The buyer's bank is demanding we sign a subordination agreement that would allow them to freeze our seller note payments if the buyer defaults on their senior loan. How do we negotiate these subordination terms to ensure we still get paid?

Question

Tyler Smith · Accepted Answer

Subordination agreements are a standard requirement for senior lenders, but a poorly negotiated agreement can turn your seller note into a permanent loss. If the buyer misses a minor financial covenant with their bank, the bank can trigger a payment blockage period, immediately halting your installment payments and trapping your cash inside the business. You must negotiate strict limitations on these blockage periods. First, insist that a payment blockage can only be triggered by a payment default on the senior loan, not a minor technical default like failing to submit a report on time. Second, limit the duration of any payment blockage to a maximum of ninety or one hundred and twenty days, and specify that the bank can only trigger one blockage period in any twelve month timeframe. Furthermore, structure the agreement so that any missed payments during a blockage period accrue interest at a default rate and become immediately payable once the blockage expires. This prevents the buyer and the bank from using the subordination agreement to permanently suspend your note payments while they try to restructure their senior debt. Your defense here is preparation. Do not wait until the week of closing to review the subordination agreement. Bring this up during the letter of intent phase as a critical deal point. Ensure your legal team understands that your seller financing is contingent on reasonable subordination terms that protect your cash flow.