The senior lender financing our buyer demands that our seller note be subordinated under an intercreditor agreement that includes a 180-day payment block notice if the buyer triggers any financial covenant breach. How do we negotiate these subordination terms and block notice limits so the bank cannot indefinitely freeze our seller note distributions?

Question

Tyler Smith · Accepted Answer

Senior commercial banks will always insist on priority payment status, but unchecked subordination agreements allow senior lenders to trap your seller note indefinitely. A standard bank intercreditor draft gives the lender the right to issue a 180-day block notice upon any technical covenant breach, such as late financial reporting, halting your interest payments even when the business is generating ample operational cash.

You must negotiate precise boundaries inside the subordination and intercreditor agreement to protect your cash flow:

- Bifurcate Defaults: Restrict automatic payment freezes strictly to senior payment defaults (non-payment of senior principal or interest) or bankruptcy events. For technical or non-monetary covenant breaches, require a mandatory thirty-day cure period before the bank can issue a block notice.

- Limit Block Duration and Frequency: Negotiate the block notice period down from 180 days to ninety or one hundred twenty days. Mandate that the senior lender can only issue one block notice within any rolling 360-day period. Once that block expires, cash payments to your seller note must resume automatically unless the bank has formally accelerated its debt and initiated commercial foreclosure proceedings.

- Payment-in-Kind (PIK) Accrual: Ensure that any interest payments blocked by senior debt do not disappear or stay interest-free. Blocked distributions must automatically capitalize into the note principal and accrue interest at a negotiated default penalty rate, typically two to four percent higher than the base note coupon.

Subordination should represent an orderly payment hierarchy, not an open-ended mechanism for the senior lender to fund the buyer operational deficits using your capital.