The buyer wants us to take a seller note subordinate to their senior cash-flow lender, but the bank's standard subordination agreement prevents us from receiving any interest or principal payments if the buyer triggers a covenant default. How do we structure our seller note to allow ongoing payments unless there is a payment default?

Question

Tyler Smith · Accepted Answer

When you carry a seller note, senior lenders will almost always demand that you sign a subordination agreement. A standard bank subordination agreement contains a payment blockage clause, which halts your payments if the buyer violates any covenant in their senior credit agreement. This means a minor administrative default by the buyer could cut off your cash flow for months.

You must negotiate the terms of this subordination to protect your cash. First, demand a double-trigger blockage provision. This ensures your payments are only paused if there is a payment default on the senior debt or a bankruptcy event, not for minor technical defaults like late financial reporting. Second, negotiate a strict payment blockage window. Limit the senior lender's right to block your payments to a maximum of one hundred and eighty days in any three hundred and sixty-five day period. If the senior lender does not accelerate their debt or file for foreclosure within that window, your payments must resume.

Third, ensure that any blocked interest continues to accrue and compound, rather than being forfeited. Finally, use your EOS tools to monitor the buyer's health. Insist on receiving the same monthly financial packages and compliance certificates that the buyer sends to their senior lender. This keeps you informed and allows you to address operational issues before they lead to a default.