An intercreditor agreement is a contract among creditor groups that sets who gets paid first, who controls enforcement, and how sale proceeds flow when the borrower stumbles. Think of it as the operating manual for distress: it decides priority of liens and payments, standstill periods, consent rights, and the waterfall. An agreement among lenders is the unitranche cousin, an internal pact that splits a single lien into first-out and last-out pieces without involving the borrower.
In private credit, these documents decide who acts and when, what remedies are on the table, and how recoveries divide. They are not form-only. Small drafting choices change leverage in amendments, exchanges, and restructurings, and can swing recoveries by double digits, creating a direct P&L impact.
Structures and incentives that shape outcomes
First-lien and second-lien agreements set lien and payment priority across two secured term loans. Split-collateral structures give the asset-based revolver priority on receivables and inventory and the term loan priority on fixed assets, with priority collateral defined for each. Unitranche deals use an agreement among lenders: one lien outside, a private waterfall and control stack inside. Mezzanine and unsecured pieces can sit under separate subordination agreements. Hedge and cash management banks often join with caps and turnover rules tailored to their exposures.
Incentives diverge. Asset-based lenders want liquidity preservation, cash dominion, and swift action to protect the borrowing base. Term lenders want control over enterprise sales and full-scale restructurings. Last-out lenders accept less control for more yield but look for vetoes on major changes. Hedge and cash management banks want their close-out amounts protected without getting pulled into corporate battles.
Law and jurisdiction: what the documents must respect
US deals generally use New York law for the intercreditor agreement, with collateral governed where assets sit. Uniform Commercial Code Article 9 governs perfection and foreclosure of personal property. Section 510(a) of the Bankruptcy Code enforces subordination agreements as written, subject to the Code’s distribution scheme and the court’s powers over cash collateral, adequate protection, priming, and sale processes. Debtor-in-possession financings and 363 sales can shift control and recoveries if the court signs off, so process risk is real.
English-law deals lean on LMA-style intercreditor terms and a security trustee. Tools include receivers, administration, schemes, and Part 26A restructuring plans. Cross-class cram-down can confirm a plan over a dissenting class if statutory tests are met. The intercreditor still matters, but a court-approved plan can bind classes.
Across Europe, civil-law rules may require notarial steps, registries, and security agents to hold collateral. Priority by registration or privilege can limit what a contract can reorder. Canada and Australia use PPSA or PPSR concepts similar to Article 9 but differ on perfection by control and proceeds tracing. Cross-border structures typically pick New York or English law for the agreement, then layer local-law security and recognition mechanics.
Priority and subordination: the core mechanics
Two tools do most of the work. Lien subordination puts the senior class ahead on shared collateral, with juniors second. Payment subordination makes juniors turn over distributions they receive on shared collateral or sometimes on any borrower payments, until seniors are satisfied. Many first and second lien arrangements use lien subordination alone, letting purely unsecured junior recoveries sit at the same level as the senior if they do not come from shared collateral. Mezzanine subordination usually includes payment turnover. For background on how lien priority interacts with drafting choices, see this overview of intercreditor agreements and lien subordination.
Collateral, agents, and releases: define the toolbox
The agreement defines collateral and excluded assets, sets the scope of guarantees, and appoints a collateral agent or security trustee. It allocates authority to perfect, release, and amend. The senior agent typically has the sole right to enforce, to release collateral in permitted sales, and to execute credit bids or 363 sales. Make releases explicit for foreclosures, strict foreclosures, exchange transactions, permitted drop-downs, and restructurings approved by the senior class. Clear language promotes closing certainty and reduces injunction fights.
Enforcement standstill and protective rights
Juniors agree to stand still on remedies after certain defaults for a set period. In US practice, 90 to 180 days after non-payment defaults is common, with shorter or no standstill after a bankruptcy filing. English-law structures favor collective enforcement and payment of recoveries into a proceeds account for application under a pre-agreed waterfall. Carve-outs usually allow juniors to file proofs of claim, seek adequate protection, object to debtor-in-possession terms that touch their priority, and act against non-collateral assets if not prohibited. These protective rights keep juniors in the process without disrupting control.
Payment blockage and turnover: simple rules, fewer disputes
Payment blockages stop scheduled payments to juniors upon defined defaults. Market practice caps the duration for non-payment defaults and lifts blockages after cure or a deal. Turnover forces juniors to remit any shared-collateral proceeds they receive out of order. Good drafting clarifies no turnover for purely unsecured recoveries and explains how setoff, netting, and error corrections work. These details provide operational clarity and reduce downstream disputes.
Waterfall design: get the order and caps right
A typical waterfall applies collateral proceeds in an agreed sequence. Draft the list precisely to avoid ambiguity, and address post-petition interest, protective advances, and make-whole amounts.
- Costs first: Pay costs and expenses of the collateral agent and secured parties entitled to priority under the agreement. Closing and auctions cost real money.
- Court-approved items: Pay superpriority claims or senior adequate protection if approved by a court.
- Senior obligations: Pay senior secured obligations, including designated hedges and cash management, subject to negotiated caps.
- Junior obligations: Pay junior secured obligations next.
- Residual value: Deliver any remainder to the debtor or as law requires.
For hedges, tie sharing to exposure hedging the credit facility and cap recoveries to avoid draining collateral. Caps keep volatility from overwhelming loan economics.
Amendments and sacred rights: protect the core economics
Not all changes are equal. Sacred rights typically include lien or payment priority, waterfall, standstill duration, turnover, collateral and guarantee scope, and debtor-in-possession consent. These require consent of affected classes. Modern terms elevate priming liens, affiliate debt, and sidecar facilities to sacred status. Senior-only waivers can cover operational items, including collateral releases in permitted deals, so speed improves without changing class economics.
DIP financing, adequate protection, and sale governance
Intercreditor agreements assign consent rights on priming DIPs, use of cash collateral, and case stipulations. Seniors often get the sole right to fund or consent to a priming DIP, while juniors can object to preserve priority. Adequate protection payments and replacement liens flow to seniors first; junior protection sits behind. Spell out credit-bid rights, cooperation on sale timing and funding, and limits on junior objections that would derail a sale supported by seniors, with a carve-out to preserve junior economics. These provisions maintain deal momentum and limit courtroom surprises. For a refresher on the principle that courts follow in Chapter 11 distributions, see the absolute priority rule.
Hedging and cash management: limit volatility bleed
Designated hedge and cash management obligations can be secured and share in proceeds. Credit support is typically capped and tied to borrower-facing agreements with approved affiliates. Define close-out calculation mechanics, setoff, netting, and turnover if those obligations sit junior to term debt. Strong caps prevent market swings from diluting loan recoveries and keep the focus on credit risk rather than derivative noise.
Unitranche AALs: one lien outside, private order inside
Agreements among lenders assign priority between first-out and last-out lenders under one lien, mirror intercreditor agreements, and stay private to the lender group. They set internal waterfalls, buyout rights, and control terms. Courts have enforced AAL subordination under Section 510(a) when it is integrated into loan documents and drafted clearly. Tight integration with amendment and transfer provisions prevents accidental reordering through sacred-rights votes, exchanges, or open market purchases. For background on how these facilities are structured and priced, see unitranche loans and a step-by-step structuring guide.
Documentation alignment: make definitions and authority match
The intercreditor must match the rest of the stack. Keep definitions consistent across borders and documents, and give the right party authority to act.
- Credit agreements: Align lien baskets, incremental and sidecar facilities, MFNs, and transfer restrictions. Make the intercreditor a related document so priority changes cannot sneak in via amendments.
- Security documents: Keep collateral and guarantees definitions consistent. For typical requirements and local limits, see security packages and guarantees.
- Trust and agency: Assign enforcement authority cleanly to avoid conflicts between agents and trustees.
- Hedging schedules: Use templates and designated-party schedules to qualify for secured treatment and caps.
- Joinders: Make joinder automatic at funding, with standard forms attached for execution certainty.
Cash dominion, information, and transfers: recurring friction points
Cash dominion is the recurring friction point in ABL versus term structures. Asset-based lenders want daily sweeps and tight springing dominion triggers. Term lenders resist sweeps that drain liquidity when a going-concern sale is likely. The intercreditor should specify who holds deposit account control agreements, when dominion springs, and how trapped cash is allocated during and after enforcement. Address information sharing and notices as well. Senior agents usually owe no duty to share material nonpublic information beyond required notices; juniors waive claims against agents for withholding it. To prevent governance distortions, block transfers to disqualified lenders and prevent cross-holdings from controlling both classes.
Economics and a simple illustration: why caps and costs matter
The intercreditor sets recoveries, amendment costs, and distribution timing. Agents charge acceptance and annual fees for administering collateral and the agreement. Hedge banks rarely pay separate fees but may negotiate cost allocation.
Example: gross foreclosure proceeds of 120; enforcement costs of 5; senior term debt 80 including 2 of accrued interest; junior term debt 60; senior hedges 10; junior hedges 5; hedge sharing capped at 20 percent of net proceeds.
- Costs paid: Five pays enforcement costs.
- Net proceeds: One hundred fifteen remains. Senior hedge cap equals 23, which is 20 percent of 115. Senior hedges share pro rata with senior term debt.
- Senior recovery: Senior takes 80 plus up to 23 for hedges. If total senior obligations are 82 inclusive of hedges, residual is 33.
- Junior recovery: Thirty-three goes to junior secured obligations, junior term 60 and junior hedges 5. Junior recovers 33 of 65, about 50.8 percent.
Change the cap or push hedges junior, and the split moves fast. Raise enforcement costs or extend standstill, and net proceeds shrink. Timing and friction cost matter as much as headline leverage.
Accounting, tax, and compliance: what does not change, what might
An intercreditor or AAL does not change instrument classification under US GAAP or IFRS. It shapes expected credit loss models through probability-weighted recoveries and timing. First-out positions carry lower expected losses and lower effective yields; last-out prices in loss given default and slower cash. Borrowers do not recognize the intercreditor; they account for secured debt under the credit agreement. Exchanges under flexibility can trigger extinguishment accounting if terms are substantially different. Disclosures should describe collateral, guarantees, and creditor priority if material to liquidity and solvency assessments.
Tax treatment typically follows the underlying instruments. The agreement usually does not alter borrower withholding or interest characterization. Cross-border payments still rely on treaty eligibility, portfolio interest, or the quoted Eurobond exemption. Payment blockages and turnover can shift interest accrual timing for lenders. For US taxpayers, cancellation of debt income turns on the debt modification, not the intercreditor, but waterfalls directing debt-for-equity at enforcement can hardwire CODI across entities. Hedge close-outs generate gains or losses on termination; netting and turnover do not change the tax but can complicate reporting. Align KYC and sanctions with joinders. Collateral agents cannot distribute to sanctioned parties, and information-sharing should respect wall-crossing and confidentiality.
Risks and edge cases: find and fix before signing
- Silent seconds: Long standstills can let value degrade. Use objective end dates and early termination if seniors fail to act.
- Priming and sidecars: Loose language enables affiliate priming. Make priming, affiliate liens, and sidecars sacred rights requiring class consent.
- Exchange leakage: Non-pro rata exchanges create new senior tranches. Tie credit agreement sacred rights to the intercreditor and define open market narrowly.
- DIP process: Courts can approve priming DIPs over junior objection with adequate protection. Give juniors a right to propose an alternative DIP within defined terms.
- Releases and transfers: Define permitted dispositions and authorize agent releases in unit sales and credit bids.
- Hedge treatment: Unclear caps let volatility eat collateral. Cap recoveries and limit designation to borrower-facing hedges.
- Foreign collateral: Confirm the agent can hold and enforce under local law, and obtain local opinions and filings.
Comparisons and alternatives: use structure to reduce conflict
Contractual intercreditor terms sit beside structural subordination and collateral allocation. Holding-company debt avoids an intercreditor but relies on upstream capacity and restricted payment covenants. Split-collateral ABL and term structures cut conflict by assigning different pools. Pari passu sharing under a collateral trust simplifies enforcement but pushes economics into pricing and internal allocation. When speed and confidentiality matter, unitranche shines. One lien lowers borrower execution risk and shortens closing. The AAL moves complexity inside the lender group and requires tight drafting to prevent priority leaks in amendments and exchanges. For a comparison of junior layers used under senior facilities, see second-lien loans and mezzanine debt, plus alternatives like preferred equity or holdco PIK notes.
Implementation notes and a one-hour diligence sprint
Practical drafting sequence
- Term sheet: Fix class splits, collateral scope, lien priority, standstill, waterfall, DIP consent, hedge treatment, sacred rights.
- First draft: Senior counsel leads; juniors focus on standstill, turnover limits, DIP carve-outs, amendments. Bridge definitions to the credit agreement.
- Collateral setup: Negotiate deposit account control agreements and stock pledges. Work out dominion and springing triggers.
- Designations: Finalize hedge and cash management schedules, caps, and forms.
- Conditions and opinions: Deliver enforceability and priority opinions; align filings with collateral definitions.
- Closing: Execute the intercreditor last to ensure alignment; include MFN and joinder terms for future facilities.
Fresh angle – model-first redlines
- Waterfall test: Build a short spreadsheet that runs proceeds through the draft waterfall with agent fees, protective advances, hedge caps, and post-petition interest toggles.
- Standstill timer: Add a Gantt line for default, notice, standstill start, and early termination triggers. Identify dead zones where no party can act.
- DIP toggles: Model a priming DIP with alternate providers and see which clause blocks or allows each path.
- Transfer stress: Simulate cross-holdings and disqualified lender scenarios to ensure governance does not flip accidentally.
A short checklist to avoid surprises
- Priority: Lien-only or payment turnover as well.
- Standstill: Duration, triggers, and early termination if seniors do not act.
- Waterfall: Order, hedge or cash caps, post-petition interest, make-whole, protective advances.
- Collateral releases: Permitted sales, credit bids, strict foreclosures, restructurings.
- DIP and cash collateral: Consent rights, junior objection carve-outs, alternative DIP rights.
- Amendments: Sacred rights list and cross-link to the credit agreement.
- Information and MNPI: Notices, confidentiality, wall-crossing protocol.
- Transfers: Restrictions, cross-holding limits, and disqualified lender list.
- Joinders: Automatic mechanics and forms for future debt and designated parties.
- Foreign-law constraints: Recognition of agents, perfection, and proceeds tracing.
Key Takeaway
Intercreditor agreements and AALs decide control and value in distress. Draft for processes, not preferred outcomes. Align the credit agreement, security documents, and intercreditor, cap and qualify hedge sharing, and build for court realities in the US and UK. Then model the math. A 30-minute waterfall test with DIP and hedge toggles will surface most of what matters before the first redline.