292 6 Mezzanine
6.3 Loan-based Mezzanine Instruments
6.3.1 General Remarks
It is characteristic of loan-based mezzanine instruments that they are subordinated.
Subordination means an arrangement where one lender or group of lenders agrees
not to be paid by a borrower until another lender or group of lenders creditors
have been paid. In addition, mezzanine instruments may entitle their holder to par-
ticipate in the profits of the issuer. This will often be achieved by means of an eq-
uity kicker. Subordination can be structural, or it can be based on different repay-
ment schedules, statutory subordination, or contractual subordination.
Payment waterfalls. In addition to subordination compared with traditional
(senior) loans, there can also be contractual “payment waterfalls” that create sub-
ordination between different holders of mezzanine instruments under the terms of
an intercreditor agreement.
Covenants and prepayment. As loan-based mezzanine instruments typically
rank junior to senior loans, the covenants typically cannot be more restrictive than
those used in senior loan facilities. The same principles apply to sanctions trig-
gered by an event of default.
For example, although the same kinds of financial covenants can be used both
in senior loan facilities and mezzanine loan facilities, the parties usually agree that
breach of a financial covenant under the mezzanine loan facility will not trigger
any right to terminate the mezzanine loan unless the circumstances are such that
they already have triggered senior creditors’ right to terminate senior loans. In ad-
dition, there may be a long grace period – for example, 120 days – before any
right to terminate the mezzanine loan is triggered.^23
IFRS. Whether loan-based mezzanine instruments are regarded as equity in-
struments or debt instruments depends on:^24 whether investors have a right to ter-
minate the investment;^25 whether there is a fixed maturity;^26 whether distributions
are in the discretion of the issuer;^27 whether the issuer has discretion to terminate
the investment;^28 and whether payment obligations are triggered by external events
or insolvency.^29
(^23) Diem A, Akquisitionsfinanzierungen. C.H. Beck, München (2005) § 38 number 19.
(^24) Kraft ET, Die Abgrenzung von Eigen- und Fremdkapital nach IFRS, ZGR 2–3/2008 p
353.
(^25) IAS 32.18(b).
(^26) IAS 32.16.
(^27) IAS 32.17.
(^28) IAS 32.20.
(^29) IAS 32.25.