An intercreditor agreement is a contract among two or more creditor groups that establishes their relative rights when the borrower defaults or becomes insolvent. In a leveraged capital structure with multiple layers of debt — first-lien loans, second-lien loans, subordinated notes — the intercreditor agreement defines who can enforce remedies, who can receive payments, who has voting control in restructuring negotiations, and who can buy out the other lender's position.
The most common intercreditor arrangement is between first-lien and second-lien lenders. The agreement establishes that: (1) first-lien lenders receive proceeds from collateral first, before second-lien lenders receive anything; (2) second-lien lenders are subject to a standstill period — typically 90 to 180 days — during which they cannot take independent enforcement actions against the collateral; (3) first-lien lenders control enforcement and have the right to direct the disposition of shared collateral; and (4) second-lien lenders cannot object to a first-lien-sponsored bankruptcy plan unless the plan fails certain tests.
Intercreditor agreements also govern payment blockages — when first-lien lenders can block the borrower from making interest or principal payments to second-lien lenders. A "standstill on payments" may be triggered if the borrower is in default on the first-lien facility, preventing cash that would otherwise flow to second-lien holders from leaking out of the business during restructuring.
The "buy-out right" (or purchase option) is another critical provision. First-lien lenders typically have the right to purchase the second-lien debt at par if they want to gain full control of the negotiating process. Second-lien lenders may have a reciprocal right. These provisions give each creditor group a mechanism to consolidate control without requiring consent from the other group.
In bankruptcy, intercreditor agreements are binding on the parties and limit a junior creditor's ability to take positions that conflict with the agreement — subject to certain good-faith exceptions recognized by bankruptcy courts. Understanding the intercreditor in a deal is essential for both originating lenders and secondary market participants: the agreement's terms can significantly affect recovery outcomes in distressed scenarios.