The buyer is requiring us to accept a seller note that is fully subordinated to their senior bank lender, which means we cannot collect payments if they default on their primary bank covenants. How do we structure the intercreditor agreement and note terms to protect our cash flow without triggering a veto from their senior lender?

Question

Tyler Smith · Accepted Answer

Subordination is a standard requirement for senior lenders, but it should not leave you entirely unprotected. When a senior lender demands subordination, they want to ensure that their debt is paid first and that they can block payments to you if the business struggles. Your goal in negotiating the intercreditor agreement is to limit the scope and duration of these payment blockages.

First, negotiate a strict payment blockage limit. The senior lender will want the right to block payments to you during any covenant default. You must cap these blockage periods to no more than one hundred and eighty days in any twelve-month period. If the buyer remains in default after that window, your payments must automatically resume unless the senior lender has initiated formal foreclosure proceedings.

Second, structure the note so that unpaid interest is capitalized. If payments are blocked, the missed payments should accrue interest at a default rate and be added to the principal balance, rather than simply being forgiven or delayed without penalty.

Third, include equity conversion rights in your agreement. If the buyer defaults on your seller note and the senior lender blocks cash payments, the note should convert into senior equity or voting shares. This gives you direct operational leverage and a seat on the board of directors without violating the senior lender's cash covenants. By structuring these guardrails, you maintain pressure on the buyer to manage their operations effectively.