This chapter was first published by IICLE Press.

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This chapter
was first
published by
IICLE Press.
Book containing this chapter and any forms referenced herein is available
for purchase at www.iicle.com or by calling toll free 1.800.252.8062
9
Subordination and
Inter-Creditor Agreements
DONALD P. SEBERGER
Vice President and Chief Counsel (USA)
Alcan Inc.
Chicago
©COPYRIGHT 2007 BY DONALD P. SEBERGER.
9—1
SECURED TRANSACTIONS
I. [9.1] Introduction
II. In General
A. [9.2] Statutory Provisions
1. [9.3] The Uniform Commercial Code
a. [9.4] 810 ILCS 5/1-209
b. [9.5] 810 ILCS 5/9-339
c. [9.6] 810 ILCS 5/9-340
2. [9.7] The Bankruptcy Code
B. [9.8] Form of Contract
III. Subordination Agreements
A. [9.9] Purposes and Uses of Subordinations
B. [9.10] Types of Subordinations
1. [9.11] Bankruptcy Subordinations
2. [9.12] Default Subordinations
3. [9.13] Standstill Subordinations
C. [9.14] Major Substantive Issues
1. [9.15] Payment in Full
2. [9.16] Defining the Debt
3. [9.17] Default Provisions
4. [9.18] Standstill Period
D. [9.19] Other Terms and Provisions
1. [9.20] Rights of Senior Lender
2. [9.21] Post-Petition Interest
3. [9.22] Covenants of Junior Creditor
4. [9.23] Representations of Junior Creditor
5. [9.24] Subrogation Rights
6. [9.25] Trust Relationship
7. [9.26] Descriptive Legend
8. [9.27] Notices
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SUBORDINATION AND INTER-CREDITOR AGREEMENTS
IV. Inter-Creditor Agreements
A. [9.28] Purposes and Uses
B. [9.29] Major Substantive Issues
1. [9.30] Defining the Collateral
2. [9.31] Allocation of Collateral and Proceeds
3. [9.32] Default and Enforcement
C. [9.33] Other Terms and Provisions
V. [9.34] Conclusion
VI. Appendix — Sample Forms
A. [9.35] Subordination Agreement
B. [9.36] Inter-Creditor Agreement
ILLINOIS INSTITUTE FOR CONTINUING LEGAL EDUCATION
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§9.1
I. [9.1] INTRODUCTION
Subordination agreements are arrangements under which a creditor (the junior creditor)
contractually undertakes to subordinate some or all of its rights against the borrower to the rights
and interests of another creditor (the senior lender or senior creditor). Inter-creditor agreements,
which are a form of subordination agreement, usually denominate an arrangement between two or
more secured creditors of a borrower who wish to establish and allocate between or among
themselves lien priorities and rights in and to collateral.
The varieties of subordination and inter-creditor agreements are virtually limitless. Their
specific provisions depend on a number of factors, including the nature of the transaction, the
borrower’s business and property, the credit needs of the borrower, and the relative bargaining
positions of the lenders or creditors of the borrower.
This chapter is an introduction to subordination and inter-creditor agreements in the context
of commercial lending transactions. It describes the basic types of subordination and intercreditor agreements, identifies some of the most common issues that arise, and includes a sample
subordination agreement and a sample inter-creditor agreement.
This chapter does not attempt to address the myriad of permutations that can arise in any
given financing transaction. Even to attempt to do so would be futile. Similarly, this chapter does
not address subordinations in the context of real estate lending transactions or in the context of
corporate finance. Those subjects are addressed in other IICLE publications. See, e.g.,
COMMERCIAL REAL ESTATE (IICLE, 2004) and ADVISING ILLINOIS FINANCIAL
INSTITUTIONS (IICLE 2002, Supp. 2006).
II. IN GENERAL
A. [9.2] Statutory Provisions
Subordination agreements are recognized under both Illinois state law and federal law.
Sections 1-209 and 9-339 (formerly §9-316) of the Uniform Commercial Code (UCC), 810 ILCS
5/1-101, et seq., both expressly refer to the right of a creditor to subordinate its rights to those of
another creditor. 810 ILCS 5/1-209, 5/9-339. See §§9.3 – 9.6 below. Likewise, §510(a) of the
Bankruptcy Code, 11 U.S.C. §101, et seq., gives effect to subordination agreements. 11 U.S.C.
§510(a). See §9.7 below.
1. [9.3] The Uniform Commercial Code
Article 9 of the UCC, 810 ILCS 5/9-101, et seq., establishes some elaborate rules for
determining the rights and priorities of competing creditors in and to a borrower’s property and
assets. See Chapter 3 of this handbook. The UCC makes it clear that the rights and priorities of
competing creditors may be altered by agreement between or among those creditors. Two
sections of the UCC — 810 ILCS 5/1-209 and 5/9-339 — make specific reference to
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§9.4
subordination agreements. See §§9.4 – 9.5 below. In addition, although 810 ILCS 5/9-340 does
not mention subordination agreements, its effect is to place substantial importance on the use of
subordination agreements by secured creditors who hold a security interest in a deposit account.
See §9.6 below.
a. [9.4] 810 ILCS 5/1-209
Section 1-209 of the UCC provides:
An obligation may be issued as subordinated to payment of another obligation
of the person obligated, or a creditor may subordinate his right to payment of an
obligation by agreement with either the person obligated or another creditor of the
person obligated. Such subordination does not create a security interest as against
either the common debtor or a subordinated creditor. This Section shall be
construed as declaring the law as it existed prior to the enactment of this Section
and not as modifying it. 810 ILCS 5/1-209.
Section 1-209 is an optional amendment that has been adopted by a number of states,
including Illinois. Professor Hawkland suggests that this section has its origin as a response to the
decision in In re Wyse, 340 F.2d 719 (6th Cir. 1965). See 1 William D. Hawkland, HAWKLAND
UNIFORM COMMERCIAL CODE SERIES §1-209:1 (2006). In Wyse, the court implied that a
subordination provision in a guaranty created a security interest that, because it was not perfected,
was avoided by the trustee of the bankruptcy debtor’s estate. Section 1-209 flatly rejects the idea
that a subordination agreement is in the nature of a secured transaction. Section 1-310 of Revised
Article 1 of the UCC (which to date has been adopted in 28 states and the U.S. Virgin Islands)
does not make any substantive changes to §1-209. It provides:
An obligation may be issued as subordinated to performance of another
obligation of the person obligated, or a creditor may subordinate its right to
performance of an obligation by agreement with either the person obligated or
another creditor of the person obligated. Subordination does not create a security
interest as against either the common debtor or a subordinated creditor. 810 ILCS
5/1-310.
The final sentence of §1-209 has been deleted from §1-310. Revised Article 1 of the UCC,
including §1-310, was introduced in the 94th Illinois General Assembly as Senate Bill 1647, but
it failed to pass prior to adjournment in January 2007. See Revision of Uniform Commercial
Code Article 1 — General Provisions (2004) (approved and adopted by the American Law
Institute and the National Conference of Commissioners on Uniform State Laws in 2001). See
also 1 William D. Hawkland, HAWKLAND UNIFORM COMMERCIAL CODE SERIES §1310:1 (2006).
In Strosberg v. Brauvin Realty Services, Inc., 295 Ill.App.3d 17, 691 N.E.2d 834, 229 Ill.Dec.
361 (1st Dist. 1998), the plaintiff initiated an action for breach of contract based on the failure of
the defendant to make a payment under a promissory note. Following a jury trial, a verdict was
entered in favor of the plaintiff, and the defendant appealed. In reversing the trial court verdict,
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§9.5
the court of appeals held that the plaintiff could not properly recover amounts owing him under
the promissory note because he had previously granted a security interest in the subject
promissory note and subordinated his claims thereunder to the rights of the defendant’s bank. The
court of appeals, citing §1-209, stated: “While subordination agreements generally are not treated
as security agreements giving security interests in the property of the subordinated creditor, such
a result can occur if the parties to the subordination agreement intend to create a security
interest.” 691 N.E.2d at 840 – 841. In this case, the court of appeals held that the clear language
in the subordination agreement and the plaintiff’s endorsement and delivery of the promissory
note to the defendant’s bank were sufficient to create a security interest. Id.
b. [9.5] 810 ILCS 5/9-339
Section 9-339 of revised Article 9 of the UCC states very simply: “This Article does not
preclude subordination by agreement by a person entitled to priority.” 810 ILCS 5/9-339. Though
the language of §9-339 differs slightly from its predecessor, former §9-316 (“Nothing in this
Article prevents subordination by agreement by any person entitled to priority.”), the result is the
same. Secured creditors may contractually modify the priorities of their security interests. See
generally 9B William D. Hawkland, HAWKLAND UNIFORM COMMERCIAL CODE SERIES
§9-339:1 (2001).
As a general principle, Article 9 establishes priorities of security interests according to their
sequence of filing or other perfection. Section 9-339 acknowledges and sanctions the contractual
freedom of a secured creditor to alter the rules of priority established by Article 9. As is generally
true in the law of contracts, and as §9-339 states, a subordination agreement cannot adversely
affect a person that is not party to it. Thus, two secured creditors may contractually agree to
reorder between them their relative rights, but they cannot affect the rights of another secured
creditor that is not a party to the subordination agreement. See Official Comment 2, 810 ILCS
5/9-339.
Section 9-339 is silent as to whether a creditor may subordinate a portion of its rights and
claims to those of another creditor. Because partial subordination is not expressly prohibited and
the nature and the terms of subordination are subject to the rules governing contracts in general, it
seems certain that partial subordinations are permissible. The parties, however, must make their
intent known by clearly defining their relative rights and priorities. In Peoples National Bank of
McLeansboro v. Karnes (In re Browning), 66 B.R. 79 (S.D.Ill. 1986), a bank held a perfected
security interest in crops planted on its borrowers’ property. In 1984, at the request of another
lender, the bank agreed to subordinate a portion of its collateral by drawing a distinction between
crops planted in 1983 and those planted in 1984, retaining its priority position in the 1983 crops
and subordinating its interest in the 1984 crops.
c. [9.6] 810 ILCS 5/9-340
Though 810 ILCS 5/9-340 does not mention subordination agreements, its effect is to place
substantial importance on the use of subordination agreements by secured creditors who hold a
security interest in a deposit account.
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§9.8
Prior to the adoption of §9-340 of the UCC, a creditor with a perfected security interest in a
deposit account generally defeated the setoff rights of the bank holding the deposit. However, §9340(a) provides that a depository bank has priority setoff rights over a competing secured creditor
unless the depository bank expressly waives its setoff rights or the secured creditor has the
deposit account placed in its own name. As a consequence, the prudent secured creditor taking a
security interest in a deposit account will insist on obtaining from the depository bank a
subordination agreement under which the bank expressly recognizes the priority rights of the
secured creditor over the setoff rights of the bank. See generally Bruce A. Markell, From
Property to Contract and Back: An Examination of Deposit Accounts and Revised Article 9, 74
Chi.-Kent L.Rev. 963, 1006 (1999).
2. [9.7] The Bankruptcy Code
Like §§1-209 and 9-339 of the UCC, 810 ILCS 5/1-209 and 5/9-339, §510(a) of the
Bankruptcy Code, 11 U.S.C. §510(a), recognizes and gives effect to subordination agreements.
Section 510(a) provides: “A subordination agreement is enforceable in a case under this title to
the same extent that such agreement is enforceable under applicable nonbankruptcy law.” See,
e.g., Bank of America, National Ass’n v. North LaSalle Street Limited Partnership (In re 203
North LaSalle Street Partnership), 246 B.R. 325, 329 (Bankr. N.D.Ill. 2000) (holding, in
applicable part, that subordination provision that does not violate Illinois law must be enforced in
bankruptcy proceeding). See also In re Chicago, South Shore & South Bend R.R., 146 B.R. 421
(Bankr. N.D.Ill. 1992). As a consequence of the application of §510(a), unless the beneficiary of
a subordination agreement has accepted a reorganization plan that waives its rights, it is entitled
to receive distributions from the bankrupt estate until its claims are satisfied in full and before the
holders of subordinated claims receive any distributions. See S.Rep. No. 989, 95th Cong., 2d
Sess. (1978). See generally 2 William L. Norton, Jr., NORTON BANKRUPTCY LAW AND
PRACTICE 2d §44:1 (1997); In re Bank of New England Corp., 364 F.3d 355 (1st Cir. 2004)
(providing very good general discussion of subordination agreements and their enforceability
under Bankruptcy Code).
As noted in §9.5 above, 810 ILCS 5/9-339 permits subordination by agreement by the person
entitled to priority. A subordination agreement cannot adversely affect a person that is not party
to it. Consistent with this rule, it has been held that a trustee in bankruptcy cannot likewise obtain
rights or benefits under a subordination agreement to which the debtor was not a party. In In re
Kors, Inc., 819 F.2d 19 (2d Cir. 1987), the trustee successfully avoided the unperfected security
interest of a creditor who was the beneficiary of a subordination by a senior secured and perfected
lender. The trustee then asserted total priority for the estate based on the existence of the
subordination agreement. The court rejected the trustee’s argument, holding that the trustee could
not accede to the benefits of the subordination agreement because the debtor was not party to it.
819 F.2d at 27. See also In re Betta Products, Inc., No. 03-10925, 2003 WL 22945664 (Bankr.
N.D. Cal. July 7, 2003) (holding that avoidance of lien does not entitle bankrupt estate to benefits
of subordination agreement belonging to holder of avoided lien).
B. [9.8] Form of Contract
The UCC sheds little light on what constitutes a subordination agreement. Section 1-201(3)
defines an “agreement” as “the bargain of the parties in fact as found in their language or by
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§9.8
implication from other circumstances including course of dealing or usage of trade or course of
performance as provided in this Act.” 810 ILCS 5/1-201(3). Thus, in general, a subordination
agreement can be formal or informal, oral or written. Indeed, courts have upheld and enforced
oral subordination agreements, subordination agreements contained in letters, and those inferred
from a course of dealing between parties. See, e.g., Louisiana National Bank of Baton Rouge v.
Belello, 577 So.2d 1099 (1st Cir. 1991) (recognizing that subordination agreements may be oral
but finding that plaintiffs had failed to establish oral subordination agreement); Williams v. First
National Bank & Trust Company of Vinita, 482 P.2d 595 (Okla. 1971) (oral subordination
agreement held effective); In re Smith, 77 B.R. 624 (Bankr. N.D. Ohio 1987) (subordination
agreement found to exist in UCC-3 financing statement and letter further detailing arrangement);
AM International, Inc. v. Tennessee Valley Authority (In re AM International, Inc.), 46 B.R. 566
(Bankr. M.D.Tenn. 1985) (creditor’s consent to lockbox arrangement held to constitute
agreement to subordinate its security interest).
Notwithstanding, however, the language of §1-201(3) that countenances agreements “by
implication,” the rule in Illinois is that subordination agreements by implication are not
recognized. In DuQuoin National Bank v. Vergennes Equipment, Inc., 234 Ill.App.3d 998, 599
N.E.2d 1367, 175 Ill.Dec. 353 (5th Dist. 1992), a bank brought a declaratory action against an
agricultural equipment dealer seeking to establish the priority of competing security interests in
the same collateral. In support of its contention that its security interest had priority, the
equipment dealer asserted that a letter between it and the bank evidenced the bank’s intent to be
subordinated. The trial court agreed and entered judgment in favor of the equipment dealer. On
appeal, the decision of the trial court was reversed. The court of appeals held: “If a subordination
agreement was intended, it must have been expressed in the agreement; a subordination
agreement by implication is not recognized.” 599 N.E.2d at 1371. See also Western Bank v.
Matherly, 106 N.M. 31, 738 P.2d 903, 906 (1987).
It is also clear that a lender need not be a party to the subordination agreement in order to
benefit from it. Section 1-209 expressly contemplates that a subordination agreement can be with
“either the person obligated or another creditor of the person obligated.” 810 ILCS 5/1-209. See,
e.g., In re Thorner Manufacturing Co., 4 U.C.C.Rep.Serv. (CBC) 595 (Bankr. E.D.Pa. 1967)
(bank held to be entitled to benefit of agreement between another creditor and borrower in which
other creditor agreed to subordinate its claims to borrower’s short-term loans from bank).
Even though a subordination agreement need not be in writing to be enforceable, the prudent
lender should always insist on a written agreement that clearly sets forth the relative rights of the
borrower and the other creditors. This point is well illustrated in Peoples National Bank of
McLeansboro v. Karnes (In re Browning), 66 B.R. 79 (S.D.Ill. 1986). In that case, a bank held a
perfected security interest in crops planted on its borrowers’ property. In 1984, at the request of
another lender, the bank agreed to subordinate to the other lender its security interest in the 1984
crops. The bank wrote a letter to the borrowers in which it affirmed its security interest in the
1983 crops and agreed to subordinate its security interest in the 1984 crops. The bank’s letter
made no mention of years other than 1983 and 1984. Subsequently, the other lender made an
additional loan to the borrowers. In 1985, the borrowers entered bankruptcy proceedings.
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§9.9
During the course of the bankruptcy proceedings, the trustee filed a motion to compromise
claims secured by the 1985 crops. Under the trustee’s proposal, the proceeds of the 1985 crops
were to be allocated between the other lender and a local fertilizer company that financed those
crops. The trustee determined, and the bankruptcy court subsequently agreed, that the bank had
subordinated its claim in all crops of the borrowers other than those of 1983.
On appeal of the order by the bank, the district court reversed the bankruptcy court, holding
that the bank’s agreement to subordinate its security interest to that of the other lender was for
1984 only and did not apply to future years. The court noted that waivers, such as subordination
agreements, will be enforced only when there is a clear and distinct manifestation of intent. The
court then concluded, as a matter of law, that the bank’s letter was unambiguous and could not be
read to apply to any years other than 1983 and 1984. Since the bank did not expressly subordinate
its interest in the 1985 crops, its claim remained superior to that of the other lender.
The lesson to be drawn from Browning is unmistakable. Creditors seeking to allocate or
reallocate between or among themselves the priorities of claims or interests should do so only in a
writing that is clear and unambiguous. See Marriott Family Restaurants, Inc. v. Lunan Family
Restaurants (In re Lunan Family Restaurants), 194 B.R. 429 (Bankr. N.D.Ill. 1996). However, if
an ambiguity exists, the court may consider evidence that is outside the four corners of the
subordination agreement. See Greenfield Direct Response, Inc. v. ADCO List Management (In re
Greenfield Direct Response, Inc.), 171 B.R. 848, 855 – 856 (Bankr. N.D.Ill. 1994). See also Bank
of America, National Ass’n v. North LaSalle Street Limited Partnership (In re 203 North LaSalle
Street Partnership), 246 B.R. 325, 329 (Bankr. N.D.Ill. 2000).
III. SUBORDINATION AGREEMENTS
A. [9.9] Purposes and Uses of Subordinations
While other motives may exist from time to time in any given transaction, the primary
motivation for most subordination agreements is to induce another creditor to advance new or
additional funds to a borrower.
For example, in a typical commercial financing transaction with a corporation, the senior
lender (as new lender) may insist, as a condition to funding, that all intercompany loans between
or among the borrower and the members of its corporate family be subordinated to the new loan
by the senior lender. By doing so, the senior lender takes steps to prevent the borrower from
dissipating its cash by transferring it to other corporate family members. Likewise, subordination
agreements can be employed with respect to loans to the borrower from its principals. When used
in this context, subordination agreements can have an effect similar to personal guaranties by
giving the borrower’s principals incentive not to abandon the borrower should it encounter
financial difficulties.
If a senior lender does not seek subordination agreements as a condition to its initial loans to
the borrower, it may seek them as a condition to either additional advances or a restructuring of
the borrower’s current debt. In this context, subordination agreements can be an important
bargaining chip for the senior lender.
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§9.10
Another common use of subordination agreements is in acquisition financing. The seller of a
business may agree to take a portion of the purchase price in the form of a promissory note, or the
new owners of the acquired entity may make one or more loans or advances to the company.
While these methods of financing can be beneficial to the acquired company, they raise concerns
for the secured lender, which is typically providing the largest share of the acquisition financing.
To protect the availability of the acquired company’s assets and cash flow to satisfy the
obligations to the senior secured lender, the senior lender often will insist on a subordination
agreement from the seller or the new owners, as the case may be.
B. [9.10] Types of Subordinations
As noted in §9.1 above, because subordination agreements are “transaction-specific,” there
appears to be no limit on the varieties of subordination agreements. On closer scrutiny, however,
all subordination agreements are really permutations on one of three basic forms. These forms,
ranging from the least stringent to the most stringent, are so-called bankruptcy subordinations,
default subordinations, and standstill subordinations. See §§9.11 – 9.13 below.
1. [9.11] Bankruptcy Subordinations
The bankruptcy subordination is the least restrictive type of subordination from the viewpoint
of the borrower and its junior creditors and the least protective from the viewpoint of the senior
lender.
In essence, a bankruptcy subordination permits the borrower to make, and the junior creditors
to receive, payments as long as no bankruptcy is initiated by or against the borrower or no other
bankruptcy-related events have occurred. For example, the operative provision of a bankruptcy
subordination typically provides:
In the event of any receivership, insolvency, reorganization, or bankruptcy proceedings,
any assignment for the benefit of creditors, or any proceeding initiated by or against the
Borrower for any relief under any federal or state bankruptcy, reorganization, or
insolvency law, or any other federal or state law relating to the relief of debtors,
readjustment of indebtedness, reorganization, or composition or extension of indebtedness,
(a) all Senior Indebtedness shall be paid in full before any payment or distribution of any
kind or character, whether in cash, property, or securities, howsoever arising or evidenced,
is made to the Junior Creditor, and (b) the Junior Creditor shall not directly or indirectly
take, set off, accept, or demand any payment for, or institute any legal action or proceedings
for the collection of, all or any portion of the amounts owing to the Junior Creditor. All
such payments or distributions that, but for the subordination provisions of this agreement,
would otherwise be payable or deliverable to the Junior Creditor shall instead be paid and
delivered to the Senior Lender until the Senior Indebtedness is paid in full.
2. [9.12] Default Subordinations
From the standpoint of the borrower and the junior creditor, the default subordination is more
restrictive than the bankruptcy subordination but less restrictive than the standstill subordination.
It is in effect a compromise position.
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§9.14
In general, a default subordination permits payments to be made by the borrower to the junior
creditor as long as there is no default under the financing agreement between the borrower and
the senior lender. A default subordination agreement might provide:
Upon the occurrence of an Event of Default, (a) all Senior Indebtedness shall be paid in
full before any payment or distribution of any kind or character, whether in cash, property,
or securities, howsoever arising or evidenced, is made to the Junior Creditor, and (b) the
Junior Creditor shall not directly or indirectly take, set off, accept, or demand any payment
for, or institute any legal action or proceedings for the collection of, all or any portion of the
amounts owing to the Junior Creditor. All such payments or distributions that, but for the
subordination provisions of this agreement, would otherwise be payable or deliverable to
the Junior Creditor shall instead be paid and delivered to the Senior Lender until the
Senior Indebtedness is paid in full.
The default subordination would also contain the same operative provision as the bankruptcy
subordination, although presumably the occurrence of a bankruptcy or of bankruptcy-related
events involving the borrower would also constitute an event of default under the agreement
between the borrower and the senior lender.
3. [9.13] Standstill Subordinations
The standstill subordination, sometimes referred to as a “standby” subordination, is the most
protective of the senior lender. As its name implies, under the standstill subordination, the junior
creditor may not receive or accept any payment from the borrower and is obligated to stand still
or stand by until all amounts (principal and interest) owing to the senior lender are paid in full. A
typical standstill subordination provides:
As long as all or any portion of the Senior Indebtedness remains unpaid or outstanding,
the Junior Creditor shall not directly or indirectly take, set off, demand, accept, or receive
any payment for, or institute any legal action or proceedings for the collection of, all or any
portion of the amounts owing to the Junior Creditor. All such payments or distributions
that, but for the subordination provisions of this agreement, would otherwise be payable or
deliverable to the Junior Creditor shall instead be paid and delivered to the Senior Lender
until the Senior Indebtedness is paid in full.
C. [9.14] Major Substantive Issues
Once the senior lender and the borrower agree generally on the type of the subordination, a
number of additional and substantive issues that materially affect the scope of the subordination
must be resolved. Among the most common are defining the indebtedness of both the senior
lender and the junior creditor, qualifying the default provisions and remedies, and settling on the
duration of any resulting standstill period. See §§9.15 – 9.18 below. There are, of course,
numerous other issues that may arise. See generally Kevin C. Dooley and Thomas G. Rock,
Subordination Agreements: Suggested Approaches to Key Issues, 113 Banking L.J. 708 (1996).
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§9.15
1. [9.15] Payment in Full
Regardless of the type of subordination, each limits or otherwise prohibits payments to a
junior lender until the senior lender is “paid in full.” The concept of “payment in full” often
receives a great deal of attention by the senior lender. At a particular point in time, a senior lender
may be paid in full, thereby freeing the borrower to make, and the junior creditor to receive,
payments on the junior indebtedness. But what happens should all or a portion of the payments
previously received by the senior lender be the subject of a recapture, such as a preference under
§541 of the Bankruptcy Code, 11 U.S.C. §541, or some similar claim under other state or federal
law? To protect themselves from such a risk, senior creditors typically characterize the required
payment as “indefeasible,” require it to be paid in cash, and include a provision stating that the
subordination will not terminate until the expiration of all applicable preference periods and is not
subject to other recapture, repayment, or disgorgement under applicable law. See, e.g., ¶2 of the
sample agreement in §9.35 below.
2. [9.16] Defining the Debt
One of the most highly negotiated areas of any subordination involves defining the various
debts. The senior lender will want the definition of the amounts owing to it (senior indebtedness)
and the amounts owing to the junior creditor (subordinated debt) to be defined as broadly as
possible. In addition, the senior lender will want to include as many persons as possible in the
pool of junior creditors. This has the effect of elevating the greatest amount of senior
indebtedness above the greatest amount of subordinated debt. From the senior lender’s
perspective, the following definitions would be appropriate:
“Senior Indebtedness” means all obligations, liabilities, and indebtedness of the
Borrower to the Senior Lender, whether now existing or hereafter arising, however
evidenced, direct or indirect, contingent or absolute, due or not due, whether these amounts
represent principal, interest, fees, charges, or expenses, and shall include without limitation
those arising directly between the Senior Lender and the Borrower and those acquired by
the Senior Lender from other persons.
“Subordinated Debt” means all obligations, liabilities, and indebtedness of the
Borrower to the Junior Creditor, whether now existing or hereafter arising, however
evidenced, direct or indirect, contingent or absolute, due or not due, whether these amounts
represent principal, interest, fees, charges, or expenses, and shall include without limitation
those arising directly between the Junior Creditor and the Borrower and those acquired by
the Junior Creditor from other persons.
Conversely, the borrower and the junior creditor will want both the senior indebtedness and
the subordinated debt defined very narrowly in terms of specific transactions or amounts. As each
is defined more narrowly, the borrower is afforded greater freedom to deal with the junior
creditor, and greater parity exists between the senior lender and the junior creditor. From the
viewpoint of the borrower and the junior creditor, the following definitions might be desirable:
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§9.17
“Senior Indebtedness” means all indebtedness of the Borrower to the Senior Lender
under that certain Loan Agreement, including principal, interest, fees, premiums, charges,
and expenses.
“Subordinated Debt” means all indebtedness of the Borrower to the Junior Creditor
evidenced by that certain Subordinated Note, including principal, interest, fees, premiums,
charges, and expenses.
In this regard, the parties will often agree on a written schedule of the relevant indebtedness.
Even when the borrower or the junior creditor narrows the definitions of “senior
indebtedness” and “subordinated debt” to specific transactions or documents, other related issues
remain to be resolved. Of particular concern to the junior creditor is the amount by which the
senior indebtedness may be increased as a result of such things as over-advances, default interest,
compounding interest, premiums, expenditures by the senior lender for taxes, insurance, and
collection costs, and attorneys’ fees. The borrower and/or the junior creditor will want to see a
cap or an upward limit on the amount of senior indebtedness. Similarly, the junior creditor likely
will be concerned about renewals and extensions of the senior debt or any other action that might
place the senior indebtedness ahead of it for an indefinite period of time. This latter concern is
particularly apt in the case of a standby subordination. A specific limitation on the term of the
subordination or a gradual phase-out of the restrictions as the senior indebtedness is reduced is a
possible way of addressing this concern of the borrower and/or the junior creditor.
3. [9.17] Default Provisions
With respect to default subordinations, a number of issues arise, including the definition of
“default” and the rights of the senior lender and junior creditor after a default occurs.
The senior lender will typically insist that the definition of “default” under a default
subordination parallel the definition of “default” under its loan agreement with the borrower. In
addition to being a convenient point of reference for the senior lender, the definition of “default”
in a loan agreement is always among those definitions that most favor the senior lender. As a
result, the senior lender will want a default under the loan agreement to trigger simultaneously the
subordination of the junior debt, thereby depriving the junior creditor of further payments and
enhancing the senior lender’s ability to receive payment from the borrower on the senior
indebtedness. Moreover, because most loan agreements define “default” both in terms of an
actual occurrence and an event that, with the passage of time or the giving of notice, could
become a default, use of the definition of a default in the loan agreement in the subordination
agreement can give the senior lender even greater control by triggering the subordination at the
earliest possible time.
The junior creditor typically wants the definition to be narrow and objective. Tying the
triggering of the subordination to an expansive definition of “default” in the senior lender’s loan
documents could have unintended and unwanted results. The junior creditor will not want every
technical or de minimis breach by the borrower under the senior lender’s loan agreement to result
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§9.17
in an event that triggers the suspension or cessation of payments under the subordinated debt. As
a result, the junior creditor may wish to consider a materiality or similar standard for determining
the existence of a default.
All of this militates strongly in favor of a careful review by the junior creditor of not only the
senior lender’s loan agreement but also related or ancillary documents and any other agreements
between the senior lender and the borrower. The existence of often-used cross-default provisions
in the senior lender’s loan documents requires the junior creditor to gain an understanding of the
entire relationship between the senior lender and the borrower. In this regard, a broadly drafted
cross-default provision could mean that a technical or de minimis default under the junior debt
(even one waived or undeclared by the junior creditor) would result in a default under the senior
indebtedness, thereby triggering a subordination of the junior debt.
Another issue deserving particular attention by the parties involves waived defaults, cured
defaults, and recurring defaults. Sophisticated loan agreements contain a myriad of
representations, warranties, and covenants, the breach of which can result in a default. Assuming
a nonmonetary default occurs, there are a number of possible outcomes short of acceleration of
the underlying obligation. If the default is technical in nature or has no material effect on the
credit, the senior lender often will not (or cannot) declare a default under its loan agreement. It
will simply either ignore the default or waive it.
In this instance, a default has occurred, but the underlying obligation was not accelerated and
the senior lender was not deprived of any payments under the senior indebtedness. The junior
creditor would undoubtedly assert that this situation should not constitute a basis for triggering
suspension or cessation of the payment of the subordinated debt. Unless, however, the
subordination agreement is carefully drafted, the junior creditor’s right to continued payment
under the subordinated debt may be jeopardized. The junior creditor will want to negotiate the
terms of the subordination agreement to make it clear that such defaults do not result in
suspension or cessation of payments of the subordinated debt. The senior lender will want to
retain as much flexibility as possible. The senior lender will not want to negotiate in advance its
response to every possible default by the borrower.
Particularly troublesome is the issue of cured defaults. Assume a nontechnical or material
default takes place and, pursuant to the loan agreement, the senior lender furnishes the borrower
with notice and an opportunity to cure. Following the notice, the borrower timely and fully cures
the default. As a result, except for the uncertainty the senior lender experienced while it awaited
passage of the cure period, the senior lender was not harmed. The borrower and the junior
creditor would undoubtedly assert that no default should be triggered under the subordination
agreement.
The danger to the senior lender in giving effect to cure provisions is that a default or a
subsequent series of defaults may be cured only for a period of time sufficient to permit the
borrower to make a substantial intervening payment to the junior debtor. Thereafter, the
preceding default(s) having been only the tip of the iceberg, the borrower again defaults, and this
time the default is uncured and incurable. In this scenario, the underlying purpose of the
subordination agreement has been thwarted to the clear detriment of the senior lender. To avoid
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§9.20
this outcome, the senior lender will want to provide that the subordination, once triggered, is
irreversible and unaffected by a subsequent cure by the borrower. Alternatively, the parties may
agree on the subordination’s remaining in effect for a specified period of time following the cure
to make sure the default is not the first of a series by the borrower, or they may agree that the
subordination will become irreversible only after the second occurrence of a default.
4. [9.18] Standstill Period
Following a default and the triggering of a default subordination, the junior creditor is
typically precluded by the subordination agreement from taking any action to enforce collection
or receive payment from the borrower under the subordinated debt. During this so-called
standstill period, the senior lender is often weighing its options, which range from foreclosure and
liquidation to restructuring the senior indebtedness. While all of this is happening, several months
may elapse.
Sophisticated junior creditors, particularly those with some bargaining position, will insist on
a cap on the standstill period (for example, six months). If the senior lender has not by that time
either concluded a workout with the borrower or accelerated and commenced an enforcement
action, the junior creditor will want the right to collect the amounts due it under the subordinated
debt or otherwise enforce its rights. Moreover, the junior creditor will also seek a period of time
following the standstill period during which the senior lender is precluded from commencing
another standstill period by declaring another default.
D. [9.19] Other Terms and Provisions
In addition to those provisions that revolve around the issues of the scope of the indebtedness,
the meaning of default, and the effect of a default on the junior creditor and its ability to recover
the subordinated debt discussed in §§9.14 – 9.18 above, there are numerous other important terms
of a subordination agreement. These additional provisions address such matters as rights of the
senior lender, representations and covenants of the junior creditor, and subrogation rights. See the
discussion in §§9.20 – 9.27 below.
1. [9.20] Rights of Senior Lender
Under the typical subordination agreement, the senior lender is vested with substantial rights.
In addition to its right to receive payment for the senior indebtedness ahead of the subordinate
debt, the senior lender is afforded the right to (a) demand, sue on, and collect the subordinated
debt and enforce any security for it; (b) file proofs of claim and vote the subordinated debt in any
bankruptcy proceedings of the borrower; and (c) require specific performance of and under the
subordination agreement. See, for example, ¶¶6 and 13 of the sample agreement in §9.35 below.
In Bank of America, National Ass’n v. North LaSalle Street Limited Partnership (In re 203
North LaSalle Street Partnership), 246 B.R. 325, 328 (Bankr. N.D.Ill. 2000), the court considered
a provision in a subordination agreement that afforded the senior creditor the right to “vote or
consent in any [Chapter 11] proceedings with respect to, any and all claims” relating to the junior
indebtedness. Prior to confirmation of the debtor’s plan of reorganization, the senior creditor
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§9.21
sought a declaratory judgment that it was entitled to vote the subordinated creditor’s claim in the
confirmation. In finding for the subordinated creditor, the court opined that §1126(a) of the
Bankruptcy Code, 11 U.S.C. §1126(a), and not the unambiguous language of the subordination
agreement and §510(a) of the Bankruptcy Code, 11 U.S.C. §510(a), governs the determination of
voting rights. Section 1126(a) of the Bankruptcy Code provides that “[t]he holder of a claim” may
vote to accept or reject a plan under Chapter 11. In reaching its decision, the court concluded that
(a) the clear language of the subordination agreement did not provide a basis for ignoring the
rights afforded a claim holder under §1126(a), (b) §510(a) does not allow for a waiver of the
voting rights under §1126(a), and (c) absent an express agency relationship between the
subordinated creditor and the senior creditor, Federal Rule of Bankruptcy Procedure 3018(c) does
not allow a senior creditor to vote the claim of the subordinated creditor. 246 B.R. at 331.
2. [9.21] Post-Petition Interest
It is common for subordination agreements to contain provisions applicable in the event of
the bankruptcy of the borrower. Subordination agreements typically attempt to reorder the
priority rights of the parties so that a distribution to a junior creditor is diverted to the senior
creditor until the borrower’s obligations to the senior creditor are fully satisfied. See, e.g., ¶2(c)
of the sample agreement in §9.35 below.
Under ordinary circumstances, an unsecured creditor is not entitled to receive post-petition
interest from the bankrupt estate. As a consequence, some courts were reluctant to enforce
subordination agreements to allow senior creditors to obtain post-petition interest that would not
have been recoverable but for the existence of the subordination agreement. Historically, the right
of the senior creditor to receive post-petition interest has been dependent on the equity powers of
the bankruptcy court. Beginning with Thomas v. Western Car Co., 149 U.S. 95, 37 L.Ed. 663, 13
S.Ct. 824 (1893), bankruptcy courts have been willing to invoke their equitable powers (known as
the “rule of explicitness” since In re Time Sales Finance Corp., 491 F.2d 841 (3d Cir. 1974)) to
allow payment of post-petition interest to senior creditors as long as the subordination agreement
was explicit as to the parties’ intent. The rule of explicitness came about under the Bankruptcy
Act and continued to survive following passage of the Bankruptcy Code in 1978. Unlike the
Bankruptcy Act, which was silent on subordination agreements, the Bankruptcy Code contains
§510(a), which provides that a “subordination agreement is enforceable . . . to the same extent
that such agreement is enforceable under applicable nonbankruptcy law.” 11 U.S.C. §510(a).
Until 1998, bankruptcy courts continued to recognize and apply the rule of explicitness even
though §510(a) of the Bankruptcy Code limits enforceability to those agreements enforceable
under “applicable nonbankruptcy law.” Because the rule of explicitness is a doctrine enunciated
and applied by federal bankruptcy courts, it is not “nonbankruptcy law” under §510(a) of the
Bankruptcy Code. In In re Southeast Banking Corp., 156 F.3d 1114 (11th Cir. 1998), the court
held that §510(a) abrogated the rule of explicitness. The court held that New York state law, and
not federal common law, controlled the issue and certified the question to the New York Court of
Appeals to determine what language had to be included in subordination agreements to afford
senior creditors priority over junior creditors. Subsequently, the New York Court of Appeals
adopted the rule of explicitness as a “guiding interpretive principle of State contract dispute
resolution” in bankruptcy cases. See In re Southeast Banking Corp., 93 N.Y.2d 178, 710 N.E.2d
1083, 1086, 688 N.Y.S.2d 484 (1999).
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§9.23
In 2004, the First Circuit Court of Appeals was asked to decide whether a senior creditor was
entitled to post-petition interest at the expense of a junior creditor. See In re Bank of New England
Corp., 364 F.3d 355 (1st Cir. 2004). It is clear that both parties assumed the rule of explicitness
controlled, and therefore the issue before the court was whether the language in the subordination
agreement was sufficiently clear to meet the requirements of the rule of explicitness. Like the
Eleventh Circuit, the First Circuit concluded that the rule of explicitness was abrogated by
§510(a) of the Bankruptcy Code. However, the First Circuit went two steps further and held that
(a) “applicable nonbankruptcy law” means state law, and (b) state law may not adopt a rule
consistent with the rule of explicitness that is solely applicable in a bankruptcy context because
§510(a) “does not vest in the states any power to make bankruptcy-specific rules: the statute’s
clear directive for the use of applicable nonbankruptcy law leaves no room for state legislatures
or state courts to create special rules pertaining strictly and solely to bankruptcy matters.” 364
F.3d at 364, citing International Shoe Co. v. Pinkus, 278 U.S. 265, 73 L.Ed. 318, 49 S.Ct. 108
(1929) (holding that state may not enact bankruptcy-specific rules or otherwise provide additional
or auxiliary regulation with respect to bankruptcy matters).
Until such time as the rule of explicitness and the application of §510(a) of the Bankruptcy
Code is fully and finally resolved, the prudent counsel for the senior creditor will continue to
assume that the rule of explicitness still has life and include specific language in its subordination
agreement permitting receipt of post-petition interest. See, e.g., the definition of “Subordinated
Debt” in ¶1, and see ¶2(c) of the sample agreement in §9.35 below.
3. [9.22] Covenants of Junior Creditor
The principal covenant or undertaking by a junior creditor in any subordination agreement is
its waiver of the right to receive payment under or enforce any rights in the subordinated debt or
any collateral for it, except to the extent permitted by the subordination agreement. Most
subordination agreements contain other covenants of the junior creditor that are also very
important to the senior lender. These include the agreement by the junior creditor that it will not,
as long as the senior indebtedness is outstanding, (a) sell, transfer, assign, convey, pledge, or
encumber the subordinated debt unless the transaction is expressly subject to the subordination
agreement; (b) change the terms of the subordinated debt in a manner that will have an adverse
effect on the rights of the senior lender under the subordination agreement; (c) accept additional
collateral security for the subordinated debt or any other obligation owing to the junior creditor
by the borrower; (d) discharge or cancel the subordinated debt or any portion of it; (e) subordinate
any of the subordinated debt to any other obligation of the borrower; or (f) commence or join
with any other creditor in any bankruptcy or similar proceeding against the borrower.
Each of these covenants is designed to make sure the status quo among the borrower, senior
lender, and junior creditor is maintained for the benefit of the senior lender. See, e.g., ¶4 of the
4. [9.23] Representations of Junior Creditor
Most subordination agreements contain some basic representations of the junior creditor. In
addition to the standard representations on the junior creditor’s authority to enter into, and the
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§9.24
validity and enforceability of, the subordination agreement, the junior creditor should represent
and warrant (a) the then current amount of the subordinated debt; (b) the completeness and
accuracy of the documents evidencing the subordinated debt; (c) the nonexistence of any other
obligations of the borrower to the junior debtor; and (d) the nonexistence of any lien, claim, or
encumbrance of the junior creditor on any property or assets of the borrower.
These basic representations and warranties are designed to elicit information from the junior
creditor that has a direct bearing on the junior creditor’s relationship with the borrower. See, e.g.,
¶3 of the sample agreement in §9.35 below.
5. [9.24] Subrogation Rights
The common law right of subrogation permits a person who pays the debt of another to be
subrogated to the rights of the person who received the payment. In the context of a
subordination, a junior creditor would be subrogated to the rights of the senior lender to the extent
the senior indebtedness was reduced as a result of proceeds of the junior debt delivered by the
junior creditor to the senior lender. As a result, following any such payment from the proceeds of
the junior debt, the junior creditor would be entitled to pursue the borrower immediately for an
amount equal to that payment. Such a result would be inconsistent with the initial purpose of the
subordination agreement and would in fact defeat the subordination.
As a result, the senior lender must insist that the junior creditor agree not to assert its
subrogation rights against the borrower until all of the senior indebtedness is paid in full. See,
e.g., ¶11 of the sample agreement in §9.35 below.
6. [9.25] Trust Relationship
Despite best efforts to the contrary and the express provisions of the subordination
agreement, sometimes payments due under the junior debt are improperly made or delivered to
the junior creditor and not the senior lender. Subordination agreements typically contain an
undertaking by the junior creditor to deliver such payments to the senior lender and, pending their
delivery, to hold them in trust for the benefit of the senior lender. By expressly providing for a
trust relationship under those circumstances, the senior lender is in a position to assert a claim for
not only breach of contract but also breach of fiduciary duties if the junior creditor fails to comply
with the payment terms of the subordination agreement. See, e.g., ¶2(f) of the sample agreement
in §9.35 below.
7. [9.26] Descriptive Legend
As noted in §9.16 above, it is important for both parties to clearly identify the junior debt that
is the subject of the subordination agreement. In addition to specifically describing or scheduling
the junior debt, often the senior lender will require that the original of any document or
instrument evidencing the subordinated debt be marked with a legend to indicate its subordinated
nature. Such a legend not only defines the subordinated debt between the parties but also puts
third-party purchasers or assignees on notice of the rights of the senior lender. See, e.g., ¶12 of
the sample agreement in §9.35 below.
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§9.28
8. [9.27] Notices
Because the junior creditor and the senior lender each have a separate contractual relationship
with the borrower, there are times when one of them may come into possession of information
about the borrower that is not known to the other. This is especially true in the context of the
occurrence of an event of default by the borrower. An event of default under an agreement
between the borrower and the junior creditor may also constitute an event of default under the
borrower’s agreement with the senior lender. In turn, the event of default may trigger the rights of
the senior lender under the subordination agreement with the junior creditor. See §9.17 above. It
is important that the subordination agreement expressly provide those instances in which each of
the parties is entitled to receive written notice from the other and, if appropriate, the content of
the notice. See, e.g., ¶2(b) of the sample agreement in §9.35 below.
In PPM Finance, Inc. v. Norandal USA, Inc., 392 F.3d 889 (7th Cir. 2004), the agent of the
senior lender filed suit against the junior creditor alleging that the junior creditor failed to remit
certain payments to the senior lender that had been made by the borrower, thereby breaching the
obligations of the junior creditor under their subordination agreement. The district court granted
summary judgment for the senior lender, and the junior creditor appealed. The thrust of the junior
creditor’s argument was that the agent was required to notify the junior creditor of the borrower’s
default and the agent’s failure acted as a bar to recovering the money paid by the borrower to the
junior creditor. In affirming the decision of the district trial, the court of appeals noted that the
subordination agreement contained no affirmative obligation on the part of the agent to provide
notice. Indeed, the junior creditor admitted that it asked for a notice provision during contract
negotiations and was rebuffed by the agent. Absent an affirmative written obligation, the court of
appeals indicated an unwillingness to imply such an obligation under Illinois law.
IV. INTER-CREDITOR AGREEMENTS
A. [9.28] Purposes and Uses
Although often used interchangeably with subordination agreements, inter-creditor
agreements are typically contractual arrangements between two or more secured creditors of the
borrower who desire to identify their lien priorities and rights in and to specific property of the
borrower.
As an illustration, assume that a borrower that is engaged in the manufacture and sale of
heavy equipment has three secured lenders. One lender serves the working capital needs of the
borrower by providing the borrower with an asset-based revolving line of credit. The second
lender provided the borrower with a term credit, the proceeds of which were used to acquire fixed
assets. Finally, the third lender financed the acquisition of the borrower’s real estate and
improvements. Each of the first two credit facilities are secured by a perfected security interest in
all of the borrower’s personal property and assets, including fixtures. The third lender’s loan is
secured by the real estate and the improvements, including fixtures. Regardless of whether the
credit facilities were entered into at the same or different times, each of the lenders will likely
have a desire to agree in advance of any potential problems with the borrower how their
respective interests in the same collateral will be treated.
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§9.29
Of course, any number of other instances may arise in which a particular borrower may have
more than one secured lender. Regardless of the structure of or reasons for the relationship,
secured lenders are likely to want to address the same types of issues discussed in §§9.29 – 9.33
below.
B. [9.29] Major Substantive Issues
Unlike in the subordination agreements discussed in §§9.9 – 9.27 above, the primary focus in
an inter-creditor agreement is not on payment but rather on the security for the payment. As a
result, the typical inter-creditor agreement places substantial emphasis on defining and allocating
the collateral and the proceeds of the collateral, quantifying the events of default, setting out the
relative rights of the lenders in the collateral in the event of a default, and providing for the
ultimate enforcement of those rights. See §§9.30 – 9.32 below.
1. [9.30] Defining the Collateral
The primary purpose of any inter-creditor agreement is to allocate among each of the
participating lenders those properties and assets of the borrower that each lender will have the
right to look to in the first instance to satisfy the borrower’s obligations to the lender. To effect
this goal, it is necessary first to clearly describe and define the collateral. This is particularly
important since each lender will have entered into its own form of security agreement with the
borrower, and those forms may vary. Often, the allocations are made according to large classes of
property, such as inventory, accounts, machinery, and general intangibles. If there is need to
allocate individual items of a larger class of property (such as a particular piece of machinery
from the class of equipment), the property should be specifically described and scheduled. See,
e.g., ¶1 of the sample agreement in §9.36 below.
2. [9.31] Allocation of Collateral and Proceeds
After having defined and described the collateral by either general class or specific items or
both, the lenders will agree on its allocation among them. There is no one way in which the
collateral is typically allocated. Each inter-creditor agreement is different, and the allocations of
the collateral depend on any number of factors, including the amounts and purposes of the loans,
the quantity and quality of the borrower’s property and assets, and the bargaining power of each
lender. In addition to allocating the collateral, the inter-creditor agreement should also address the
proceeds of that collateral. See, e.g., ¶¶2 and 3 of the sample agreement in §9.36 below.
To illustrate further and to continue with the example set out in §9.28 above, it would be
likely that the lender that provided the asset-based revolving line of credit would be accorded (a)
a first priority security interest in all of the borrower’s inventory, accounts receivable, and general
intangibles; and (b) a second position in all other personal property and assets. Likewise, the
lender that provided the term financing for the fixed asset acquisitions would receive (a) a first
priority security interest in machinery and equipment, and (b) a second position in all other
personal property and assets. Finally, the mortgage lender would likely have only a first priority
mortgage and security interest in the real estate, improvements, and fixtures. In this example, the
first and second lenders would have to allocate between themselves the junior position in the
fixtures.
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§9.33
3. [9.32] Default and Enforcement
The provisions regarding default and, more importantly, what happens after a default are
critical and constitute the core of the inter-creditor agreement.
Often, what constitutes a default under the inter-creditor agreement is defined by the terms of
the loan documents of the respective creditors. Each of the creditors should review the others’
documents to make sure there is general agreement on such things as the nature of the events that
constitute a default and the existence of any applicable cure periods. The purpose of this review is
to make sure that each of the creditors will have the right to proceed against the borrower and its
respective collateral in the event of a default. This allows for flexibility and a coordinated effort.
The existence of a broad cross-default provision in each of the underlying loan agreements should
achieve this result. If necessary, the underlying loan agreements should be amended to provide
that a default under one loan agreement constitutes a default under any other loan agreement.
Generally, inter-creditor agreements provide that the creditors give each other written notice
before commencing any action to enforce their rights against the collateral. The prior consent of
the other creditors to proceed with enforcement action usually is not required, although particular
inter-creditor arrangements may provide for it. Inter-creditor agreements typically authorize each
creditor to enforce its rights against that portion of the collateral in which it has the priority
interest but not against any other collateral in which it may have only a junior interest.
A good inter-creditor agreement should always address the rights of each of the creditors to
use the others’ portion of the collateral for a short period of time in order to maximize the value
of all of the collateral. While each of the blocks of the collateral may be easily allocated among
the creditors, those blocks of collateral are interdependent and interrelated in the context of an
operating business. The lender whose collateral is comprised of the inventory and accounts
receivable will want to have access to and use of the machinery and equipment in order to convert
raw materials, complete work-in-process, and ship the finished goods. The lender whose
collateral consists primarily of the machinery and equipment will need to have continued use of
the premises either to continue operations or merely to store the machinery and equipment
pending sale and disposition. Finally, the mortgage lender may want to maximize the value of the
real estate by marketing the premises while they are operational rather than totally vacant. For
varying reasons, each of the creditors may agree among themselves to permit use of and access to
the others’ collateral for a period of three or four months to liquidate the collateral in an orderly
way. Of course, the inter-creditor agreement may provide for compensation to each other or, at
the very least, indemnification for losses or damages resulting from this use. See, e.g., ¶4 of the
C. [9.33] Other Terms and Provisions
In addition to the core provisions of the typical inter-creditor agreement described in §§9.29 –
9.32 above, a number of other ancillary matters usually are addressed, including additional
extensions of credit, agency, and marshaling of assets. See, e.g., ¶¶5, 8, and 15 of the sample
agreement in §9.36 below.
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§9.34
V. [9.34] CONCLUSION
A subordination agreement is a written promise by a junior creditor of a borrower not to
receive payment after a designated time until the senior creditors of the borrower have been paid.
All other features of the typical subordination agreement are derivative of this undertaking.
An inter-creditor agreement, which is a form of subordination, is an agreement among
secured creditors of the same borrower in which their rights in and to specific property and assets
of the borrower are allocated and their remedies set forth.
While most subordination agreements and inter-creditor agreements have a number of
common provisions, each is dependent on the specific transaction. The drafter must have
complete command of the facts in order to tailor the agreement to fit the parties and the
circumstances.
VI. APPENDIX — SAMPLE FORMS
A. [9.35] Subordination Agreement
NOTE: The form in this section is furnished for illustration purposes only and may not be
satisfactory for particular transactions.
This Subordination Agreement is made and entered into this _____ day of __________,
20__, by and between _________________________, a _______________ (Senior Lender),
and _________________________, a _______________ (Junior Creditor).
Introduction
A. _________________________, a _______________ (Borrower), is currently indebted
to the Junior Creditor pursuant to the terms of a certain promissory note, dated
__________, 20__, in the principal sum of $__________ (Subordinated Note).
B. The Borrower desires to obtain additional credit from the Senior Lender pursuant
to the terms of a certain loan and security agreement, dated __________, 20__ (Loan
Agreement).
C. In order to induce the Senior Lender to enter into the Loan Agreement with the
Borrower and to make available to the Borrower the credit under it, the Junior Creditor is
willing to subordinate the priority of the indebtedness evidenced by the Subordinated Note
to the indebtedness evidenced by the Loan Agreement, all pursuant to the terms of this
Agreement.
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§9.35
Now, therefore, in consideration of the mutual promises and undertakings set forth in
this Agreement, and for other good and valuable consideration, the receipt and sufficiency
of which are hereby acknowledged, the Junior Creditor and the Senior Lender agree as
follows:
1. Definitions. As used in this Agreement, the following terms shall have the meanings
specified below:
“Collateral” has the meaning set forth in the Loan Agreement.
“Event of Default” has the meaning set forth in the Loan Agreement.
“Loan Agreement” means the agreement referred to in Paragraph B of the
Introduction, together with all amendments to and renewals and extensions of it.
“Revolving Credit Note” has the meaning set forth in the Loan Agreement.
“Senior Debt” means and includes (a) all obligations of the Borrower now or later
existing under the Loan Agreement, the Revolving Credit Note, and the Term Loan
Note, whether for principal, interest (including interest accruing after the filing of a
petition initiating a proceeding described in Paragraph 2(c) of this Agreement and
whether or not such interest accrues after the initiation of a proceeding described in
Paragraph 2(c) or is an allowed claim in such proceeding), prepayment premium,
fees, expenses (including without limitation attorneys’ fees, paralegals’ fees, and all
out-of-pocket expenses incurred in connection with the enforcement of Borrower’s
obligations), or otherwise; and (b) all obligations of the Borrower to the Senior
Creditor under any of the Other Documents.
“Subordinated Debt” means all obligations of the Borrower under the Subordinated
Note or any other agreement, instrument, or promissory note related to it, whether
for principal, interest, premium, fees, costs, indemnification, or otherwise, and
including without limitation any amounts payable as damages or for rescission
under any cause of action arising out of or relating to any of the foregoing, and shall
include any post-petition interest paid or payable to the Junior Creditor following
the initiation of a proceeding by or against the Borrower under the United States
Bankruptcy Code.
“Subordinated Note” shall mean the promissory note referred to in Paragraph A of
the Introduction, a copy of which is attached as Exhibit [A].
“Term Loan Note” has the meaning specified in the Loan Agreement.
2. Subordination. The Junior Creditor covenants and agrees that the Subordinated
Debt is and shall be subordinate in right of payment to the prior indefeasible payment in
full in cash of the Senior Debt as and to the extent provided in this Paragraph. The Senior
Debt shall not be deemed to have been paid in full until (a) the Senior Lender’s obligation to
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make advances under the Loan Agreement shall have been terminated as provided in the
Loan Agreement, and (b) the Senior Lender shall have received indefeasible payment in
cash in full of the Senior Debt. The priority of all present and future security interests of the
Junior Creditor in any property of the Borrower shall be subordinated to all present and
future enforceable perfected security interests of the Senior Lender in the property of the
Borrower. Prior to the occurrence of an Event of Default or an event described in clause (c)
below of this Paragraph 2, the Junior Creditor shall be entitled to receive all regularly
scheduled payments of principal and interest on the Subordinated Debt.
(a) Event of Default. Upon the occurrence of an Event of Default, (i) all Senior Debt
shall be paid in full before any payment or distribution of any kind or character,
whether in cash, property, or securities, however arising or evidenced, is made to
the Junior Creditor; and (ii) the Junior Creditor shall not directly or indirectly take,
set off, accept, or demand any payment for or institute any legal action or
proceedings for the collection of all or any portion of the amounts owing to the
Junior Creditor. All such payments or distributions that, but for the subordination
provisions of this Agreement, would otherwise be payable or deliverable to the
Junior Creditor shall instead be paid and delivered to the Senior Lender until the
Senior Debt is paid in full.
(b) Notice of Event of Default. No direct or indirect payment in respect of the
Subordinated Debt or exercise of any other rights or remedies with respect to the
Subordinated Debt shall be made if, at the time of the payment, there exists any
Event of Default and the Senior Lender has so advised the Junior Creditor in
writing, and the Event of Default has not been cured or waived in writing or the
benefits of this sentence have not been waived in writing by the Senior Lender. In
the absence of a written notice from the Senior Lender to the Junior Creditor of the
occurrence of an Event of Default, the Junior Creditor shall be entitled to assume
that an Event of Default does not exist unless the Junior Creditor has actual
knowledge of the existence of an Event of Default.
(c) Dissolution, Liquidation, and Bankruptcy. In the event of any dissolution,
winding up, or liquidation of the Borrower, any receivership, insolvency,
reorganization, or bankruptcy proceedings of the Borrower, any assignment by the
Borrower for the benefit of its creditors, any payment or distribution of all or
substantially all of the assets or securities of the Borrower of any kind or character,
whether in cash, property, or securities, or any proceeding initiated by or against
the Borrower for any relief under any federal or state bankruptcy, reorganization,
or insolvency law, or any other federal or state law relating to the relief of debtors,
readjustment of indebtedness, reorganization, composition, or extension of
indebtedness, (i) all Senior Debt shall be paid in full before any payment or
distribution of any kind or character, whether in cash, property, or securities,
however characterized (as principal, interest (including post-petition interest), or
otherwise), arising, or evidenced, is made to the Junior Creditor; and (ii) the Junior
Creditor shall not directly or indirectly take, set off, accept, or demand any payment
for or institute any legal action or proceedings for the collection of all or any portion
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of the amounts owing to the Junior Creditor. All such payments or distributions
that, but for the subordination provisions of this Agreement, would otherwise be
payable or deliverable to the Junior Creditor shall instead be paid and delivered to
the Senior Lender until the Senior Indebtedness is paid in full.
(d) Prior Payments. The provisions of clauses (a) and (c) of this Paragraph 2 shall in
no way affect the Junior Creditor’s right to retain any payments previously made to
the Junior Creditor that the Junior Creditor was entitled to receive pursuant to the
terms of this Subordination Agreement.
(e) Acceleration of Subordinated Debt. If the Subordinated Debt is declared due and
payable before its stated maturity, the Senior Lender shall be entitled to receive
indefeasible payment in cash in full of all amounts due or to become due on or in
respect of the Senior Debt (whether or not a Default or Event of Default has
occurred or the Senior Debt is, or has been declared to be, due and payable prior to
the date on which it otherwise would have become due and payable) before the
Junior Creditor is entitled to receive any payment of the Subordinated Debt
(including any payment that may be payable by reason of the payment of any other
indebtedness of the Borrower’s being subordinated to the payment of the
Subordinated Debt).
(f) Payments Received by Junior Creditor. In the event that, notwithstanding the
foregoing provisions prohibiting such payment or distribution, the Junior Creditor
shall receive any payment or distribution in respect of the Subordinated Debt
contrary to the provisions of this Agreement, the Junior Creditor shall promptly
remit these payments or distributions to the Senior Lender. Pending their delivery
to the Senior Lender, the Junior Creditor shall receive and hold these payments or
distributions in trust for the benefit of the Senior Lender. Without limiting the
generality of the foregoing, in the event all or any portion of a payment made by the
Borrower to the Senior Lender is recovered from the Senior Lender, by virtue of an
action or proceeding of the nature described in Paragraph 2(c) above, or otherwise,
any amount received by the Junior Creditor at any time after any such payment is
recovered from the Senior Lender shall be subject to and treated and held in
accordance with the provisions of this clause (f).
3. Representations of Junior Creditor. The Junior Creditor represents to the Senior
Creditor as follows:
(a) Subordinated Note. Attached as Exhibit [A] is a full, complete, and correct copy
of the Subordinated Note and all other documents between the Borrower and the
Junior Creditor evidencing the Subordinated Debt that have not been modified and
are in full force and effect. There are no other agreements or understandings
relating to the Subordinated Debt between the Borrower and the Junior Creditor.
(b) Other Indebtedness. Except for the Subordinated Debt and the Subordinated
Note that evidences it, the Borrower is not indebted to the Junior Creditor.
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§9.35
(c) Liens of Junior Creditor. Except as expressly set forth in the documents attached
as Exhibit [A], the Junior Creditor has no lien, security interest, or other charge or
encumbrance in or on any of the Borrower’s property, whether real, personal, or
mixed, as security for the Borrower’s obligations to the Junior Creditor.
(d) Authority and Validity. This Agreement has been duly executed and delivered by
the Junior Creditor and is the valid and binding obligation of the Junior Creditor,
enforceable against it in accordance with its terms, except as may be limited by
bankruptcy, insolvency, or similar laws affecting creditors’ rights generally and by
principles of equity.
4. Covenants of Junior Creditor. The Junior Creditor covenants and agrees with the
Senior Lender that, unless the Senior Lender shall otherwise expressly agree in writing,
prior to the termination of the Loan Agreement and indefeasible payment in cash in full of
the Senior Debt:
(a) The Junior Creditor shall not cancel or otherwise discharge any of the
Subordinated Debt.
(b) The Junior Creditor shall not subordinate any of the Subordinated Debt to any
indebtedness of the Borrower other than the Senior Debt.
(c) The Junior Creditor shall not sell, transfer, assign, pledge, encumber, or
otherwise dispose of any of the Subordinated Debt to any person (collectively, a
“Transferee”) unless (i) the Junior Creditor provides the Senior Lender with not
less than 30 days’ prior written notice; and (ii) prior to consummation of any
transfer, assignment, pledge, encumbrance, or other disposition, the Transferee
shall execute and deliver an agreement substantially identical to this Agreement
providing for the continued subordination of the Subordinated Debt as provided
herein, all in form and substance satisfactory to the Senior Lender.
(d) The Junior Creditor shall not permit or agree to any amendment, modification,
or supplement to any document, agreement, or instrument evidencing or relating to
all or any portion of the Subordinated Debt the effect of which is to (i) increase the
principal amount of, and/or the interest rate applicable to, the Subordinated Debt;
(ii) change the dates for payment or repayment of principal and/or interest of the
Subordinated Debt, (iii) modify, amend, or add any event of default or covenant
governing or applicable to the Subordinated Debt; (iv) modify or amend any
redemption or prepayment provision governing or applicable to the Subordinated
Debt; or (v) increase the obligations of the Borrower or the rights and remedies of
the Junior Creditor in a manner that is materially adverse to the Borrower or that
will have any adverse effect on the rights or interests of the Senior Creditor under
this Agreement.
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(e) The Junior Creditor shall not accept additional collateral security for the
payment of any Subordinated Debt or any other obligation of the Borrower to the
Junior Creditor, or obtain a lien, security interest, or other charge or encumbrance
of any nature whatsoever against the Borrower’s property, whether now owned or
later acquired.
(f) The Junior Creditor shall not commence or join with any other person in any
bankruptcy or similar proceeding against the Borrower.
5. Rights of Senior Lender Not To Be Impaired. No right of the Senior Lender to
enforce the subordination as provided in this Agreement shall at any time in any way be
prejudiced or impaired by any act or failure to act in good faith by the Senior Lender or by
any noncompliance by the Borrower with the terms, provisions, and covenants of this
Agreement, regardless of any actual or imputed knowledge of this noncompliance by the
Senior Lender. The provisions of this Agreement are for the benefit of and shall be
enforceable directly by the Senior Lender.
6. Authority of Senior Lender To Effect Subordination. The Senior Lender is
irrevocably authorized and empowered (in its own name or in the name of the Junior
Creditor or otherwise), but shall have no obligation, to demand, sue for, collect, and receive
every payment referred to in Paragraph 2 above and give acquittance for them and to file
claims and proofs of claim and to take any other action (including without limitation voting
the Subordinated Debt or enforcing any security interest or other lien securing payment of
the Subordinated Debt) it may deem necessary or advisable for the exercise or enforcement
of any of its rights or interests in respect of the Senior Debt. In addition, and without
limiting the generality of the foregoing, the Junior Creditor hereby irrevocably appoints the
Senior Lender to act as the agent of the Junior Creditor for the purpose of voting or
consenting in any bankruptcy or other similar proceeding with respect to any and all claims
relating to the Subordinated Debt.
7. Cooperation of Junior Creditor. The Junior Creditor shall duly and promptly take
any action the Senior Creditor may request to (a) collect the Subordinated Debt for the
account of the Senior Lender; (b) file appropriate claims or proofs of claim in respect of the
Subordinated Debt; (c) execute and deliver to the Senior Lender any powers of attorney,
assignments, or other instruments the Senior Lender may reasonably request to enable it to
enforce any and all claims with respect to and any security interests and other liens securing
payment of the Subordinated Debt; and (d) collect and receive any and all payments or
distributions that may be payable or deliverable on or with respect to the Subordinated
Debt.
8. Standstill and Suspension of Remedies. Until the Senior Debt shall have been
indefeasibly paid in cash in full, the Junior Creditor shall not (a) ask, demand, or sue for
any payment, distribution, or other remedy in respect of the Subordinated Debt or any
collateral security for it; or (b) commence or join with any other creditor (other than the
Senior Creditor) in commencing any proceeding referred to in Paragraph 2(c) above.
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9. Invalidity of Senior Debt. All rights and interests of the Senior Lender under this
Agreement and all agreements and obligations of the Junior Creditor under this Agreement
shall remain in full force and effect irrespective of (a) any setoff, avoidance, invalidation,
disallowance, subordination, or lack of enforceability of, or other defect or deficiency in, the
Loan Agreement, the Revolving Credit Note, the Term Note, or any other agreement or
instrument relating to this Agreement or the Senior Debt (including without limitation any
mortgage or security interest securing all or any portion of the Senior Debt); (b) any change
in the time, manner, or place of payment of, or in any other term of, all or any of the Senior
Debt or any other amendment or waiver of or any consent to departure from the Revolving
Credit Note, the Term Loan Note, the Loan Agreement, or any other agreement or
instrument relating to this Agreement or to the Senior Debt (including without limitation
any mortgage or security interest securing all or any portion of the Senior Debt); (c) any
exchange, release, or non-perfection of any collateral, or any release, amendment, or waiver
of or consent to departure from any guaranty, for all or any of the Senior Debt; or (d) any
other circumstance that might otherwise constitute a defense available to or a discharge of
the Borrower or a subordinated creditor.
10. Effect of Bankruptcy of Borrower. The provisions of this Agreement shall continue to
be effective or be reinstated, as the case may be, if at any time any payment of any of the
Senior Debt is rescinded or must otherwise be returned by the Senior Lender upon the
insolvency, bankruptcy, or reorganization of the Borrower or otherwise, all as though the
payment had not been made.
11. Subrogation. Subject to the indefeasible payment in cash in full of the Senior Debt
and the termination of all lending commitments by the Senior Lender under the Loan
Agreement, the Junior Creditor shall be subrogated to the rights of the Senior Lender to
receive payments or distributions of assets of the Borrower applicable to the Senior Debt
until the Senior Lender has received payment in cash in full of the Senior Debt.
12. Subordination Legend. The Junior Creditor will cause each instrument evidencing
the Subordinated Debt to be endorsed with the following legend:
The indebtedness evidenced by this instrument is subordinated to the prior
indefeasible payment in cash in full of certain Senior Debt pursuant to, and to the
extent provided in, that certain Subordination Agreement dated __________, 20__,
in favor of the Senior Lender. This instrument may not be offered, sold, or
otherwise transferred until the purchaser, assignee, or transferee has become a
party to or expressly agrees in writing to be bound by that Subordination
Agreement.
13. Specific Performance. The Senior Lender is hereby authorized and empowered to
demand specific performance at any time when the Junior Creditor shall have failed to
comply with any of the provisions of this Agreement. The Junior Creditor (a) irrevocably
waives any defense based on the adequacy of a remedy at law that might be asserted as a
bar to the remedy of specific performance; and (b) acknowledges that the provisions of this
Agreement are intended to be enforceable at all times, whether before or after the
commencement of a proceeding referred to in Paragraph 2(c) above.
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14. Waiver. Except as otherwise expressly required by the terms of this Agreement, the
Junior Creditor waives promptness, diligence, notice of acceptance, and any other notice
with respect to any of the Senior Debt and any requirement that the Senior Lender protect,
secure, perfect, or insure any security interest or lien or any property subject to a security
interest or lien or exhaust any right or take any action against the Borrower or any other
person or entity or any collateral. No failure on the part of the Senior Lender to exercise
and no delay in exercising any right under this Agreement shall operate as a waiver of that
right, nor shall any single or partial exercise of any right under this Agreement preclude
any other or further exercise of that right or any other. The remedies provided in this
Agreement are cumulative and not exclusive of any remedies provided by law.
15. Continuing Agreement. The provisions of this Agreement constitute a continuing
agreement and shall (a) remain in full force and effect until the Senior Lender’s obligation
to make advances under the Loan Agreement shall have been terminated as provided and
the Senior Debt shall have been indefeasibly paid in cash in full; (b) be binding on the
Junior Creditor and its successors and assigns; and (c) inure to the benefit of and be
enforceable by the Senior Lender and its successors, transferees, and assigns. Without
limiting the generality of the foregoing, the Senior Lender may assign or otherwise transfer
any Senior Debt or portion of it held by it or grant any participation in any of its rights or
obligations under the Loan Agreement to any other person or entity, and that other person
or entity shall then become vested with all the rights in respect of the Senior Debt or portion
of it granted to the Senior Creditor in this Agreement or otherwise.
16. Amendments. No amendment or waiver of any provision of this Agreement or
consent to any departure from it by the Junior Creditor shall in any event be effective
unless in writing and signed by the Senior Creditor, and then the waiver of consent shall be
effective only in the specific instance and for the specific purpose for which it was given.
17. Legal Fees. The Junior Creditor agrees to pay on demand to the Senior Lender the
amount of any and all reasonable expenses, including fees and expenses of its counsel, that
the Senior Lender may incur in connection with the exercise or enforcement of any of its
rights, remedies, or interests under this Agreement.
18. Notices. All demands, notices, and other communications provided for under this
Agreement shall be in writing (including telegraphic communication) and sent to the
following addresses:
[list]
or another address designated by a party in a written notice to the other party delivered
according to the terms of this Agreement. All such demands, notices, or other
communications shall, when mailed or telegraphed, be effective when deposited in the mails
or delivered to the telegraph company, as the case may be, addressed as provided above.
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§9.36
19. Governing Law. This Agreement shall be governed by, and construed in accordance
with, the internal laws and not the conflict of laws rules of the State of Illinois. The
invalidity or unenforceability of any term or provision of this Agreement shall not affect the
validity or enforceability of any other term or provision.
IN WITNESS WHEREOF, the Junior Creditor and the Senior Lender have caused this
Agreement to be duly executed and delivered by their respective, duly authorized officers as
of the date first above written.
_______________________________________
By: ___________________________________
Its _________________________________
_______________________________________
By: ___________________________________
Its _________________________________
ACKNOWLEDGMENT
The Borrower, while not a party to the foregoing Agreement, acknowledges its terms
and conditions and agrees to do all things reasonably in the Borrower’s power to comply
with it and further agrees not to take any action that would result in a violation of the
Agreement.
_______________________________________
By: ___________________________________
Its _________________________________
B. [9.36] Inter-Creditor Agreement
NOTE: The form in this section is furnished for illustration purposes only and may not be
satisfactory for particular transactions.
This Inter-Creditor Agreement is made and entered into this _____ day of __________,
20__, by and among _________________________, a _______________ (ABC Bank),
_______________________, a ______________ (OPQ Bank), and ______________________,
a _______________ (XYZ Bank) (collectively, the “Banks”).
Introduction
A. _________________________, a _______________ (Borrower), is currently party to
a certain loan and security agreement, dated __________, 20__, with ABC Bank pursuant to
which ABC Bank has agreed to make loans and advances to the Borrower up to the
principal sum of $__________ (ABC Agreement).
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B. The Borrower is currently party to a certain loan and security agreement, dated
__________, 20__, with OPQ Bank pursuant to which OPQ Bank has agreed to make loans
and advances to the Borrower up to the principal sum of $__________ (OPQ Agreement).
C. The Borrower is currently party to a certain loan and security agreement, dated
__________, 20__, with XYZ Bank pursuant to which XYZ Bank has agreed to make loans
and advances to the Borrower up to the principal sum of $__________ (XYZ Agreement).
D. Each of the Banks has filed financing statements under the Uniform Commercial
Code perfecting a security interest in all of the Borrower’s personal property and assets.
XYZ Bank has recorded the XYZ Mortgage.
E. The Banks desire to agree on the relative priority of their respective security
interests and liens on the property and assets of the Borrower.
Now, therefore, in consideration of the mutual undertakings set forth below and for
other good and valuable consideration, the receipt and sufficiency of which are hereby
acknowledged, the parties agree as follows:
1. Definitions. As used in this Agreement, the following terms shall have the meanings
specified below:
“ABC Claim” means all “Obligations” of the Borrower to ABC Bank as set forth in
the ABC Agreement, including without limitation all sums loaned and advanced to
or for the benefit of the Borrower at any time, any interest on those sums, any
future advances, any costs of collection or enforcement, including reasonable
attorneys’ and paralegals’ costs and fees, and any prepayment penalties.
“ABC Senior Collateral” means the Collateral in which ABC Bank has a senior lien
or security interest as described in and provided by Paragraph 2(a).
“Accounts” means (a) all of the Borrower’s accounts, accounts receivable, book
debts, instruments, documents, contracts, notes, drafts, acceptances, chattel paper,
and other forms of obligation now or at any later time owned, held by, or payable to
the Borrower relating in any way to Inventory or arising from the sale of Inventory
or the rendering of services by the Borrower, together with all merchandise
represented by any of the Accounts; (b) all such merchandise that may be
reclaimed, repossessed, or returned to the Borrower; (c) the Borrower’s rights as an
unpaid vendor, including stoppage in transit, reclamation, replevin, and
sequestration; (d) all pledged assets and all letters of credit, guaranty claims, liens,
and security interests held by or granted to the Borrower to secure payment of any
Accounts and that are delivered for or on behalf of any account debtor; and (e) all
proceeds and products of all of the foregoing described properties and interests in
all proceeds of insurance with respect to them, including the proceeds of any
applicable casualty or credit insurance or fidelity bond, whether payable in cash or
in kind.
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§9.36
“Collateral” means, collectively, the accounts, equipment, fixtures, general
intangibles, and inventory, and all products and proceeds thereof, including without
limitation and as applicable, insurance proceeds.
“Enforcement” means, collectively or individually, for ABC Bank, OPQ Bank,
and/or XYZ Bank to make demand for payment or accelerate the indebtedness of
the Borrower, repossess any material amount of Collateral, or commence the
judicial enforcement of any of the rights and remedies under the XYZ Agreement,
the ABC Agreement, or the OPQ Agreement, or any related mortgages, guaranties,
or agreements or applicable law.
“Enforcement Notice” means a written notice delivered, at a time when an “Event of
Default” (as defined in the XYZ Agreement) or a “Default” (as defined in the ABC
Agreement or the OPQ Agreement) has occurred and is continuing, by either XYZ
Bank, OPQ Bank, or ABC Bank to the other lenders announcing that an
“Enforcement Period” has commenced, specifying the relevant Event of Default or
Default, stating the current balance of the XYZ Claim, the OPQ Claim, or the ABC
Claim, and requesting the current balance of the other lenders’ claims.
“Enforcement Period” means the period of time following the receipt by either XYZ
Bank, OPQ Bank, or ABC Bank of an Enforcement Notice from another lender
until either (a) the final payment or satisfaction in full of either the XYZ Claim, the
OPQ Claim, or the ABC Claim; or (b) XYZ Bank, OPQ Bank, and ABC Bank agree
in writing to terminate the Enforcement Period.
“Equipment” means all of the Borrower’s equipment, machinery, furniture,
furnishings, fixtures, tools, supplies, and motor vehicles of every kind and
description, now or at any later time owned by the Borrower, wherever located,
together with any and all parts, improvements, additions, replacements, accessions,
and substitutions to or for them.
“Fixtures” shall have the meaning ascribed to it in the Uniform Commercial Code.
“General Intangibles” means all choses in action, causes of action, corporate or
other business records, computer programs, source codes, use codes, software,
customer lists, tax refund claims, trademarks, service marks, trade names, trade
secrets, patents, including all applications and registrations for them, designs,
inventions, know-how, trade secrets, methods, processes, drawings, specifications,
descriptions, and all memoranda, notes, and records with respect to any research
and development, licenses, franchise rights, goodwill and all rights under any real or
personal property leases, permits, all claims under guaranties, security interests or
other security held by or granted to the Borrower, all rights to indemnification, and
all other intangible personal property of any kind or nature (other than Accounts),
wherever located or arising and whether now or hereafter owned, acquired, arising,
or existing.
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“Inventory” means all existing or later-acquired inventory of the Borrower,
including without limitation all merchandise, raw materials, parts, supplies, workin-process, and finished products intended for sale or lease, of every kind and
description, together with all the containers, packing, packaging, shipping, and
similar materials related to them, and including all inventory temporarily out of the
Borrower’s custody or possession and items in transit and including any returns
and repossessions on any accounts, documents, instruments, or chattel paper
relating to or arising from the sale of inventory (as these documents, instruments, or
chattel paper relate to the sale of inventory) and any other identifiable proceeds of
these items, including insurance proceeds.
“OPQ Claim” means all “Obligations” of the Borrower to OPQ Bank as set forth in
the OPQ Agreement, including without limitation all sums loaned and advanced to
“OPQ Senior Collateral” means the Collateral in which OPQ Bank has a senior lien
or security interest as described in and provided by Paragraph 2(b).
“XYZ Claim” means all “Obligations” of the Borrower to XYZ Bank as set forth in
the XYZ Agreement, including without limitation all sums loaned and advanced to
“XYZ Senior Collateral” means the Collateral in which XYZ Bank has a senior lien
or security interest as described in and provided by Paragraph 2(c).
2. Lien Priorities. Notwithstanding the date, manner, or order of perfection of the
security interests and liens granted to the Banks and notwithstanding any provisions of the
Uniform Commercial Code, any applicable law or decision, the ABC Agreement, the OPQ
Agreement, or the XYZ Agreement and notwithstanding whether ABC Bank, OPQ Bank,
or XYZ Bank holds possession of all or any part of the Collateral, the following, as among
ABC Bank, OPQ Bank, and XYZ Bank, shall be the relative priority of the security
interests and liens in the Collateral:
(a) ABC Bank shall have a first and prior security interest in all Accounts, all
Inventory, the General Intangibles specifically described on Exhibit ________
attached hereto, the Equipment and Fixtures specifically described on Exhibit
________ attached hereto, and any proceeds thereof, including insurance proceeds
(collectively, “ABC Senior Collateral”), and OPQ Bank and XYZ Bank shall have
an equal second and subordinate security interest in the ABC Senior Collateral.
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§9.36
(b) OPQ Bank shall have a first and prior security interest in the Equipment and
Fixtures specifically described on Exhibit ________ attached hereto, and any
proceeds thereof, including insurance proceeds (OPQ Senior Collateral), and ABC
Bank and XYZ Bank shall have an equal second and subordinate security interest in
the OPQ Senior Collateral.
(c) XYZ Bank shall have a first and prior security interest in the General
Intangibles specifically described on Exhibit ________ attached hereto, and any
proceeds thereof, including insurance proceeds (XYZ Senior Collateral), and ABC
Bank and OPQ Bank shall have an equal second and subordinate security interest
in the XYZ Senior Collateral.
3. Distribution of Proceeds of Collateral. Whether during an Enforcement Period or
otherwise, all proceeds of Collateral shall be distributed in accordance with the following
procedure:
(a) Proceeds of the ABC Senior Collateral shall be applied to the ABC Claim. After
the ABC Claim is paid in full and the ABC Agreement is terminated and fully paid
or otherwise satisfied, any remaining proceeds of the ABC Senior Collateral shall be
applied to the OPQ Claim and the XYZ Claim, pari passu, until the OPQ
Agreement and the XYZ Agreement are terminated and fully paid or otherwise
satisfied.
(b) Proceeds of the OPQ Senior Collateral shall be applied to the OPQ Claim. After
the OPQ Claim is paid in full and the OPQ Agreement is terminated and fully paid
or otherwise satisfied, any remaining proceeds of the OPQ Senior Collateral shall be
applied to the ABC Claim and the XYZ Claim, pari passu, until the ABC
Agreement and the XYZ Agreement are terminated and fully paid or otherwise
satisfied.
(c) Proceeds of the XYZ Senior Collateral shall be applied to the XYZ Claim. After
the XYZ Claim is paid in full and the XYZ Agreement is terminated and fully paid
or otherwise satisfied, any remaining proceeds of the XYZ Senior Collateral shall be
applied to the ABC Claim and the OPQ Claim, pari passu, until the ABC
Agreement and the OPQ Agreement are terminated and fully paid or otherwise
satisfied.
4. Enforcement Actions. Each of the Banks agrees not to commence Enforcement until
an Enforcement Notice has been given to the other Banks. Subject to the foregoing, each of
the Banks agrees that during an Enforcement Period:
(a) Each of the Banks may, at its option, take any action to accelerate payment of its
Claim and to foreclose or realize on or enforce any of its rights with respect to its
Senior Collateral, without the prior written consent of the other Banks; provided
that a Bank shall not take any action to foreclose or realize on or to enforce any of
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its rights with respect to any of the Collateral in which it has a lien or security
interest junior to that of any of the other Banks without the prior written consent of
the other Banks.
(b) If the Banks elect to proceed with Enforcement, then each shall proceed with the
enforcement of any security interests in or liens on any Collateral in which it has a
senior lien or security interest.
(c) Each of the Banks may, for the first 90 days of any Enforcement Period
(Liquidation Period), (i) enter upon one or more of the Borrower’s premises,
whether leased or owned, without force or process of law and without obligation to
pay rents, royalties, or compensation to any of the other Banks or the Borrower;
and (ii) use the Equipment and other Collateral to the extent necessary to complete
the processing of Inventory, collect the Accounts, and sell or otherwise dispose of
any of the Collateral during the Liquidation Period. Each of the Banks shall
indemnify each other for any material damage or destruction to the others’
Collateral that is caused by use of the others’ Collateral during the Liquidation
Period.
5. Additional Credit Extensions. Subject to any provisions contained in their respective
agreements with the Borrower that restrict the Borrower’s ability to incur additional
indebtedness, each of the Banks shall have the right, without the consent of the others, to
extend credit to the Borrower in excess of the maximum amounts set forth in their
respective agreements with the Borrower secured by their respective Senior Collateral and
otherwise having the same priorities as contained in this Agreement. Notwithstanding the
foregoing, if any advance is secured by assets other than the Collateral described in this
Agreement, the advancing Bank shall have no obligation to marshal the other assets of the
Borrower in which it has a lien or security interest before enforcing its rights in the
Collateral under this Agreement, and the non-advancing lender shall have no rights under
this Agreement to share or participate in any proceeds of these other assets. Each of the
Banks shall use its best efforts to give to the others notice of its intent to extend additional
credit, but the failure to do so shall not affect the validity of the extension of credit, create a
cause of action against the party failing to give this notice, or create any claim or right on
behalf of any third party.
6. Accountings. Each of the Banks agrees to render accounts to the others upon
request, giving effect to the application of proceeds of Collateral as previously provided.
7. Notices of Default. Each of the Banks agrees to use its best efforts to give to the
others copies of any notice of the occurrence or existence of a Default or Event of Default
sent to the Borrower simultaneously with the sending of the notice to the Borrower, but the
failure to do so shall not affect the validity of the notice or create a cause of action against
the party failing to give the notice or create any claim or right on behalf of any third party.
The sending of a notice shall not give the recipient any obligation to cure the Default or
Event of Default.
9 — 35
§9.36
8. Agency for Perfection. Each of the Banks appoints the others as agents for purposes
of perfecting their respective security interests and liens on the Collateral described in this
Agreement. To the extent that any lender obtains possession of another Bank’s Senior
Collateral, the Bank having possession shall notify the other Banks of that fact and shall
deliver the Collateral to the Bank having the senior claim.
9. Actions upon Repayment. If any Bank’s Claims are paid in full as a result of an
Enforcement under this Agreement, but not the Claims of all, the Bank whose claim is fully
paid shall transfer any Collateral or its proceeds held by it to the other Bank enjoying the
next senior position, unless otherwise required to remit the proceeds according to law, and
shall assign (without representation, warranty, or recourse of any kind whatsoever) its
security interest and all of its rights under financing statements to the other Bank, unless
otherwise agreed to in writing by the other Bank.
10. UCC Notices. In the event that any of the Banks shall be required by the Uniform
Commercial Code or any other applicable law to give notice to the others of intended
disposition of Collateral, the notice shall be given in accordance with Paragraph 11 of this
Agreement, and ten days’ notice shall be deemed to be commercially reasonable.
11. Notices. All notices under this Agreement shall be effective upon receipt and shall be
in writing and sent by either certified mail, return receipt requested, or telecopy to the
addresses set forth above or to another address that any party may designate in writing to
the other parties. Notice shall be deemed received, if mailed, when presented for delivery to
the United States Post Office or, if telecopied, upon confirmation that the telecopy has been
received.
12. Contesting Liens or Security Interests. None of the Banks shall contest the validity,
perfection, priority, or enforceability of any lien or security interest granted to the other
Banks, and each of the Banks agrees to cooperate in the defense of any action contesting the
validity, perfection, priority, or enforceability of these liens or security interests.
13. Independent Credit Investigations. None of the Banks, nor any of their respective
directors, officers, agents, or employees, shall be responsible to the other Banks or to any
other person, firm, or corporation for the Borrower’s solvency, financial condition, or
ability to repay the respective Claims, or for statements of the Borrower, oral or written, or
for the validity, sufficiency, or enforceability of any of the Banks’ Claims, the Banks’
respective agreements with the Borrower, or any liens or security interests granted by the
Borrower to the Banks in connection with these agreements. Each of the Banks has entered
into its respective financing agreements with the Borrower based on its own independent
investigation and makes no warranty or representation to the other Banks, nor does it rely
on any representation of the other Banks with respect to matters identified or referred to in
this Paragraph 13.
14. Limitation on Liability of Banks to Each Other. Except as provided in this
Agreement, none of the Banks shall have any liability to the other Banks except for gross
negligence or willful misconduct.
9 — 36
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§9.36
15. Marshaling of Assets. Each of the Banks waives any and all rights to have all or any
part of the Senior Collateral of any other Bank marshaled upon any foreclosure by the
holder of the Senior Collateral.
16. Successors and Assigns. This Agreement shall be binding on and inure to the benefit
of the respective successors and assigns of each of the parties but does not otherwise create
and shall not be construed as creating any rights enforceable by any person not a party to
this Agreement.
17. Governing Law. The validity, interpretations, enforcement, and effect of this
Agreement shall be governed by the internal laws and not the conflict of laws rules of the
State of Illinois.
IN WITNESS WHEREOF, the parties have executed this Agreement as of the day and
year first above written.
ABC BANK
By: ___________________________________
Its _________________________________
OPQ BANK
By: ___________________________________
Its _________________________________
XYZ BANK
By: ___________________________________
Its _________________________________
9 — 37
9S
Subordination and
Inter-Creditor Agreements
DONALD P. SEBERGER
Special Counsel
Rio Tinto Alcan
Chicago
©COPYRIGHT 2010 BY IICLE.
9S — 1
SECURED TRANSACTIONS — SUPPLEMENT
I. [9S.1] Introduction
II. In General
A. Statutory Provisions
1. The Uniform Commercial Code
a. [9S.4] 810 ILCS 5/1-209
III. Subordination Agreements
D. Other Terms and Provisions
1. [9S.20] Rights of Senior Lender
2. [9S.21] Post-Petition Interest
5. [9S.24] Subrogation Rights
9S — 2
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§9S.20
I. [9S.1] INTRODUCTION
The citation sentence at the end of the last paragraph is revised:
See, e.g., COMMERCIAL REAL ESTATE (IICLE, 2004, Supp. 2007) and ADVISING
ILLINOIS FINANCIAL INSTITUTIONS (IICLE 2002, Supp. 2006).
Add at the end of the section:
The Syndications and Lender Relations Subcommittee of the Commercial Finance
Committee of the American Bar Association’s Business Law Section has formed a Model
Intercreditor Agreement Task Force (ABA Task Force). The purpose of the ABA Task Force is to
develop a “market-based” form of subordination and inter-creditor agreement. On July 30, 2009,
the ABA Task Force published its Draft Model Intercreditor Agreement with some accompanying
commentary and alternate provisions. The most recent draft of the inter-creditor agreement,
together with earlier drafts from 2008 and 2009, can be found at www.abanet.org/
dch/committee.cfm?com=CL190029 (case sensitive).
II. IN GENERAL
A. Statutory Provisions
1. The Uniform Commercial Code
a. [9S.4] 810 ILCS 5/1-209
The second sentence following the second bold quotation is revised:
Revised Article 1 of the UCC, including §1-310, was passed as part of P.A. 95-895 and became
effective January 1, 2009.
III. SUBORDINATION AGREEMENTS
D. Other Terms and Provisions
1. [9S.20] Rights of Senior Lender
Add at the end of the section:
In In re Aerosol Packaging LLC, 362 B.R. 43 (Bankr. N.D.Ga. 2006), the bankruptcy court
reached the opposite conclusion from the court in North LaSalle Street, supra. In Aerosol
Packaging, Blue Ridge Investors, a business investment fund, made an investment in Aerosol
Packaging in the form of secured debt. Subsequently, Aerosol Packaging refinanced its working
capital facility, and in connection with that refinancing, the new lender (a predecessor of
9S — 3
§9S.21
SECURED TRANSACTIONS — SUPPLEMENT
Wachovia Bank) required Blue Ridge to enter into a subordination agreement pursuant to which,
among other things, Blue Ridge granted to Wachovia Bank the right to vote Blue Ridge’s claim
in any bankruptcy proceeding involving Aerosol Packaging. When Aerosol Packaging did indeed
seek Chapter 11 protection and a plan of reorganization was presented to the creditors for
approval, Wachovia Bank demanded that Blue Ridge deliver a ballot in favor of the plan of
reorganization. Blue Ridge refused, and, pursuant to the subordination agreement, Wachovia
Bank delivered a ballot on behalf of itself and Blue Ridge voting in favor of the plan of
reorganization. Blue Ridge cast its own separate ballot voting against the plan of reorganization.
In making its case before the bankruptcy court, Blue Ridge relied on North LaSalle Street. In
rejecting Blue Ridge’s argument and its reliance on North LaSalle Street, the bankruptcy court
held that (a) §1126 of the Bankruptcy Code does not prohibit voluntary delegation or assignment
to vote, (b) there was no evidence that the subordination agreement was unenforceable under state
law and therefore unenforceable under §510 of the Bankruptcy Code, and (c) Fed.R.Bankr.P.
9010 and 3018 expressly permit agents to cast ballots, and an agent is not always bound to
comply with the directions of its principal. On appeal by Blue Ridge, the district court affirmed
the decision of the bankruptcy court. Blue Ridge subsequently filed a notice of appeal, but it was
later withdrawn with prejudice following a settlement.
2. [9S.21] Post-Petition Interest
Add before the last paragraph:
Despite the apparent demise of the rule of explicitness resulting from the Eleventh Circuit’s
decision in Southeast Banking, supra, and the First Circuit’s decision in Bank of New England,
supra, it continues to receive a good deal of attention. See, e.g., Patrick Darby, Southeast and
New England Mean New York: The Rule of Explicitness and Post-Bankruptcy Interest on Senior
Unsecured Debt, 38 Cumb.L.Rev. 467 (2008).
5. [9S.24] Subrogation Rights
Add after the first sentence:
See, e.g., UnionBank v.Thrall, 374 Ill.App.3d 785, 872 N.E.2d 542, 313 Ill.Dec. 559 (2d Dist.
2007) (containing excellent review and summation of principles and law of subrogation in
Illinois).
9S — 4
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This chapter was first published by IICLE Press.

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