Mezzanine Debt Intercreditor Relationships

A key element in any mezzanine transaction is the critical relationship of the mezzanine holders to senior and junior creditors. The mezzanine lender is often positioned under the bank but ahead of a seller note or equity investor.

The type and amount of debt to which mezzanine lenders will agree to be subordinated is frequently a highly negotiated point. Some deals make the mezzanine debt subordinated to all debt of the issuer that is not explicitly subordinated by its terms.

Others provide that the mezzanine debt is subordinated only to the bank credit facility. Typically, a mezzanine lender is only subordinated to the senior lender.

Intercreditor relationships are essential to define as they can help a company get through a difficult time period. If a company has a down year, it may not have extra cash to pay its mezzanine lender.

In this instance, a senior loan covenant would be tripped and the interest payment to the mezzanine lender would be blocked. This helps the company refresh its cash position and get back on its feet again.

The subordination provisions in the debt instruments, together with the intercreditor agreement, commonly provide that payments on the mezzanine notes will be suspended if a payment default occurs on the designated senior debt.

Moreover, if a covenant default under the designated senior debt occurs, holders of such senior debt usually have the right to send a blockage notice to the mezzanine debt holders, which suspends payment on the mezzanine debt for up to 179 days.

The mezzanine lenders generally limit the senior lenders to one blockage notice per 365-day period and sometimes limit the total number of blockage notices that can be delivered during the term of the mezzanine debt.

Senior lenders expect the mezzanine holders to be subject to standstill provisions that limit their ability to exercise any remedies, such as bringing suit for payment after a default or acceleration, until action is taken by the senior lenders.

Some mezzanine investors negotiate to shorten the standstill period. At the end of the payment blockage period, the issuer must make catch up payments to the mezzanine holders or the mezzanine investors have a right to accelerate their debt.

Some senior lenders negotiate for complete subordination where the mezzanine holders are prohibited from exercising any contractual remedies before maturity absent consent of the senior creditors. In most cases, mezzanine lenders resist these requests.