The buyer's senior lender is insisting on a subordination agreement that prevents us from receiving any interest payments on our seller note if the business falls below a certain debt service coverage ratio. How do we negotiate a standstill period or payment block limits to protect our cash flow?

Question

Tyler Smith · Accepted Answer

Senior lenders almost always demand that a seller note be subordinated to their bank debt. This means if the buyer breaches a bank covenant, the lender can trigger a payment blockage. This blockage stops your interest and principal payments immediately. This can leave you stranded without recourse for months.

To protect your cash flow, you must negotiate strict limits on the bank's ability to block your payments. First, demand a standstill period of no more than ninety to one hundred and eighty days. A standstill period means the bank can only block your payments for a limited window. Once that window expires, the bank must either foreclose on the business or allow your seller note payments to resume.

Second, limit the number of blockage notices the bank can issue. For example, negotiate that the bank can only issue one payment blockage notice in any twelve-month period. This prevents them from continuously blocking your cash.

Finally, ensure that any unpaid interest during a blockage period is capitalized. This means it should be added to the principal balance of your note and compound over time. This structure forces the buyer and their senior lender to treat your seller note as a real, expensive obligation, rather than a cheap source of junior capital they can ignore whenever they miss a covenant.