agreement may be governed by New York law, but ship mortgages by Marshall Islands law, account pledges by Dutch law, and shipbuilding agreement and charterparties by English law. In the foreclosure scenario, the law of the jurisdiction where the vessel is arrested also comes into play. The analysis may be further (and especially) complicated if the second lender chooses to use different governing laws for their transaction documents. Appropriate considerations need to be given in considering intercreditor agreement provisions in light of the interplay between different legal regimes and potential conflicts.
- Perfection – Under New York law (or the laws of other states in the United States for that matter), certain type of collateral require possession or “control” for the purposes of perfecting a lender’s security interest. For obvious reasons, that is not possible to be obtained by two lenders at the same time, and there needs to be some arrangement made between the two lenders, so that both lenders can be perfected. That may require one lender effectively acting as an agent for the other lender for perfection purposes.
- Precedent – Traditionally, a typical ship financing transaction structure would involve one lender financing one or more vessels housed in individual special purpose vehicles, a predictable structure that many lenders preferred to use. The type of multi-layered financing structures utilized in other industries with an intercreditor arrangement is relatively rare. Therefore, it is not easy to speak of “market” terms when it comes to intercreditor terms, and negotiation for an intercreditor agreement can be a challenge (and a time-consuming activity) when the parties cannot pinpoint to a market-leading precedent or other established benchmarks.
An intercreditor agreement (whether it’s styled as an intercreditor or subordination agreement or documented as part of a collateral trust agreement or in the case of a unitranche deal, an agreement among lenders) sets forth the relationship between the lenders having differing rights against the interests that they share (most notably, the payment rights against the borrower and the collateral granted by the borrower). Perhaps the most common intercreditor arrangement in commercial lending may be that of first and second lien lenders whereby two lenders agree to share common collateral but the first lien lender has a priority against the second lien lender as relating to the proceeds of such collateral. Another common example of the intercreditor arrangement is that of a senior lender and a subordinated lender where the senior lender has a priority against the subordinated lender as to its right to collect payments from the borrower; depending on the deal terms, that may mean that the subordinated lender cannot collect any payment from the borrower until the senior lender is paid in full (subject to certain limited exceptions as may be negotiated between the lenders).