6.3 Loan-based Mezzanine Instruments 297- stand still-period (where senior lenders have called an event of default, mezza-
nine lenders are bound by a period of, say, 90 days before they can call an e-
vent of default based on the mezzanine financing documents); - use of proceeds (surplus revenues such as proceeds from sales or insurance
payments must be allocated between the parties); - amendments to facility documents (they are usually subject to restrictions in
order to prevent circumvention of the inter-creditor arrangements); - default provisions (mezzanine investors want to prevent senior lenders from
calling events of default for minor breaches); - take-out options (repayments of senior debt may trigger the right of mezzanine
lenders to buy the senior debt); and - priority ranking (security granted to senior lenders will rank prior to any securi-
ty granted to mezzanine investors).
Conflicting interests. Generally, senior lenders and mezzanine lenders can have
conflicting interests.
Senior lenders generally want to ensure: that mezzanine loans are as close to
share capital as possible; that senior lenders receive all their principal and interest
before mezzanine lenders get any principal (and, if possible, interest); and that se-
nior lenders have maximum flexibility to agree changes to the senior debt with the
borrower. For example, they want the mezzanine loan to be subordinated to any
current or future finance which they advance and the mezzanine lenders to have
minimal rights to call the mezzanine loan in default and trigger bankruptcy.^58
In addition, senior lenders want to prevent certain things from happening: that
the arrangements can be modified without their consent;^59 that junior lenders may
assign their claims or dispose of them otherwise before senior debt has been re-
paid in full;^60 and that the debtor may set off its claims against the claims of junior
lenders.^61
Junior lenders (mezzanine lenders) generally may want to: keep the difference
between senior debt and mezzanine debt small; minimise the extent to which sen-
ior lenders may increase the risk to which mezzanine lenders are exposed; restrict
the definition of senior debt to a maximum amount; and restrict amendments to
the terms of the senior debt.^62
The parties will need to address, for example, the following questions when
subordinating debts:^63 What rights are to be subordinated? Which loans and lend-
ers are to have the benefit of the subordination? Is the subordination a complete
subordination (the debt is subordinated to all other present or future indebtedness
of the borrower and its subsidiaries) or a ‘limited inchoate’ subordination (the debt
(^58) Dyer R, Mezzanine Finance: Subordination and Priorities – an Overview, JIBL 5(4)
(1990) pp 154–155.
(^59) Fuller G, op cit, paragraph 8.19.
(^60) Diem A, op cit, § 39 number 14.
(^61) Diem A, op cit, § 39 number 15; See Fuller G, op cit, paragraph 8.24.
(^62) Dyer R, op cit, pp 154–155.
(^63) Ibid, pp 154–155.