The senior lender's draft subordination agreement allows them to freeze our seller note payments for one hundred eighty days upon any technical default by the borrower, even if all bank debt payments are current. How do we negotiate intercreditor terms to restrict these payment blockages?

Question

Tyler Smith · Accepted Answer

Senior lenders routinely attempt to draft subordination agreements that allow them to halt subordinated seller note payments whenever the borrower triggers any technical covenant default, such as a delayed delivery of quarterly financial statements or a minor reporting variance. If left unchecked, the buyer and lender can trap your cash flow indefinitely while the operating company continues business as usual.

First, restrict payment blockage triggers strictly to material payment defaults on senior debt. A payment blockage should only occur if the borrower actually fails to pay senior principal or interest, or if the borrower files for bankruptcy protection. Eliminate technical and reporting covenants entirely from the definition of a blockage event.

Second, limit the duration and frequency of technical blockage notices if the lender insists on including covenant defaults. Cap the blockage period at ninety days instead of one hundred eighty days, and stipulate that the senior lender may only issue one blockage notice within any consecutive three-hundred-sixty-five-day period. This prevents the lender from rolling back-to-back blockage periods that freeze your payments perpetually.

Third, mandate an automatic catch-up provision. As soon as the specified blockage period expires or the underlying default is cured or waived by the senior lender, the borrower must immediately pay all accrued, unpaid principal and interest to you. Require that interest accrues at a higher default rate during any blockage period, and insert language that if the senior lender continues to block payments while accepting borrower distributions or bonuses, the standstill expires immediately.