The buyer is requiring us to accept a seller note to bridge their funding gap, but their senior bank lender is demanding we sign a subordination agreement with a strict standstill provision. How do we negotiate these subordination terms so we do not lose our right to collect interest and principal if the business misses its covenants?

Question

Tyler Smith · Accepted Answer

Senior lenders will always demand that your seller note is subordinated to their bank debt, but you must fight to keep this subordination from turning into a complete block on your cash flow. A standard bank-drafted subordination agreement often includes a standstill clause that prevents you from taking any collection action or receiving payments for up to one hundred and eighty days if the buyer defaults on their bank loan.

To protect your yield, you must negotiate clear carve-outs before signing the letter of intent.

First, ensure the subordination agreement permits the ongoing payment of regularly scheduled interest and principal, often called permitted payments, as long as there is no active senior default. Do not agree to block payments unless a formal default notice has been issued by the bank.

Second, limit the standstill period. A reasonable standstill should not exceed ninety to one hundred and twenty days. Once that period expires, you must have the right to pursue remedies or receive payments if the senior lender has not accelerated their own debt.

Third, insist on a block limit. The senior lender should only be allowed to trigger one payment blockage period in any twelve-month period to prevent them from continuously rolling over the default status.

During this transition, your leadership team must use the Accountability Chart to ensure the business transition is seamless. Keep tracking your operational metrics closely. If you see the buyer struggling to maintain the standard operational rhythm, use your relationship to address the issues before a bank covenant is tripped. Your goal is to keep the business healthy enough that the senior lender never has a reason to trigger the standstill.