The LMA REF intercreditor agreement for contractual subordination

Andrew Besser, partner and head of real estate finance (REF) at Olswang, reviews the background to the new form of agreement recommended by the Loan Market Association (LMA) for use between creditors in REF and outlines the circumstances in which it is to be used.

Original news

The LMA has announced the launch of a new recommended form of intercreditor agreement for real estate finance transactions, the REF Contractual Intercreditor Agreement. The agreement, for use in conjunction with the LMA’s Recommended Form of Facility Agreement for REF multi-property investment transactions, uses the same boilerplate as the LMA Recommended Form of Intercreditor Agreement for the leveraged finance market.

What is the background to the launch of this document?

There was concern particularly in the light of the 2008 financial crisis that the intercreditor agreements that were drafted before that time were inconsistent and that therefore there was lack of clarity and certainty. This led to a lot of litigation.

There was therefore a call for a more standardised approach both to the structure of intercreditor arrangements and consequentially documentation.

Accordingly, the LMA took the reins and brought out a precedent document in 2014.

However, the existing form of intercreditor agreement produced by the LMA predicated only one structure known as structural subordination. It was also only forward looking to future transactions.

This meant that the document was not suitable for all situations in which an intercreditor agreement would be relevant—for example, where structural subordination was not available or appropriate.

Because this document was the only precedent available, to some extent it was driving the market to the structural subordination route, even if on occasion it was not the most appropriate.

In which circumstances can the REF contractual intercreditor be used?

It is this background that led the LMA recently to introduce the REF Contractual Intercreditor Agreement. The REF contractual intercreditor can be used in those transactions where the parties do not want to adopt a structural subordination and where the parties want to rely on a contractual subordination. The most common examples would be firstly where there is an existing senior or mezz structure already in place. Here, the parties may be amending and restating arrangements and would like to use the terms of the new documentation but it is not appropriate to restructure the asset owning stack. It is also useful for A/B structures. These exist where the terms of the senior and the mezzanine loans are contained within the same loan agreement. It may be that a transaction just does not justify the cost of creating all the vehicles necessary to implement the structural subordination structure. Finally, the subordinated structure is just not effective in certain overseas jurisdictions where only contractual subordination works.

The LMA said specifically that the REF contractual intercreditor agreement was:

‘…proposed in response to demand from members documenting smaller- to mid-sized transactions in the regional real estate finance market who were increasingly seeing loans provided via a combination of senior and mezzanine finance and ranked by way of contractual subordination only and with common security.’

What are the key provisions of the REF contractual intercreditor?

The REF contractual intercreditor is really no different to the existing intercreditor agreement.

The key provisions of a typical REF structural subordination intercreditor agreement in real estate finance relate to:

  • subordination and priority of payments
  • permitted enforcement of the first ranking mezzanine share security
  • the mezzanine lender’s right to cure a default under the senior loan
  • the mezzanine lender’s right to purchase the senior loan, and
  • the consent and consultation rights of the mezzanine lender

The terms of each of these provisions will be subject to negotiation.

In a contractual subordination, the rights of the mezzanine lender are much narrower and much of the above would either not be relevant or acceptable.

The commercial end is the same, namely really to protect the integrity of the rights of the senior lender. The differences are largely technical to fit the existing contractual position into the other structures.

What are the key differences between the REF contractual intercreditor and the existing REF intercreditor?

Accordingly, the main differences mainly relate to the fact that both loans are made available to one borrower and that there is no separate remedy of mezzanine enforcement against a separate mezzanine shareholder. Therefore all references to the mezzanine lender having its own security package over the ‘equity’ are removed.

What effect will the launch of the REF contractual intercreditor have on the documentation for REF facilities?

It means that there now are precedent documents available for most intercreditor situations. It will help to add familiarity to the documentation for this structure. It may avoid pressure to adopt the structural subordination where it is not totally appropriate. It is to be welcomed.

Interviewed by Bridget O’Connell.

The views expressed by our Legal Analysis interviewees are not necessarily those of the proprietor.

First published on LexisPSL Banking & Finance. Click here for a free trial.

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