The intercreditor that was never drawn.

Most private-markets structures end up with three kinds of debt. A capital-call or portfolio facility at the fund, secured on the commitments or the holding companies. An acquisition or construction facility at the asset company, secured on the asset and its receivables. And shareholder loans from the fund down the chain to the asset company, put there for tax, for flexibility or because the adviser's model had them. Each was negotiated separately, with its own lender or with nobody, at a different time, and each has a view about what happens if the asset company cannot pay. The views were never reconciled because nobody was paid to reconcile them, and at default each creditor reads its own document and acts on it. The ranking that results is decided by whoever moves first, in whichever jurisdiction it moves, and the structure that had three documents has no map.

This note sets out the three debts and what each expects, what an intercreditor settles and the seven questions it answers, the shareholder loan as the debt most often left unranked, the sequence of enforcement across two jurisdictions, the distribution stop and its carve-outs, the release of security on an enforcement, the moment the intercreditor is drawn and why, the forum of the intercreditor, a comparison, a worked intercreditor as a type, cases, what each party holds, the sequence, questions, terms and what to read.

The three debts and what each expects

The fund-level lender expects the fund's commitments and, in some facilities, the distributions from below. It has security over the call right, the call account and, for a net asset value facility, the holding companies' shares. It expects that a default at the asset company will not reach it, because it did not lend to the asset company, and that the distributions up the chain will continue, because its facility is serviced by them.

The asset-level lender expects the asset and its receivables. It has a mortgage over the asset, a pledge over the asset company's shares and receivables, and a charge over its accounts. It expects the shareholder loans to be subordinated to it, because it lent on the asset and the fund's loans to the asset company are the fund's equity by another name. It expects that on a default it may enforce against the asset without the fund-level lender's interference, and that the fund-level lender's enforcement over the holding companies will not disturb its security.

The fund, as shareholder lender, expects to be repaid on its loans before it distributes equity, because the loans are senior to the equity in the asset company's own capital structure. It expects that its loans may be repaid from the asset company's cash flows in the ordinary course. And it expects to rank, on the asset company's insolvency, as a creditor rather than as a shareholder.

None of the three documents was written with the other two in view. The fund-level facility does not mention the asset-level lender's security. The asset-level facility may require subordination of shareholder loans in a sentence, without a document that subordinates them. The shareholder loan agreement, if there is one, says nothing about either lender. At default each party reads its own.

What the intercreditor settles

An intercreditor agreement settles the ranking and the conduct between the creditors, and it answers seven questions.

Who is paid first from which asset. The asset-level lender from the asset and its receivables; the fund-level lender from the commitments and the holding companies; the shareholder loans after the asset-level lender from the asset company's assets.

Whether the shareholder loans are subordinated and on what terms: to the asset-level lender only, or to both; fully, or only on an insolvency; with payments permitted in the ordinary course or stopped on a default.

Whether distributions up the chain may continue while the asset-level facility is in default, which is the distribution stop, and what carve-outs it has for the fund's own costs, the manager's charge and the fund-level facility's service.

Who may enforce and when: whether the asset-level lender may enforce without the fund-level lender's consent, whether the fund-level lender may enforce over the holding companies while the asset-level facility is performing, and a standstill for one while the other acts.

What the fund-level lender may do with the asset company's shares if it enforces its own security over the holding companies: take them subject to the asset-level lender's security, or not at all without the asset-level lender's consent.

What happens to each lender's security on an enforcement by the other: a release of the holding company pledges on an asset-level sale, a release of the asset-level security on a fund-level sale of the holding company with the asset-level facility assumed or repaid.

How proceeds are applied and turned over: a waterfall between the creditors, and an obligation on a creditor that receives what it should not to hold it on trust for the one that should.

Each of those is a question the structure has answered implicitly by its drafting, and the intercreditor makes the answer explicit and agreed.

The shareholder loan, unranked

The shareholder loan is the debt most often left unranked, because it was put there by an adviser for a purpose unconnected with the lenders and nobody thought of the fund as a creditor. At the asset company's insolvency the fund's loan ranks with the asset-level lender unless subordinated, which the asset-level lender will not accept, or ranks behind it under a subordination the asset-level facility required in a sentence and nobody documented, which a court in the asset's state may or may not enforce. The shareholder loan is subordinated in a document, with the terms stated: to whom, how far, with what payments permitted, with what turnover. It is also read against the treaty layer's beneficial-ownership condition, because a shareholder loan whose repayment is obliged on receipt of the asset company's cash is the conduit the treaty note warns of.

Why it is never drawn

It is never drawn because it belongs to nobody. The fund-level facility is the fund's counsel's; the asset-level facility is the asset company's counsel's, often in another state; the shareholder loan is the tax adviser's. Each document is complete in itself and each adviser's engagement ends with its own document. The intercreditor is the document between the documents, and the party whose interest it serves most, the fund, is the party that did not know it needed one until the default. The structure paper's table of debts is the cure: a row per debt, a column per asset it reaches, a cell for the ranking between each pair, and a blank cell is an intercreditor to draw. The table is the manager's, and the manager is the only party that sees all three debts.

The subordination, drafted

A subordination of the shareholder loan says five things. That the fund's claim ranks after the asset-level lender's on the asset company's insolvency and on any enforcement. That the fund will not demand or accept repayment while a default subsists under the asset-level facility, or at all until that facility is repaid, as the lender requires. That interest and ordinary-course repayments are permitted while no default subsists, which keeps the loan a loan for the tax adviser's purpose. That the fund will turn over to the lender anything it receives in breach. And that the fund will not take security for its loan, or will hold any security it has on trust for the lender. The document is signed by the fund, the asset company and the lender, and it is drafted beside the treaty note's conduit problem so that the permitted payments are at the borrower's board's discretion rather than obliged on receipt.

The standstill, read closely

A standstill on the fund-level lender's enforcement over the holding companies while the asset-level lender enforces over the asset is the asset-level lender's protection against a buyer that will not take a parcel whose owner is in a centre enforcement. It runs for a period the asset-level lender's route needs, with the fund-level lender's right to enforce thereafter, and it carries the fund-level lender's right to receive the carve-out payments during the period. The reverse standstill, on the asset-level lender while the fund-level lender sells a holding company, is rarer and is usually replaced by the asset-level lender's consent in advance to a sale to a buyer meeting a test, with the facility assumed. The two standstills, or the one and the consent, are the intercreditor's core, and a document without them has ranked the claims and not the conduct.

Where it surfaces

At the default, when two lenders' counsel file in two jurisdictions on the same week.

At the distribution stop, when the fund's costs and the fund-level facility's interest stop with the asset company's cash.

At the asset company's insolvency in the asset's state, when the court reads the shareholder loan agreement and finds no subordination.

At the enforcement sale, when the buyer declines a parcel company whose holding company is pledged to another lender that has not released.

At the treaty layer, when the subordination obliges repayment on receipt and the conduit problem appears.

The cost of getting it wrong

Three creditors without a map cost, at default, two enforcements in two jurisdictions against one chain, a buyer who will not buy, a shareholder loan that dilutes the asset lender's recovery or is litigated, and a fund whose costs and fund-level facility stop with the asset company's cash. The intercreditor costs a negotiation at the asset-level facility's signing, when the parties have reasons to agree, and a document in a forum the lenders accept. The difference is the difference between a default that runs on a map and one that runs on a race.

Enforcement across two jurisdictions

The asset-level lender enforces in the asset's state, over the asset and the asset company's shares, under that state's route. The fund-level lender enforces in the centre, over the holding companies' shares, under the centre's court. The two enforcements can run at once, in two jurisdictions, against the same chain, and without an intercreditor each lender's counsel files on its own timetable. The intercreditor sequences them: a standstill on the fund-level lender while the asset-level lender enforces, or the reverse, with a period and an outcome; a rule on which lender's enforcement sale carries the other's security; and a rule on what the fund-level lender may do with a holding company it has taken while the asset-level lender's route runs.

The distribution stop

The asset-level facility commonly stops distributions from the asset company on a default, so that the asset company's cash is preserved for the lender. The stop reaches the chain: the holding companies receive nothing, the fund receives nothing, the fund-level facility is not serviced from below, and the fund's own costs and the manager's charge are funded from commitments or not at all. The intercreditor carves out what the stop does not reach: the fund's administration costs, the manager's charge where the constitution permits it to be funded from the asset company's cash, and the fund-level facility's interest, each up to a cap and for a period. A stop without carve-outs is a stop that makes a default at one asset a default at the fund.

The release of security

An enforcement sale by the asset-level lender is a sale of the asset or the asset company's shares, and the buyer takes free of the fund-level lender's security over the holding companies above only if that security is released. The intercreditor provides the release: the fund-level lender's pledges over the holding companies fall away to the extent of the sold asset, against the turnover of any surplus. An enforcement sale by the fund-level lender of a holding company is a sale of a company whose asset company carries the asset-level facility, and the buyer takes it with the facility, which the asset-level lender's change-of-control clause reaches; the intercreditor says whether the asset-level lender consents in advance to a sale to a buyer meeting a test. Without the releases, each lender's enforcement is a sale of something encumbered by the other's security, which no buyer takes at a price.

When it is drawn

At the asset-level facility's signing, because that is the last moment all three creditors are in the room with something to gain from agreeing. The fund-level lender is asked to acknowledge the asset-level security and to agree the standstill and the release; the asset-level lender is given the subordination it wants in exchange for the distribution carve-outs the fund needs; the shareholder loans are documented as subordinated from the start with the ordinary-course payments permitted. A structure that signs the asset-level facility without the intercreditor has three creditors who will meet for the first time at the default, and the default is the moment each has least reason to agree.

The forum

The intercreditor is between lenders about ranking and conduct, and it is governed by a law and a forum the lenders accept, commonly the centre's law and court where the fund-level facility sits there, with the asset-level lender's security documents in the asset state's law. Its provisions on enforcement name the asset state's process for the collateral and the centre's court for the debts, so that an enforcement under one does not trigger a claim under the other without the intercreditor having said what happens.

By question · by creditor	Fund-level lender	Asset-level lender	Shareholder loans
Paid first from	The commitments; the holding companies	The asset; the receivables; the asset company's shares	The asset company's surplus after the asset-level lender
Subordination	Not subordinated to the asset-level lender as to its own collateral	Senior at the asset	Subordinated to the asset-level lender, fully or on insolvency
Distributions on a default below	Carve-out for interest, costs and the manager's charge, capped	Stop, with the carve-outs	Stopped
Enforcement	Over the holding companies, after a standstill or with consent	Over the asset, freely	None while subordinated
Release on the other's enforcement	Releases the holding company pledges on an asset sale	Consents in advance to a holding company sale to a buyer meeting a test	Not applicable
Turnover	Holds what it should not receive on trust	The same	The same

A timeline, as a type

Month one: the construction facility's term sheet; the structure paper's table of debts shows three rows and a blank cell between each pair. Month two: the intercreditor's first draft from the construction lender's counsel with the subordination; the fund's counsel adds the carve-outs, the releases and the turnover; the capital-call lender's counsel confirms the standstill and the acknowledgement. Month three: the three documents signed on one day: the construction facility, the subordination of the shareholder loan and the intercreditor. Year two: a refinancing of the construction facility; the intercreditor's accession by the new lender. Year four: the default; the map runs; the construction lender enforces on the route; the carve-out services the capital-call facility; the parcel sells; the releases and the turnover operate; the fund's equity is what is left after the ranking said.

The structure paper's page

The structure paper's intercreditor page is the table of debts: each debt, its lender, its security, the assets it reaches, its ranking against each other debt, the distribution stop and its carve-outs, the standstills and consents, the releases and the turnover, and the forum. Beneath it, the subordination's five terms quoted. The page is the answer to the lender that asks where it ranks, to the committee that asks what a default at one asset does to the fund, and to the register that asks whether a default below reaches the fund's costs.

The refinancing and the accession

A refinancing of the asset-level facility by a new lender is a new creditor in the chain, and the intercreditor provides for its accession: the new lender signs up to the same ranking, standstill, carve-outs and releases, and the old lender's rights fall away on repayment. An intercreditor without an accession mechanism is renegotiated at every refinancing, with the new lender holding a pen it did not hold before; one with it is a document the new lender signs as a condition of lending.

The developer's position in the chain

Where the asset company is a joint venture with a developer, the developer may also be a creditor: for its costs, for a development loan it made, or for a promote crystallised and unpaid. The developer's claims rank under the joint venture agreement, and the intercreditor reads them: the construction lender wants the developer's claims subordinated as the fund's are, the developer wants its costs paid in the ordinary course, and the fund wants the promote paid after the lender and not before. The joint venture agreement and the intercreditor are reconciled so that the developer is a party to the ranking rather than a creditor outside it.

An intercreditor, as a type

A fund with a capital-call facility finances a parcel company's development with a construction facility and lends the equity down the chain as a shareholder loan. At the construction facility's signing, the three documents are drawn together. The capital-call lender acknowledges the construction lender's security over the parcel company and agrees a standstill on enforcement over the portfolio holder while the construction lender enforces, with a release of the portfolio holder's pledge on a sale of the parcel against turnover of the surplus. The construction lender obtains a subordination of the shareholder loan, full on insolvency and with ordinary-course interest permitted while no default subsists, and agrees a distribution carve-out for the fund's administration costs and the capital-call facility's interest, capped, for twelve months. The shareholder loan is documented as subordinated with its own repayment at the parcel company's board's discretion, so that the treaty layer above is not a conduit. The intercreditor is in the centre's law and court, and names the Kingdom's movables route and execution court for the collateral. In year four the parcel company defaults; the construction lender enforces on the route; the capital-call lender stands still and is serviced from the carve-out; the parcel is sold; the construction lender is paid; the surplus is turned over; the portfolio holder's pledge is released as to that parcel; the shareholder loan is paid from the surplus after the construction lender and before the equity.

Four cases, as types

A fund has a portfolio facility, a construction facility at its largest parcel company and a shareholder loan to it, with no intercreditor. The parcel company defaults. The construction lender stops distributions; the portfolio facility's interest is unserviced and the portfolio lender enforces over the holding companies in the centre while the construction lender enforces over the parcel in the Kingdom; the construction lender's buyer declines to take a parcel company whose holding company is in a centre enforcement; the shareholder loan ranks with the construction lender in the parcel company's insolvency and the construction lender litigates the subordination its facility mentioned in a sentence.

A fund's asset-level facility requires subordination of shareholder loans and nobody documents it. At the asset company's insolvency in the asset's state, the court reads the shareholder loan agreement, which says nothing about subordination, and ranks the fund with the lender, and the lender's recovery is diluted by the fund's own claim.

A fund's intercreditor stops distributions on a default without carve-outs. A default at one asset company stops the fund's administration costs and the capital-call facility's interest across the whole fund; the fund funds both from commitments the holders did not expect to be called for them; the capital-call facility is in default for want of interest within the quarter.

A fund draws the intercreditor at the asset-level facility's signing, with the seven questions answered, the shareholder loan subordinated in a document, the carve-outs capped and the releases provided. The default in year four runs on the map, and each creditor is paid from what the map said.

What each party holds

The manager holds the decision to draw the intercreditor at the asset-level facility's signing, the seven questions answered in the structure paper, and the shareholder loan documented as subordinated.

The fund-level lender holds the acknowledgement, the standstill, the carve-out and the release.

The asset-level lender holds the subordination, the distribution stop and its own enforcement.

Counsel holds the drafting in a forum the lenders accept, with the asset state's process named for the collateral.

The treaty layer's board holds the shareholder loan's repayment at its discretion.

The register holds the carve-outs, which keep a default at one asset from reaching the fund's costs.

The sequence

1. The three debts in the chain are listed, with the assets each reaches and the ranking each expects.
2. The intercreditor is drawn at the asset-level facility's signing, with all three creditors in the room.
3. The seven questions are answered in the document: priority, subordination, the distribution stop and its carve-outs, enforcement and standstill, the holding company shares, the releases, the turnover.
4. The shareholder loan is documented as subordinated, with ordinary-course payments permitted and repayment at the borrower's board's discretion.
5. The intercreditor's forum is chosen with the fund-level facility's, and the asset state's process is named for the collateral.
6. The structure paper carries the table of debts and rankings, and a blank in it is the intercreditor that was never drawn.

Questions a manager asks

Is an intercreditor needed where the fund-level lender has no security over the holding companies. Where the fund-level facility is a capital-call facility secured on the commitments only, the questions are fewer but the distribution stop and its carve-outs still reach the facility's service, and a short acknowledgement settles them.

Who drafts it. The asset-level lender's counsel usually produces the first draft, because the asset-level lender wants the subordination; the fund's counsel drafts the carve-outs and the releases; the fund-level lender's counsel confirms the standstill.

Why subordinate the shareholder loan at all. Because the asset-level lender will not lend on an asset whose owner ranks beside it, and because an unsubordinated shareholder loan is a claim the fund is making against its own asset company in competition with its own lender.

Can the shareholder loan be avoided. Equity instead of loans avoids the ranking question and raises the tax adviser's; the choice is read with the adviser, and a loan that is kept is subordinated.

What if the asset-level lender will not give carve-outs. Then a default at that asset stops the fund's costs and the fund-level facility's service, and the fund reserves commitments for both or reads the asset as one whose default it cannot afford.

Does the intercreditor affect the exit. The releases are the exit's mechanics on an enforcement, and the consents in advance to a sale to a buyer meeting a test are the exit's mechanics on a sale; an intercreditor without either is an exit that needs three consents.

Terms used

Intercreditor: the agreement between creditors of a structure ranking their claims and governing their conduct.

Subordination: the agreement that one creditor's claim ranks after another's.

Distribution stop: the asset-level facility's prohibition on distributions during a default.

Carve-out: the payments the stop permits, capped and for a period.

Standstill: one creditor's agreement not to enforce while another does.

Release: the fall-away of one creditor's security on the other's enforcement sale.

Turnover: a creditor's obligation to hold on trust what it receives in breach of the ranking.

What to read

The fund-level facility's security and covenants; the asset-level facility's security, distribution stop, subordination requirement and change-of-control clause; the shareholder loan agreements; the asset state's insolvency law on the ranking of shareholder claims; the centre's law on intercreditor arrangements. On this site, the financing, security and holding chains rooms under Structures.