FIRST LIEN/SECOND LIEN INTERCREDITOR AGREEMENTS AND RELATED ISSUES

Transcription

1 FIRST LIEN/SECOND LIEN INTERCREDITOR AGREEMENTS AND RELATED ISSUES An Introduction to the ABA Model Intercreditor Agreement Presented by: Michael S. Himmel, Chapman and Cutler LLP ABA Business Law Section Secured Lending & Secured Transactions Joint Meeting April 11, 2014

2 Introduction to ABA Model Intercreditor Agreement Sample Provisions and Alternatives: The Model First Lien/Second Lien Intercreditor Agreement Task Force was established to develop a balanced, market-based model form of intercreditor agreement that specifies the rights of first lien and second lien lenders holding pari passu senior debt secured by identical collateral that fairly protects the respective interests of first lien and second lien lenders while reflecting market expectations and standard practices. The Task Force Report along with the Model Agreement was published in the May 2010 edition of The Business Lawyer. 1

3 There is No One Market Standard The form of the Model Agreement tries to identify the different interests and includes alternative and optional provisions as well as commentary, in light of: 2

4 A. Goals from the perspective of the First Lien Claimholders include: (1) The liens of the first lien claimholders have priority over the liens of the second lien claimholders. (2) The enforcement rights of the first lien claimholders have priority over the enforcement rights of the second lien claimholders. (3) The first lien claimholders have priority as to the application of the proceeds of collateral from any enforcement action over the second lien claimholders. (4) Limit the extent to which the rights of the second lien claimholders may be asserted in conflict with the interests of the first lien claimholders in a bankruptcy proceeding. 3

5 B. Concerns from the perspective of the Second Lien Claimholders include: (1) The second lien claimholders want to avoid de facto payment subordination if (i) the lien securing first lien obligations maintains priority, and a turn-over right, under the intercreditor agreement even if unperfected, invalid, avoided or equitably subordinated, or (ii) first lien obligations include amounts whether or not allowable in an insolvency proceeding and the amounts are not allowed. (2) The second lien claimholders do not want to have less rights than they might otherwise have as an unsecured creditor. 4

6 Section 1. - Lien Priorities Section 1.1. Seniority of Liens Securing First Lien Obligations. The scope of the first lien to which the second lien is subordinate potentially has serious consequences for the second lien lender. First Lien Claimholder favorable alternative: First lien lenders lien on the common assets remains superior (up to the amount of the first lien cap) even if the first lien lenders fail to properly perfect their lien or allow their lien to lapse, or their lien is avoided in bankruptcy or otherwise. Second Lien Claimholder favorable alternative: First lien lenders lien on the common assets remains superior (up to the amount of the first lien cap) only if the first lien lenders have a valid and perfected security interest not subject to avoidance as a preferential transfer or otherwise by the debtor or a trustee in bankruptcy. 5

7 Section 1.2. No Payment Subordination. The subordination of liens securing second lien obligations to liens securing first lien obligations pursuant to Section 1.1 affects only the relative priority of those liens, and does not subordinate the second lien obligations in right of payment to the first lien obligations. The Model Agreement provides that nothing in the intercreditor agreement will affect the entitlement of any second lien claimholder to receive and retain required payments of interest, principal, and other amounts in respect of second lien obligations unless the receipt is expressly prohibited by, or results from the second lien claimholder s breach of, the intercreditor agreement. 6

8 Unintended Payment Subordination. Unintended payment subordination by the second lien lenders may result if (i) the lien securing first lien obligations maintains priority, and a turn-over right, under the intercreditor agreement even if invalid, unperfected, avoidable or equitably subordinated, or (ii) first lien obligations include amounts whether or not allowable in an insolvency proceeding and the amounts are not allowed, and the second lien lenders are forced by their agreement to an absolute priority provision in the intercreditor agreement to be subordinate to the first lien lenders. An agreement to continue to treat a first lien lender having an unperfected, avoided, disallowed or equitably subordinated claim as being perfected and senior to the second lien lender converts lien subordination into payment subordination to unsecured, avoided, disallowed or equitably subordinated indebtedness. This can result in payment subordination of the claims of second lien lenders to the extent of first lien claims not allowed in an insolvency proceeding, which also leaves the second lien lenders with no enforceable subrogation rights in respect of such claims. Second lien lenders may be in a far worse position than if they were unsecured creditors. 7

9 Section 1.3. First Lien Obligations and Second Lien Obligations. First lien obligations typically include loans and letter of credit obligations under the first lien credit agreement (including all such obligations guarantied by other debtors/grantors) as well as hedging obligations and sometimes cash management obligations, together with guaranties. Second lien obligations typically include loan obligations under the second lien credit agreement (including all such obligations guarantied by other debtors/grantors) and sometimes hedging obligations as well. First Lien Claimholder favorable alternative: Include all amounts, whether or not allowable in an insolvency proceeding and whether or not any payment or lien securing the same is declared to be fraudulent, preferential, or set aside. Second Lien Claimholder favorable alternative: Limit first lien obligations to the extent they are secured by a valid, perfected and unavoidable lien on the collateral in favor of the first lien agent, and a claim for such obligations would be allowed or allowable in an insolvency proceeding applicable to the relevant debtor. 8

10 Section 1.4. First Lien Cap (and Second Lien Cap). The Model Agreement recognizes second lien claimholders interest in limiting the first lien obligations, and notes that sometimes first lien claimholders have an interest in capping the second lien obligations. While a first lien cap is designed to protect the second lien claimholders from unanticipated increases in the first lien debt, the first lien claimholders want to make sure that they have a sufficient cushion to deal with additional cash needs by the borrower as part of a loan workout or otherwise. While generally consistent as it relates to principal (with cushions ranging from 110%-115% of the aggregate commitments under the first lien documents), there are different approaches to dealing with (i) term amortization and conversion from term loan to revolver, (ii) advances in excess of borrowing base formulas, (iii) interest and fees, including PIK payments, (iv) indemnity claims, (v) bank product claims and hedging caps, and (vi) inclusion of a cushion for DIP financing extended by first lien claimholders. 9

11 Effect of exceeding the Cap: Even though obligations in excess of the first lien cap are not intended by the parties to be treated as first lien obligations, the liens securing the first lien obligations (including UCC financing statements and mortgages or deeds of trust) are usually filed before the liens securing the second lien obligations (including UCC financing statements and mortgages or deeds of trust) and would therefore remain first priority liens under the first to file rule. Many intercreditor agreements fail to address the consequences of the first lien lenders exceeding their first lien cap. The Model Agreement tries to answer this by providing in Section 1.11 that the lien on collateral securing first lien obligations will have priority over the second lien obligations up to but not in excess of the first lien cap, and the lien on collateral securing first lien obligations in excess of the first lien cap will be subordinate to the lien securing the second lien obligations (subject to any second lien cap). If the first lien lenders negotiate a second lien cap (where, for example, there is uncertainty as to whether the value of the collateral will exceed all obligations that could be incurred by the borrower to the first lien lenders and the second lien lenders), then the lien on collateral securing second lien obligations in excess of the second lien cap will be subordinate to the lien on collateral securing first lien obligations in excess of the first lien cap. 10

12 Section 1.8. Prohibition on Contesting Liens; No Marshaling. First and second lien lenders typically agree not to challenge the priority, perfection, or validity of their respective liens. In light of the decision in In re ION Media Networks (SDNY November 2009), in which, as a result of an intercreditor agreement that subordinated second lien claims to any lien purportedly securing any of the first lien obligations, the second lien lenders failed in their attempt to argue that certain FCC licenses were not first lien collateral, the comments to the Model Agreement point out that the parties may want to consider: First Lien Claimholder favorable alternative: expressly prohibiting second lien claimholders from having any right to challenge priority on the grounds that certain property does not constitute first lien collateral. Second Lien Claimholder favorable alternative: preserve for the second lien claimholders an express right to challenge priority on the grounds that certain property does not constitute first lien collateral. 11

13 Section Release of Liens [or Guaranties]. Provides that the lien of the second lien agent on collateral will be automatically and simultaneously released if the first lien agent releases its lien on such collateral in connection with: (1) an enforcement action, or (2) a disposition of any collateral under the first lien loan documents other than pursuant to an enforcement action (whether or not there is an event of default under the first lien loan documents), unless (x) for an enforcement action, as to any collateral the net proceeds of the disposition of which will not be applied to repay (and, to the extent applicable, to reduce permanently commitments with respect to) the first lien obligations, or (y) for a disposition, if the disposition is prohibited by a provision of the second lien credit agreement [other than solely as the result of the existence of a default or event of default under the second lien loan documents] (the bracketed language is more favorable to first lien claimholders). Second lien lenders should have their own asset sale covenants. 12

14 A. What about release of guarantors (not just collateral): First Lien Claimholder favorable alternative: include in the automatic release mechanism the release of a debtor from its obligations under a guaranty of the second lien obligations if the first lien agent releases such debtor from its obligations under a guaranty of the first lien obligations which guaranty is secured by a lien on collateral. Second Lien Claimholder favorable alternative: do not extend the automatic release mechanism to the release of a debtor from its obligations under a guaranty (since this may have the effect of subordinating second lien claims to unsecured creditors of the guarantor). 13

15 B. What about a disposition of collateral during a default, but sold voluntarily by a debtor (as opposed to a forced sale by the first lien agent under the UCC or other applicable law): First Lien Claimholder favorable alternative: the Model Agreement provides that the disposition of collateral by any debtor after the occurrence and during the continuation of an event of default under the first lien loan documents with the consent of first lien agent may be included in the definition of enforcement action. Second Lien Claimholder favorable alternative: do not include a voluntary disposition of collateral (even if such disposition is consented to by the first lien agent during a default) as an enforcement action. 14

16 To understand the effect of a First Lien/Second Lien Intercreditor Arrangement, consider the following examples: 15

17 A. Debtor has $100 million in assets, $150 million in creditor claims where 1st Liens and 2nd Liens are valid, perfected, and not avoidable. Holder of First Lien Debt Holder of Second Lien Debt Holder of Unsecured Debt Amount held by each creditor $50 million $50 million $50 million Distribution in an insolvency proceeding $50 million $50 million 0 Payover provision adjustments Amount received by each creditor $50 million $50 million 0 16

18 B. Debtor has $100 million in assets, $150 million in creditor claims where 1st Liens are not perfected (and 2nd Liens are valid, perfected and not avoidable) where Intercreditor Agreement recognizes 1st Lien claims as prior on the collateral whether or not valid, perfected or avoidable. Holder of First Lien Debt Holder of Second Lien Debt Holder of Unsecured Debt Amount held by each creditor $50 million $50 million $50 million Distribution in an insolvency proceeding $25 million $50 million $25 million Payover provision adjustments +$25 million -$25 million Amount received by each creditor $50 million $25 million $25 million 17

19 C. Debtor has $100 million in assets, $150 million in creditor claims where 1st Liens are not perfected (and 2nd Liens are valid, perfected and not avoidable) where Intercreditor Agreement qualifies 1st Lien priority to being valid, perfected and not avoided. Holder of First Lien Debt Holder of Second Lien Debt Holder of Unsecured Debt Amount held by each creditor $50 million $50 million $50 million Distribution in an insolvency proceeding $25 million $50 million $25 million Payover provision adjustments Amount received by each creditor $25 million $50 million $25 million 18

20 D. Comparison to subordinated debt capital structure where Debtor has $100 million in assets, $150 million in creditor claims: Holder of First Lien Debt Holder of Second Lien Debt Holder of Unsecured Debt Amount held by each creditor $50 million $50 million $50 million Distribution in an insolvency proceeding $33.33 million $33.33 million $33.33 million Payover provision adjustments +$16.67 million -$16.67 million Amount received by each creditor $50 million $16.67 million $33.33 million 19

21 Section 2. Modification of Obligations: The Model Agreement starts with the base line concept that the first lien claimholders and second lien claimholders are generally free to amend their respective loan documents and refinance the obligations thereunder subject to meeting a limited set of parameters. The modification provisions are intended to balance the desire of each class of creditor to freely administer its loan documents and refinance the debt thereunder against the interest of the other class of creditor in protecting against any modification or refinancing that alters any fundamental assumption about the borrower s capital structure relied on in underwriting the transaction. 20

22 Fundamental issues usually addressed in the modification provisions requiring consents include prohibitions on: (1) increasing the maximum permitted advances of first lien/second lien obligations above negotiated caps; (2) extension of the maturity of the first lien obligations beyond the maturity date of the second lien obligations; (3) accelerating the amortization/maturity of the second lien obligations or increasing any mandatory prepayment obligations; and (4) increasing interest rates above specified levels. 21

23 Section 3. Enforcement First lien claimholders are afforded enforcement priority over the second lien claimholders with respect to the collateral for a limited standstill period in which to exercise their exclusive right to bring enforcement actions with respect to the collateral, which typically ranges from 120 to 180 days, depending upon factors such as the relative bargaining strength of the parties, the nature of the borrower s business and the collateral, and other factors that may reduce or lengthen the amount of time necessary for first lien claimholders to evaluate whether or not to commence an enforcement action. After the standstill period expires, the second lien claimholders are entitled to pursue enforcement actions unless first lien claimholders are diligently pursuing an enforcement action with respect to all or a material portion of the collateral. In all cases, any judgment lien obtained by a second lien claimholder as a result of such exercise of rights is intended to be included in the second lien collateral and to be subject to the intercreditor agreement for all purposes. 22

24 Notwithstanding the foregoing, the form of the Model Agreement acknowledges that there are different points of view on the exercise of unsecured creditor rights: First Lien Claimholder favorable alternative: Other than as expressly set forth under the terms of the intercreditor agreement, the second lien claimholders may exercise any rights and remedies that could be exercised by an unsecured creditor other than initiating or joining in an involuntary case or proceeding under the Bankruptcy Code with respect to a debtor. Second Lien Claimholder favorable alternative: second lien claimholders may exercise any rights and remedies that could be exercised by an unsecured creditor. 23

25 Section 4. Application of proceeds of collateral; insurance proceeds; and turn over protection The Model Agreement provides for the application of proceeds received in connection with an enforcement action (and proceeds of insurance) first to the first lien obligations up to any cap amount, then to the second lien obligations (up to any cap amount), then to any excess first lien obligations, and finally to any excess second lien obligations. Commonly referred to as a waterfall provision, it applies before or after the commencement of an insolvency proceeding. The Model Agreement acknowledges that the requirement that the second lien claimholder turn over any amounts it receives in connection with the exercise of enforcement actions (and certain other actions) is fundamental to the operation of the waterfall provisions. It should be noted, however, that this provision does not apply to payments or other distributions made in an insolvency proceeding unless those payments or other distributions are received in connection with an enforcement action. 24

26 Section 5. Purchase of First Lien Obligations by Second Lien Claimholders The Model Agreement recognizes market practice is to grant the second lien lenders a right to purchase the first lien debt following an acceleration of the first lien debt, the filing of bankruptcy proceedings, or following an uncured payment default. The purchase price is at par. The Model Agreement includes provisions to deal with undrawn letters of credit and with prepayment premiums as well as provisions for the unwinding of any hedging obligations that are included as first lien obligations. The Model Agreement sets forth procedures for giving notice of the election of the exercise of the purchase option (which is to be on a non-recourse basis), establishing the purchase price, and purchase closing mechanics, in addition to setting forth what happens if there are first lien obligations in excess of the cap amount and how certain actions are dealt with post closing. 25

27 Section 6. Insolvency Proceedings Goal of this Section is to obtain consents and waivers by second lien claimholders to limit the extent to which the rights of second lien claimholders in collateral may be asserted in conflict with the interests of the first lien claimholders during a bankruptcy case. Negotiations dependent on how silent the second lien has been negotiated with respect to the business points. These provisions are usually one of the most vigorously negotiated portions of the intercreditor agreement - transaction counsel frequently involve bankruptcy counsel to assist in negotiations and drafting. 26

28 Primary insolvency issues include: (1) Use of Cash Collateral and DIP Financing (2) Second Lien Lender s Ability to Provide DIP Financing (3) Section 363 Sale of Collateral (4) Stay Relief (5) Adequate Protection (6) First Lien Objections to Second Lien Actions (7) Avoidance and Reinstatement (8) Plan Confirmation/Voting Rights (9) Reorganization Securities and Other Topics 27

29 1. USE OF CASH COLLATERAL AND DIP FINANCING The Model Agreement includes customary deemed consent provision by second lien claimholders to use of cash collateral and priming DIP facility supported by first lien claimholders. Limitations and conditions to deemed consent embraced by the Model Agreement: (1) Cap on amount of DIP financing obligations - defined term: first lien cap - consider whether it is desirable to formulate cap differently to include an incremental cushion for DIP financing or cap that is lesser of first lien cap and some cushion over outstanding first lien obligations on petition date. (2) Acknowledges that second lien claimholders will often retain right to object to DIP financing provisions that dictate terms of a restructuring or an expedited liquidation of assets. (3) Acknowledges that second lien claimholders are typically able to request junior replacement liens in post-petition collateral as adequate protection against collateral diminution. 28

30 (4) Provides that DIP financing liens and claims are pari passu or superior in priority to prepetition first lien claimholders liens and claims. Note, comments suggest first lien claimholders consider deleting this requirement given first lien cap and ability to do a junior DIP. (5) Provides that DIP facility interest rate, fees, advance rates and lending limits and sublimits are commercially reasonable. Note, comments suggest first lien claimholders will view this as creating the potential for delay and uncertainty - second lien claimholders generally retain rights to assert objections that may be asserted by unsecured creditors. (6) Grants first lien claimholders right to compel second lien claimholders to join any objection by first lien claimholders to use of cash collateral for any purpose other than agreed payments to second lien claimholders. This attempts to harmonize market considerations that generally give first lien claimholders the power to compel second lien claimholders to consent to the diminution of collateral (in the form of use of cash collateral) or permitting additional secured (DIP) financing even if the first lien claimholder is sufficiently oversecured and is otherwise not motivated to police the excess use of cash collateral or DIP financing. To the extent compelled, second lien claimholders typically require that their expenses be paid by DIP financing or first lien claimholders. 29

31 (7) Treats professional fee carve-outs as a use of cash collateral and/or part of the DIP financing. Note, first lien cap has to take this into account if carve out is to be included in the DIP financing. Thus, second lien claimholder is deemed to consent to carve out agreed to by first lien claimholder. (8) May permit a second lien claimholder to propose providing a priming DIP facility if no first lien claimholder offers to provide DIP financing, although the first lien claimholders may object. This attempts to reach a compromise between first lien claimholders desire to have an absolute bar and second lien claimholders argument that they should be permitted since other parties are able to propose the same. (9) Permits second lien claimholders to assert any objection to DIP financing that is generally available to unsecured creditors and is consistent with the intercreditor agreement. First lien claimholders do not want second lien claimholders to object in any capacity so long as DIP financing satisfies parameters specified in the intercreditor agreement. 30

32 2. SECTION 363 SALE OF COLLATERAL The Model Agreement provides that second lien claimholders will consent and not object to a 363 sale provided that: (1) Liens of second lien claimholders attach to proceeds (2) The net cash proceeds are applied to permanently reduce first lien obligations (3) Second lien claimholders have not waived right to credit bid for assets Other acknowledged points of contention between first and second lien claimholders. Compelling second lien claimholders to join any objection of first lien claimholders to a sale. Usually resisted by second lien claimholders. In split collateral situations, parties should consider agreeing on a methodology to allocate value received in a disposition between the different categories of assets. 31

33 Need to reconcile permanent paydown provision with circumstances where liabilities of grantors are assumed or where proceeds are not used to pay down loans (i.e., cure payments for assumed contracts and carve out payments). Second lien claimholders retain rights to assert general unsecured creditor objections to the extent not inconsistent with the intercreditor agreement. Usually resisted by first lien claimholders, especially given second lien claimholders buyout rights. 32

34 3. STAY RELIEF AND ADEQUATE PROTECTION The Model Agreement permits second lien claimholders to seek adequate protection and stay relief in the form of: Junior replacement lien on collateral junior to DIP financing liens and first lien claimholder liens if the first lien claimholder is granted adequate protection in the form of a replacement lien in connection with a DIP financing or use of cash collateral motion. Superpriority administrative claim under Section 507(b) for diminution in value of collateral that is subordinate to 507(b) claim of first lien claimholders. The Model Agreement suggests a provision that would permit confirmation of a plan so long as second lien claimholder s 507(b) claim could be satisfied under a cram down type test. Other considerations are subordinating the right of second lien claimholders to assert 507(b) claims in their entirety until first lien obligations are satisfied in full. Cash payments (usually equal to interest) so long as the first lien claimholders are receiving cash adequate protection payments subject to turnover if first lien claimholders claims are not paid in full on effective date of plan. The Model Agreement contemplates that parties may negotiate whether adequate protection payments may be contested by first lien claimholders. 33

35 4. FIRST LIEN OBJECTIONS TO SECOND LIEN ACTIONS The Model Agreement preserves the right of first lien claimholders to generally object to any actions taken, or relief requested, by second lien claimholders. For example, first lien claimholders may want to support a position that second lien claimholders are unsecured to facilitate the completion of a plan or sale. The Model Agreement provides alternative section favorable to second lien lenders which specifies that the first lien claimholders may not object to the second lien claimholders seeking adequate protection consistent with the intercreditor agreement. 34

36 5. AVOIDANCE; REINSTATEMENT OF OBLIGATIONS The Model Agreement provides that in the event a payment is avoided, that the intercreditor agreement continues to govern the relationship between the parties with respect to their claims against the debt as a result of disgorgement. Includes controversial language that compels second lien claimholders to disgorge to first lien claimholders amounts they received constituting collateral proceeds during the time between the initial payment to the first lien claimholder and the avoidance of that payment. 35

37 6. REORGANIZATION SECURITIES The Model Agreement confirms common view that second lien claimholders can receive distributions prior to payment in full of the first lien claimholders. Includes a first lien claimholder favorable provision that provides that distributions to second lien claimholders on account of their secured claims are only permitted if the first lien claimholder class supports the plan. Intercreditor provisions continue to govern relative priorities and other rights of secured debt if both first and second lien claimholders receive new secured debt that shares collateral. 36

38 7. PLAN VOTING RIGHTS There is no provision in the Model Agreement regarding waiver of second lien claimholders rights to vote on a plan not supported by first lien claimholders or a requirement that second lien claimholders vote in favor of a plan supported by first lien claimholders. Such a waiver by second lien claimholders can cause second lien claimholders to be in a worse position than unsecured creditor in plan negotiations. Second lien claimholders may require an express provision in the intercreditor agreement that their voting rights are not waived. There are issues as to the enforceability of waiving voting rights. 37

39 This document has been prepared by Chapman and Cutler LLP attorneys for informational purposes only. It is general in nature and based on authorities that are subject to change. It is not intended as legal advice. Accordingly, readers should consult with, and seek the advice of, their own counsel with respect to any individual situation that involves the material contained in this document, the application of such material to their specific circumstances, or any questions relating to their own affairs that may be raised by such material Chapman and Cutler LLP 38