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Real EstateLaw Practice
Intercreditor Agreements 2.0:
Lessons Learned in the ‘Tranches’
By Mark S. Fawer
and Carolyn M. Austin
T
HE CREDIT CRISIS in the commercial
real estate market continues. Trepp,
LLC recently reported that “the tone in
the CMBS market has been acutely negative
for the past three months,” with 9.56 percent
of outstanding U.S. commercial mortgage
backed securities loans in delinquency as
of September 2011.1
As the rate of default continues or even
accelerates, some mezzanine lenders, forced
to dust off the intercreditor agreements
entered into with senior lenders in happier
times, may be surprised to learn that their
rights and protections are surprisingly
limited. This article will focus on the next
chapter in structured commercial real estate
finance and, in particular, on certain key
components of the intercreditor agreement,
with an eye toward how mezzanine
lenders may better protect themselves
in the next generation of intercreditor
agreements.
Make Key Provisions Work
Senior real estate loans are secured by
mortgages on real property. Mezzanine
financing is secured by a pledge of the
ownership interests in the entity owning
the property, rather than the property
itself. The owner of the property is
typically a “special asset entity” whose
sole asset is the real property that is the
Mark S. Fawer is a partner, and Carolyn M. Austin an
associate, at Dickstein Shapiro in New York.
subject of the senior lender’s mortgage.
The mezzanine lender’s pledged equity
collateral is, therefore, one step removed
from the real estate. Thus, foreclosing on
the equity collateral (or the threatened
ability to do so) is often the mezzanine
lender’s primary remedy when confronted
with a mezzanine borrower’s default,
especially if there is also a looming default
by the senior borrower under the senior
loan that threatens to wipe out the equity
via a senior lender’s foreclosure of the
mortgage covering the real property.
A mezzanine lender in that situation must
move quickly, and a foreclosure of the
pledge of membership or partnership
interest in the property owner may
generally be effected under the Uniform
Commercial Code within 45 to 90 days
after sending a notice of sale. Though
far shorter than the time it would take
in New York to obtain a judgment of
foreclosure in a judicial foreclosure of
a mortgage, a mezzanine lender may
be racing against the clock if unduly
impeded by a straitjacketing intercreditor
agreement.
The relationship between senior and
mezzanine lenders is governed by an
intercreditor agreement. The typical form
of agreement contains certain standard
provisions concerning the subordination
of the mezzanine loan to the senior loan
and the relative rights and obligations
of each lender to the other. Below is an
examination of certain material provisions
and practical drafting solutions designed
to anticipate the needs of the mezzanine
lender in the context of a borrower’s default
and potential workout of the loan.
www. NYLJ.com
Monday, November 21, 2011
Right to Foreclose
Other than timely repayment, the
bedrock issue for the mezzanine lender
is its ability to realize upon its collateral
what is often referred to as “separate
collateral” or “equity collateral” in the
event of a default and in effect take over
the senior borrower as the owner of the
property. Many intercreditor agreements
contain onerous conditions to a mezzanine
lender’s right to foreclose, among which
and perhaps most significantly, is that any
existing senior loan default must first be
cured as a condition to the mezzanine
lender’s right to foreclose.
In Bank of America, N.A. v. PSW NYC
LLC (the Stuyvesant Town Case), 2 the
court enjoined the mezzanine lender
from foreclosing on the pledged equity
without first repaying the senior lender’s
outstanding indebtedness in full (the senior
loan had been previously accelerated). The
decision turned on the interpretation of a
provision in the intercreditor agreement
entitled “Foreclosure of Separate
Collateral,” which allowed the transfer
to a Qualified Transferee of title to the
equity collateral
subject to (i) the Senior Loan…
provided, however, that…all defaults
under (1) the Senior Loan and (2)
the applicable Senior Junior Loans,
in each case which remain uncured
or unwaived as of the date of such
acquisition have been cured by such
Qualified Transferee.3
Notwithstanding that “such Qualified
Transferee shall cause, within ten (10)
days after the transfer, (1) Borrower…to
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reaffirm in writing…all of the terms and
conditions and provisions of the Senior
Loan Documents and the related Senior
Junior Loan Documents, as applicable,
on Borrower’s or the applicable Senior
Junior Borrower’s, as applicable, part to
be performed,”4 the court rejected the
mezzanine lender’s argument that this
provision should apply to require the
Qualified Transferee’s cure of the Senior
Loan default only after the mezzanine
lender foreclosed and transferred its
equity to such Qualified Transferee.5
This condition to the mezzanine lender’s
right to foreclose on its equity was a
land mine that effectively left it without
a viable remedy. Mezzanine lenders should
therefore strive to avoid any limitation
on the exercise of their right to foreclose
(or otherwise realize on any “Separate
Collateral” that is not also collateral for
the senior loan), and to make sure that any
such foreclosure should never be an event
of default under the terms of the senior
loan. At the very least, the intercreditor
agreement should clearly provide that
any cure of a senior loan default need
not occur before or as of the completion
of a mezzanine loan foreclosure sale as
a condition of such sale, but rather may
occur thereafter.
Qualified Transferee
As in the Stuyvesant Town case, many
intercreditor agreements provide that (i)
a mezzanine loan may be transferred by
a mezzanine lender and (ii) the pledged
equity may be transferred in a foreclosure
or deed-in-lieu of foreclosure of that pledged
equity—in each case, only to a “Qualified
Transferee.” Here, the object should
be to expand the universe of “Qualified
Transferees”: The more broadly the term
Qualified Transferee is defined, the more
liquid the mezzanine loan and the pledged
equity become.
For instance, at a public UCC foreclosure
sale of the pledged equity, the mezzanine
lender (who may “credit bid” up to the
amount it is owed) could benefit from
an active auction with many third-party
bidders. However, an overly restrictive
Qualified Transferee definition could chill
the interest in the auction and the bidding
process itself. Even if the mezzanine lender
is the winning bidder, it may wish to assign
its winning bid to a Qualified Transferee.
A mezzanine lender should take care,
therefore, to include in the definition of
Qualified Transferee itself and its affiliates
(especially since it may wish to take title
to the equity in a special purpose entity)
and as broad an array of institutional and
industry players as possible. Furthermore,
since most definitions also include “net
worth” or “liquid asset” requirements,
care should also be taken to keep these
thresholds as low as feasible.
A broader definition of Qualified
Transferee may also permit mezzanine
lenders to more easily infuse new capital
into a deal. Often intercreditor agreements
restrict mezzanine lenders from transferring
more than 49 percent of their interest in
the mezzanine loan unless the transfer
is to a Qualified Transferee. In a workout
scenario, a mezzanine lender may well
find itself in the best position to infuse
new capital into a failing project (such as
through a protective advance); however, an
overly restrictive definition of a Qualified
Transferee may unduly limit the mezzanine
lender’s ability to syndicate the mezzanine
loan and bring in that money from a thirdparty co-mezzanine lender.
Timing Restrictions
Mezzanine lenders often obtain a guaranty
as additional security for their loans. The
intercreditor agreement will commonly
prohibit the mezzanine lender from enforcing
its guaranty until the senior loan is paid
in full. A mezzanine lender, however, may
need to enforce its guaranty prior to the full
repayment of the senior loan, especially to
deter “bad boy” acts, like a bankruptcy filing;
bad faith interference with the enforcement of
remedies; and breaches of certain obligations,
such as unpermitted modifications to the
senior loan documents.
In Highland Park CDO I Grantor Trust,
Series A v. Wells Fargo Bank, N.A., 6 the
mezzanine lender’s rights in connection
with the enforcement of its guaranty were
essentially eviscerated by the enforcement
limitations contained in the intercreditor
agreement. In Highland, the mezzanine
lender was barred from exercising its rights
or remedies under its guaranties until the
senior loan was fully paid off. The court
based its decision on the subordination
provision of the intercreditor agreement
whereby the mezzanine lender is prohibited
from receiving any payments on the
mezzanine loan before the senior loan is
repaid in full. The mezzanine lender argued
this section applied only to payments
received from the borrower, not from any
guarantor. The court did not agree with
the mezzanine lender’s interpretation.
Accordingly, care should be taken in
drafting the intercreditor agreement to give
a mezzanine lender the unimpeded right to
enforce its guaranty against the guarantor
to judgment (or less ideally, the right to
enforce the guaranty with the obligation
to apply the proceeds of any judgment in
repayment of any then-outstanding senior
loan obligations), or to permit the mezzanine
lender to enforce the guaranty to the extent
that the senior lender fails to do so after a
stated period of time.
Often intercreditor agreements
restrict mezzanine lenders
from transferring more than
49 percent of their interest
in the mezzanine loan unless
the transfer is to a Qualified
Transferee.
Replacement Guarantor
M a n y i n t e rc re d i t o r a g re e m e n t s
require that in the wake of a mezzanine loan foreclosure, the mezzanine lender
must provide a replacement guaranty in the
event that the original guaranty securing a
part of the senior loan is released. Because
there is nothing inherent in a mezzanine
loan foreclosure that results in a release
of a senior loan guarantor, a mezzanine
lender should avoid agreeing to provide a
replacement guarantor, indemnitor, pledgor,
or other obligor under the senior loan
documents so long as the original stays in
place.
Loan Amendment Rights
Intercreditor agreements usually
provide that neither the senior lender
nor the mezzanine lender, without the
consent of the other, may modify certain
material terms of its respective loans,
such as:
• increase in loan amount, interest rate,
or other monetary obligations;
• extension or shortening of the
maturity date;
• conversion or exchange for other
indebtedness or subordination to other
indebtedness;
• modification of transfer provisions;
Monday, November 21, 2011
• extension of the period during which
voluntary prepayments are prohibited or
penalized;
• modification of partial release prices;
and
• modification of the terms concerning
the application of casualty proceeds.
However, senior lenders often want, and
obtain, much greater latitude to modify
the senior loan in a default or workout
scenario, often placing limits only on the
senior lender’s right, without the mezzanine
lender’s consent, to enter into otherwise
prohibited modifications from a narrower
list.
The prudent mezzanine lender, on the
other hand, should try to eliminate the
workout carveout altogether, or at least
maintain, even in the context of a workout,
as many of the limits on a senior lender’s
ability to modify as would prevail absent
a workout. Otherwise, a mezzanine lender
may find itself defenseless to stop senior
loan modifications which compromise the
mezzanine lender when it most needs the
protections against such modifications.7
Senior Loan Buyout
Typically, intercreditor agreements
provide the mezzanine lender with an option
to purchase the senior loan. The focus here
should be on two major issues: option price
and timing of the exercise of the option.
From the perspective of the mezzanine
lender, the option price should be no
greater than “par” (i.e., the sum of the
outstanding principal balance, accrued
but unpaid interest at the contract rate, and
unreimbursed lender expenses), but should
exclude late charges, default interest, and
exit and prepayment fees. In terms of timing,
an option should be exercisable at any time
after the occurrence and continuance of a
senior loan default and remain open until a
certain period of time after the senior lender
commences a foreclosure action.
Cure Periods
Intercreditor agreements generally
provide that a senior lender must
give the mezzanine lender notice of
defaults under the senior loan and an
opportunity to cure the default. The
timing and curing of defaults (which
may often match whatever is provided
to a senior borrower in the senior loan
documents) should be contingent on the
type of default: monetary; non-monetary
susceptible to cure prior to completion of
a foreclosure by a mezzanine lender; nonmonetary not susceptible to cure until
following a foreclosure by a mezzanine
lender; and those not susceptible to cure
at any point.
For monetary defaults, the cure period
should be at least five business days after
the later of: (i) the receipt by senior lender
of a notice of default and (ii) the expiration
of senior borrower’s cure period set forth
in the senior loan documents.
For non-monetary defaults susceptible
to being cured prior to completion of a
mezzanine lender’s foreclosure action, the
cure period should be at least as long as that
given to the senior loan borrower (but the
cure period should only start after notice
has been given to the mezzanine lender).
For non-monetary defaults susceptible to
cure following the completion of a mezzanine
loan foreclosure sale, the cure period
should only commence after completion of
the foreclosure sale, and the cure period
thereafter should be at least as long as the
cure period set forth in the senior loan
documents.
For those defaults not susceptible to being
cured by a mezzanine lender or a Qualified
Transferee (e.g., the bankruptcy of the
senior borrower, a failure by a guarantor
of a net worth test, a default based on the
performance of an individual, or a default
arising from the failure of the senior borrower
to timely complete construction), the senior
lender should either waive the default or
modify it to apply only to any future default
arising from the mezzanine lender’s or
Qualified Transferee’s actions following a
foreclosure of the pledged equity.
Protective Advances
A mezzanine lender may be faced with
a situation where it may want or need
to make a “protective advance,” usually
for the payment of property taxes,
maintenance costs, insurance premiums
or other items (including capital items)
reasonably necessary to protect the
real property or the mezzanine lender’s
collateral from forfeiture, casualty, loss, or
waste. A mezzanine lender should ensure
that nothing in the intercreditor agreement
prohibits it from making reasonable
protective advances and adding that
amount to the principal balance of the
mezzanine loan, notwithstanding the
existence of a default under the senior loan
or a prohibition against increasing its loan
amount.
Conclusion
The time and effort spent by a mezzanine
lender and its counsel to better address in an
intercreditor agreement a mezzanine lender’s
rights concerning the administration and
enforcement of its loan could greatly reduce
the contractual barriers that may otherwise
exist to maximizing its loan repayment or
recovery later. Of course, pursuit of more
favorable intercreditor provisions must
be tempered with an overall awareness
of deal terms and market conditions and
practitioners are advised to take a holistic
view when approaching each issue. For
those looking to buy mezzanine loans
with an in-place intercreditor agreement
negotiated by a predecessor mezzanine
lender, the intercreditor agreement should
be reviewed carefully in advance to assess
the risks of a less than ideal agreement.
In sum, to avoid or minimize the risk of
“tranche warfare” with senior lenders,
mezzanine lenders should heed the words
of the fabled General George S. Patton,
who said: “A pint of sweat saves a gallon
of blood.”
•••••••••••••• ••••••••••••••
•
1. “U.S. CMBS Delinquency Report-September
’11,” TreppWire, Oct. 3, 2011, at 1, available at
http://www.trepp.com/m/Press_release/displayFile.
cgi?input=treppwire201110.pdf.
The
overall
commercial real estate market, with the exception
of hotel properties, has shown an increase in
delinquency rates, with multifamily properties
remaining the worst, having a delinquency rate
increase of 52 basis points for a 16.96 percent rate.
Id. at 3.
2. 29 Misc. 3d 1216(A), 918 N.Y.S. 2d 396
(unpublished table decision), 2010 WL 4243437 (Sup.
Ct. N.Y. County 2010). The senior loan was secured
by mortgages covering the Manhattan apartment
commonly known as “Stuyvesant Town.”
3. Id. at *2.
4. Id. at *3.
5. It is worthwhile noting that had the court allowed
the mezzanine lender’s foreclosure to proceed,
the mezzanine lender would still have had to cure
the senior loan default or, absent a successful loan
restructuring (in or outside of bankruptcy court),
run the risk of a mortgage foreclosure and having its
equity wiped out.
6. No. 08 Civ. 5723 (NRB), 2009 WL 1834596 (S.D.N.Y.
June 16, 2009).
7. For example, if a senior lender were permitted
to increase the principal balance of its loan without
the consent of the mezzanine lender, the security
and value of the mezzanine loan would be further
impaired since the senior lender would be adding
more debt, the repayment of which has priority over
the repayment of the mezzanine loan.
Reprinted with permission from the November 21, 2011 edition of the NEW
YORK LAW JOURNAL © 2012 ALM Media Properties, LLC. All rights reserved.
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