The buyer's senior lender is insisting on a stand-by provision in our seller note that halts our interest and principal payments if the buyer defaults on their senior bank covenants. How do we negotiate a limited block period and equity-conversion fallback to protect our stream of payments?

Question

Tyler Smith · Accepted Answer

A bank's demand for a stand-by provision in your seller note is a standard requirement, but you must prevent it from becoming a permanent freeze on your cash flow. If the buyer defaults on their senior debt, the bank will want to block all payments to subordinate lenders. To manage this risk, you must negotiate a strict limit on the block period and build in protective fallback mechanisms.

First, limit the block period to a maximum of ninety to one hundred and eighty days. The agreement must state that the bank can only block your payments once in any twelve-month period. Once the block period expires, the buyer must resume making payments to you, including all accrued and unpaid interest, even if the senior default is not yet cured.

Second, structure an equity-conversion feature that triggers if payments are blocked for more than ninety days. If the bank prevents the buyer from paying you cash, the unpaid amount should convert into senior preferred equity in the holding company at a highly favorable valuation.

This dilutes the buyer's ownership and gives you a voice in the boardroom. It also creates a powerful incentive for the buyer to resolve the senior default quickly rather than using the bank's stand-by provision as an excuse to ignore your note.