Intercreditor Agreements: What are they and Why it’s Important to EB-5 Investors?

Since most EB5 offerings come in the form of mezzanine, 2nd position debt, it is therefore critically important for investors to understand the relationship between a senior construction loan and the EB5 loan. This relationship is governed by an intercreditor agreement.

Intercreditor agreements in commercial real estate are legal documents that outline the respective rights and priorities of different creditors who have extended financing to a particular project. These agreements are typically put in place when multiple lenders are involved in financing a single project, which is common in large-scale commercial real estate developments or acquisitions.

The Agreement establishes the right to liens amongst multiple creditors on an asset or project. In the event of a default by a borrower, an Intercreditor Agreement serves as the foundation of each creditor’s rights and payment priority. If there is no intercreditor agreement, conflicts amongst the different creditors will likely occur as each creditor is looking out after their own interests.

The need for a Intercreditor Agreement is imperative for projects involving mezzanine debt. Mezzanine debt, or lenders subordinate to the senior lender, will be loaned to a project under the pretext that if the borrower defaults on the mezzanine, then the mezzanine lender can take over the equity shares of the borrower should all other financing be in good standing. This is the added reward for mezzanine finance as they are in a riskier position than the senior lender. In order for a mezzanine lender to be afforded this right from a senior lender, it must be negotiated and included in an Intercreditor Agreement. Otherwise, a mezzanine lender would have no legal claim to taking over a project from a defaulted borrower as the senior lender has priority in lien position and can control the future of the project.

Therefore, even though most EB5 loans come with an equity pledge as collateral, to understand the validity of the equity pledge, an investor must first ask to read the intercreditor agreement.

The issue with many EB-5 projects that use EB-5 loans is that there is often either no intercreditor agreement or, to the extent that there is, it is written in a highly disadvantageous way. This means that regional centers often do not have the right to take over a project from a borrower/developer in the case that the EB-5 loan defaults despite having an equity pledge from the borrower/developer.

Unless the mezzanine lender has extensive experience as a developer, most senior lenders will not allow a mezzanine lender to assume their loan from the developer, thereby rendering an equity pledge useless. Instead, many regional centers will often extend the EB5 loan beyond the original loan term, allowing developers more time to cure the default all the while profitting before the EB-5 investors and adding more risk of failing to repay EB-5 investors. This is one of the main reasons developers often seek EB-5 capital as it’s more flexible and less restrictive than traditional mezzanine debt.

To this point, we have only contemplated a default on the EB5 loan. However, this is not the worst thing that can happen as a mezzanine lender. The worst thing that can happen as a mezzanine lender is the devleoper defaulting on the senior loan. This is because almost all intercreditor agreements require the mezzanine lender to immediately acquire the senior loan if the developer is in default of the senior loan. If not, the mezzanine lender would then stand to lose ALL of its investment. For this reason, only extremely well capitalized groups with extensive development experience typically act as mezzanine lenders. Unfortunately, this does not fit the description of the vast majority of EB5 regional centers.

Key features of intercreditor agreements include:

1. Seniority: States the ranking of different loans from senior to subordinated. Higher ranking debts have preference over lower ranking ones and will recover their interest, fees, costs, etc. before subordinate lenders.
2. (P)Repayment: Specifies the order in which creditors will be paid or repaid in the event of default or bankruptcy. They establish the hierarchy of debt, determining which creditors have priority over others in accessing the project’s assets for repayment and which creditors can be blocked from being repaid prior to the senior lender
3. Subordination: These clauses dictate that certain creditors agree to subordinate their claims to those of others. For example, mezzanine lenders might agree to subordinate their claims to senior lenders, meaning they will only be repaid after the senior lenders have been satisfied.
4. Collateral and Security: Intercreditor agreements detail the collateral securing each lender’s loan. They may also outline how the collateral will be managed and distributed in the event of default.
5. Dispute Resolution & Voting Rights: Enables the enforcement structure regarding lenders especially in the event of a default. In some cases, intercreditor agreements may address voting rights in major decisions affecting the project, such as changes in ownership or significant amendments to the project’s structure.
6. Default and Enforcement: These agreements specify the rights and responsibilities of each party in the event of default. They outline procedures for enforcing rights, including the ability to take control of the project or pursue other remedies.
7. Information Sharing: Discloses process for sharing financial performance and other financial details so all creditors can act in a unified, concerted manner.
8. Amendments, Waiver, and Release/Termination Rights: Includes provisions governing amendments and waivers to the terms of the agreement. These provisions outline the process by which changes to the agreement can be made and the circumstances under which waivers may be granted. Defines the situations in which creditors can be updated and released from the Agreement upon satisfaction of their obligation.

Overall, mezzanine financing is highly complex and intercreditor agreements are essential in managing the intricate relationships between multiple creditors involved in financing commercial real estate developments. They provide clarity and structure to the rights and obligations of each party, helping to mitigate potential conflicts and ensure a smoother resolution in the event of financial distress.

Beyond reviewing offering documents for an EB5 investment, potential investors should also review existing intercreditor agreements to properly evaluate risk.