Inter Creditor Agreement

Dewan Housing Finance Corporation Ltd. (DHFL), one of the biggest housing finance corporations in India, ran into financial issues in 2018—not long after the collapse of Infrastructure Leasing & Financial Services (IL&FS), a major shadow banking organization. The result was a serious liquidity crunch for both lenders. According to Mint, one of the suggested alternatives to salvaging DHFL hit a major roadblock on September 17, 2019, because few bondholders had agreed to take part in the suggested settlement.

However, some bondholders started the process of taking DHFL to bankruptcy court, which further complicated things. In an Inter creditor Agreement (ICA), the banks agreed to restructure Rs. 1 trillion (about $14 billion) of DHFL's debt in order to develop a restructuring strategy. They also tried to enlist bondholder support because, in order for the strategy to succeed, bondholder permission was also required.

What is Inter Creditor Agreement?

A written agreement, frequently a deed, that establishes the relative rights and priority of two or more financiers (typically both debt and equity) in a financing. Typically, the contract governs the rights to receive payments from and to impose security over the assets of a common debtor (including principal, interest, and fees prior to any enforcement of security).

Because both sorts of documents aim to achieve ranking among creditors, the terms are frequently used interchangeably.

• An inter creditor agreement, on the other hand, is normally a more complicated contract than a deed of priority, which will typically just rank secured debt providers and govern the allocation of enforcement revenues.

Let's use an illustration to better comprehend the standstill provision intercreditor agreement.

The bank has agreed to pay $20 million of the $100 million that XYZ Company plans to raise, leaving $80 million to be raised from outside sources. A total of $50 million and $30 million will be paid to two foreign creditors, respectively. If the borrower defaults, who will have the first claim to the borrower's property, and how much can each lender recover?

By creating an intercreditor agreement form and having it signed by the two lenders, all of this uncertainty is cleared up. The standstill provision intercreditor agreement is included in the arrangement. This is because, in the event of a default, it will assist the creditors in distributing the borrower's collateral. Hence, the agreement forbids lenders from having uncalled disputes over the distribution of collateral. An agreement that was reached by the two lenders clarifies all of this uncertainty.

The agreement is known as an intercreditor agreement. This is because, in the event of a default, it will assist the creditors in distributing the borrower's collateral. Hence, the essential provisions of the intercreditor agreement prohibit lenders from having ad hoc disputes over the distribution of collateral.

Advantages of ICA

There are two main advantages of inter creditor agreement as given below −

• The payout after bankruptcy is already determined, so an inter creditor agreement template should be turned into a legal contract to prevent confusion when the borrower defaults on payments. As a result, it aids in removing ambiguities and promotes settlement efficiency.

• Junior creditors feel more secure and agree to extend loans to borrowers because they are aware that superior lenders will not disregard their rights.

Disadvantages of ICA

There are two main disadvantages of inter creditor agreement as given below −

• The unfavorable provisions of the arrangement must be followed entirely by the junior creditor if they fail to draft favorable terms.

• Superior lenders may pervert the course of justice in a dispute because they are thought to be more powerful than subordinate lenders

Significance of ICA

The right to lien is significantly influenced by the inter creditor agreement. As a result, it is essential for both lenders to establish a firm foundation for their rights and obligations in the event that a borrower's financial situation deteriorates and it defaults. In the absence of such a document, each party may act in accordance with its own resolutions concurrently. The entire process might be immoral and wasteful and soon devolve into a legal quagmire in court.

Need of ICA

There are two basic needs of this agreement −

• In the event of a borrower's payment default, this agreement clarifies any ambiguities and conflicts that might exist. It can be difficult to disburse the collateral, for instance, if a borrower receives a loan from many sources and the assets are not all liquid and equal in value.

• In order to properly allocate assets and rights, it is crucial to design a model intercreditor agreement. In order to handle the proper collateral allocation upon default, this agreement was created. Also, it stops needless harassment of collateral distribution.

Issues with ICA

The issues and difficulties of an intercreditor agreement can be shown by the following examples −

• In many intercreditor agreements, the senior lender is typically the one that sets the terms of the lien. As a result, junior lenders who do not vigorously negotiate the deed may be at a disadvantage.

• Senior lenders that are requesting permission to complete agreements or claims may intentionally cause delays for junior lenders. As a result, taking such action could result in the junior lender giving up.

• It might be challenging to determine the order of precedence for the claim made on certain assets in the event of default. So, if the property is restricted to paying only one creditor, it is challenging to select who would be listed first in the claim.

Conclusion

When more than one lender is present in a capital structure, intercreditor agreements, or ICAs, are crucial legal papers that are required. The ICAs play a crucial role in establishing how the lenders can continue collecting interest due, recovering past payments, and receiving cash consideration from collateral liquidations when debtors are in default or seek bankruptcy protection.

Frequently Asked Questions

Q1. What are the contents of an inter creditor agreement?

Ans. It may contain clauses outlining who has the authority to declare defaults, seize the collateral, give waivers, and modify loan and security arrangements. This agreement may also lay out how the loan payments from the borrower are to be distributed.

Q2. What are the key provisions of an inter creditor agreement?

Ans. The main goal of the inter creditor agreement is to guarantee that each type of debt utilized in the transaction carries a risk appropriate to its price, i.e. senior debt (which has a lower return) carries a lower risk than the more expensive junior debt.

Q3. Who drafts the inter creditor agreement?

Ans. The majority of the accompanying paperwork is related to an intercreditor contract for a mezzanine loan. Loan Agreement: Generally, the mortgage on the property is first negotiated by the senior lender. A mezzanine loan agreement will then be created by the mezzanine lender.

Q4. What was the purpose of Inter-Creditor Agreement signed by Indian banks and financial institutions recently?

Ans. To minimize the ongoing financial and current account deficits that the Indian government must deal with.

Q5. What is an inter creditor and subordination agreement?

Ans. When a borrower defaults, an inter creditor agreement is a distribution of collateral in the event that both lenders are stronger. The loans are prioritized in accordance with the subordination agreement. It entails assigning a ranking to the debts in terms of which should be paid off first.

Q6. Why do you need an inter creditor agreement?

Ans. The majority of the time, intercreditor agreements are employed when mezzanine debt is added to a senior commercial real estate loan. Usually, the agreement establishes a number of protections for the senior lender's interest in the property in the event that the borrower defaults on their loan.