With the increase in corporate bankruptcy filings over the past year, there have been some interesting bankruptcy court decisions that affect those of us on the front end in corporate lending. One recent case took up the question of whether a second lien is truly second — and whether it is safe to expect that the terms of your intercreditor agreement will be enforced.
In an intercreditor agreement, the senior lender will usually require that the junior lender waive several of its rights, including
- the right to challenge the validity or priority of the senior lender’s liens, and
- the right to oppose a plan of reorganization supported by the senior lender.
The intercreditor agreement in the ION Media case, as is common for an agreement of this type, included a broad waiver of these and other rights. In the agreement, the junior creditor agreed that its rights to the company’s assets would be junior, and the relative priorities of the lenders’ claims would not be affected or impaired by “any nonperfection of any lien purportedly securing” any of the senior obligations. However, in the bankruptcy case, the junior creditor took issue with these terms, and argued that some of the assets weren’t “collateral” as defined in the intercreditor agreement — so the waiver should not apply. The bankruptcy court disagreed, deciding instead to enforce the waiver as written.
When we draft these kinds of waivers in intercreditor agreements, this is exactly the type of situation we are trying to address: if it turns out that there’s a problem with the senior lender’s lien (perhaps liens as to some of the collateral don’t appear to have been properly perfected, for example), the junior lender is still supposed to remain in the junior position. These terms help ensure that the senior lender actually receives the benefit of its senior position. And this agreed-upon allocation of risk affects many other elements of the lending relationship for both creditors — including loan pricing. Junior creditors typically receive significantly higher rates of return than senior lenders, due to the higher level of risk they take on.
Until now, we were pretty sure that all these provisions worked, but we didn’t have the benefit of a published case on point. It is helpful for both junior and senior creditors to have more certainty here.