Collateral Agency and Inter-Creditor agreement

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Collateral Agency and Inter-Creditor agreement

A collateral agency agreement is an agreement through which a lending institution acts as an agent for different secured lenders during certain specific requests. Whereas, an inter-creditor agreement is an agreement between two or more creditors who decide in advance as to how their competing interests in their common borrower will be dealt with.

A collateral agency and inter-creditor agreement bring together the principles of both these agreements 

When Do you Need a Collateral Agency and Inter-Creditor Agreement 

When several organisations lend money to a company, they decide with the debtor company what the terms of the deal are, and they will also need to come to arrangements between themselves to establish how their competing interests towards that company will be handled in the event of a dispute. The purpose of the agreement is to outline clearly the relationship between the creditors and also to state how the collateral security will be held by the collateral agent. 

This agreement is required as defining lien priority between two secured creditors is needed when both have security interests in the same collateral. In case of a senior/junior lender scenario, the lenders enter into this agreement to establish their respective rights. The reason for this is usually the senior lender will seek to be repaid first from the proceeds of collateral upon enforcement of the lien, while the junior lender will expect to collect from the remaining proceeds if any only.

 Inclusions in a Collateral Agency and Inter-Creditor Agreement 

The agreement must clearly state the names of the parties between whom the agreement is made. This will include a Collateral Agent, the Lender(s), and each of the Creditors. The date at which the agreement is entered into must also be mentioned along with the territory in which the agreement is enforceable. The Agreement must clearly mention under which law it will be governed and how the agreement shall be terminated. The manner in which the agreement is to be modified should also be described.

How to Draft a Collateral Agency and Inter-Creditor Agreement 

The following are the most important terms that should be negotiated by the parties before drafting the agreement:

  • Priority of the creditors i.e. senior debt vs. junior debt. There may be an overall limit on the senior debt amount which is to take priority over the junior debt.
  • Payment restrictions and undertakings of borrowers: For e.g. the borrowers shall not pay the junior debts until the senior debt is repaid in full.
  • Permitted payments: For e.g. the only payments allowed to the junior debtor during the term of the senior debt will be in relation to interest on the junior debt and the payment of certain fees and expenses.
  • Purchase option: The right of the junior lender to purchase the senior mortgage loan in the event of default under the senior loan is a customary feature of any inter-creditor agreement.

Benefits of a Collateral Agency and Inter-Creditor Agreement 

  • The rights of the creditors are clearly defined
  • The priority of the lien is clearly defined
  • The collateral agent is given the right to deal with the collateral security on behalf of the creditors.
  • The process of repayment is laid out clearly
  • The manner in which the collateral security shall be utilized for repayment is also made clear.
  • The entire process can be completed without entering into a legal battle in court.
  • Having an agreement in place between all the creditors is a more practical process than dealing with a legal mess in court when the lien is enforced.

Consequences of Not Having a Collateral Agency and Inter-Creditor Agreement

If such an agreement does not exist between the creditors, each creditor will exercise his/her own resolutions at the same time and will be inconsistent. The entire process may be unethical and may turn into a legal mess in court. The senior lenders will have an upper hand and could wipe out the junior lender if they foreclosed on their interest in the first lien mortgage.

Key Clauses in a Collateral Agency and Inter-Creditor Agreement

The following are the key terms of a collateral agency and inter-creditor agreement:

  • Relationship among secured creditors
  • Borrower’s grant of security interest
  • Acknowledgement of First Lien
  • Acknowledgement of Second Lien
  • Priority of Liens
  • Payments
  • Subordination of Liens
  • Enforcement of Liens
  • Release of Liens on Collateral
  • Appointment of Collateral Agent
  • Powers of Collateral Agent
  • Duties and Obligations of Collateral Agent
  • Indemnification of the Collateral Agent
  • Resignation / Removal of Collateral Agent
  • Appointment of successor collateral agent
  • Termination of Agreement
  • Limitation of liability
  • Insolvency or Liquidation Proceedings
  • Amendments to transaction documents
  • Governing Law

What Happens When You Violate a Collateral Agency and Inter-Creditor Agreement 

Generally, collateral agency and inter-creditor agreements have a clause that talks about the actions to be taken when a party to the agreement breaches the clauses of the said agreement. If a party takes any step with respect to the collateral security (including any attempt to realise upon or enforce any remedy with respect to the agreement) that is against the agreement or does not take any step that is required by the agreement, the other party or parties may obtain relief against such a party by injunction, specific performance or other appropriate equitable relief. 

Some agreements restrict a junior lender’s right to challenge a senior lien or limit them from exercising certain remedies. When such rights are waived by the junior lenders, they made be liable for breach of contract if they try to assert such waived rights. The court will, in most circumstances, enforce a well-drafted waiver.

Sample of a Collateral Agency and Inter-Creditor Agreement

You can download a sample Modification and Consolidation Agreement here

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Collateral Agency and Inter-Creditor agreement

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