Intercreditor Agreements typically are contractual arrangements among lenders of similar or differing priorities to a single borrower secured by the assets of the borrower, often including real estate assets. These multiple layers of financing create uncertainty regarding the respective rights of the various lenders. To seek to avoid controversy, competing lien claims, extended time frames toward resolution and additional costs, the lenders seek agreements among themselves to establish priority, rights and obligations and procedures for addressing competing claims on assets among the lenders, especially to sort out the priorities of the first and second lien lenders.
Second-lien loans have been a part of leveraged finance markets for a long time, often fueled by the congruence of investors seeking higher returns and borrowers desirous of additions to their capital stack. Intercreditor agreements have played a pivotal role in enabling many of these transactions, delineating the rights and obligations of and among senior and junior creditors and establishing procedures for addressing defaults by borrowers. These agreements typically address issues like lien priority and subordination arrangements and agreements among lenders (whether in pari passu (equal priority) or subordinate priority positions), payment distributions, funding of operational costs and taxes coming due and pre-bankruptcy waivers. Such agreements exist because the various lenders wish to mitigate potential and actual conflicts in lender's claims and assertion of rights in cases of borrower default, workout or bankruptcy scenarios.
This paper considers the legal framework governing intercreditor agreements, focusing on subordination provisions under the U.S. Bankruptcy Code (the "Code") and, specifically, Section 510(a) thereof also considers key court decisions that have defined the scope and enforceability of these agreements, in whole or in part, particularly in cases involving contested waivers of statutory rights. Finally, the paper addresses some practical elements for structuring enforceable intercreditor agreements in bankruptcy situations.
Subordination under Bankruptcy Code Section 510
Section 510(a) of the Code provides that subordination agreements are enforceable in bankruptcy to the extent they are valid under applicable non-bankruptcy law. In re Bank of New England Corp., 364 F.3d 355 (2004), In re La Paloma Generating Company, 595 B.R. 466 (2018). Courts generally interpret such agreements under state contract law, focusing on the clarity and intent of the parties and sometimes contradictory provisions of the Code, as the Code does not provide a specific federal statute for interpreting these agreements. In re Bank of New England Corp., 364 F.3d 355 (2004). Intercreditor agreements also typically are enforced pursuant to their terms, and ordinary contract principles apply to their interpretation. In re Air Safety Intern., L.C., 336 B.R. 843 (2005). Where terms are unambiguous, they govern creditor rights in bankruptcy, but they cannot create a conflict with, or override fundamental protections guaranteed by the Code In re Ion Media Networks, Inc., 419 B.R. 585 (2009).
For example, in In re Best Products Co., Inc., 168 B.R. 35 (Bankr. S.D. N.Y. 1994)1, the court emphasized that subordination agreements must align with state law principles of enforceability. Ambiguities in such agreements may lead courts to consider extrinsic evidence, including the negotiating history underlying specific executed intercreditor agreements, to ascertain the parties' intent and match that to coordinate with Code requirements.
Key Court Decisions on Subordination Agreements
Beatrice Foods Co. v. Hart Ski Manufacturing Co. Inc., 5 B.R. 734 (Bankr. D. Minn 1980), is one of the earliest bankruptcy cases addressing intercreditor agreements governing the rights of creditors holding liens on the same collateral. The court limited subordination agreements to the priority of payment, emphasizing that statutory rights under the Code, such as stay relief or claim assertion, are not altered by pre-petition agreements. This decision highlights the principle that bankruptcy law preserves certain creditor rights regardless of contractual subordination provisions to the contrary.
In re 203 N. LaSalle Street Partnership,2 246 B.R. 325, 331 (Bankr. N.D. Ill, 2000), dealt with priority of claims and rights of senior and junior...
