If we agree to carry a subordinate seller note to close a valuation gap, what specific intercreditor terms and default remedies must we demand so the senior bank cannot permanently freeze our interest payments?

Question

Tyler Smith · Accepted Answer

Senior commercial lenders always treat seller debt as an equity cushion designed to absorb operational shocks ahead of the bank. When an owner accepts a seller note without reading the intercreditor agreement, they often discover too late that the buyer bank can switch off their quarterly interest payments under standard debt service coverage covenants.

To ensure your seller note functions as an asset rather than uncompensated subordinate equity, negotiate these specific terms before signing the term sheet:

- Limit payment blockage periods. Senior banks routinely ask for the right to freeze payments to subordinate noteholders upon any covenant default. You must cap these payment blockages to a hard limit, typically 90 to 180 days in any 360-day period. Once that window expires, regular interest payments must resume unless the senior lender has initiated formal foreclosure proceedings.
- Allow unblocked cash interest payments. Never agree to complete payment-in-kind interest unless you receive a corresponding equity conversion right. Insist that non-default cash interest payments flow unobstructed as long as the business meets a realistic debt service coverage ratio.
- Establish personal guarantees or parent guarantees. If the buyer operates through an acquisition shell entity, require a corporate parent guarantee or an individual sponsor guarantee to secure the principal balance.
- Retain inspection and reporting rights. You must receive quarterly financial packages, including trailing twelve-month balance sheets and income statements, within 30 days of quarter-end. This is standard corporate hygiene.

If the senior lender demands total standstill terms that strip away all default remedies for multiple years, the seller note is not debt. It is disguised equity. In that scenario, demand warrants or a higher headline interest rate to justify the junior risk profile.