298 6 Mezzanine
is a second ranking secured debt coming behind a specified amount of senior
debt)? Subordination will usually not apply to the payment of interest.^64 Should
subordination be limited to repayment of principal (and are senior lenders to get
all their principal before mezzanine lenders get any) or should the mezzanine
lenders’ rights to interest also be subordinated? Should the senior lenders get all
their principal and interest before the mezzanine gets any interest or, as is more
usual, should interest on the mezzanine only be subordinated while the senior loan
is in default? For how long is the subordination to last?^65
6.3.6 Contractual Subordination of Collateral
Normally, what is subordinated is debt, and the subordinated mezzanine debt is
secured by the same collateral as senior debts. The intercreditor agreement will
then provide that senior debt will be repaid before mezzanine debt.^66 Alternatively,
the parties may “subordinate” collateral rather than debt. For example, the parties
can use second lien financing as an alternative to subordinated debt.^67 In principle,
the parties can agree to subordinate either the debt or the collateral or both.
Investor preferences. Sometimes the subordination of collateral can increase
investor demand. As said above, mezzanine loan instruments are always subordi-
nated pursuant to the intercreditor agreement and, in many cases, even structurally
subordinated. This can create a problem for some fund investors, if their invest-
ment parameters require them to buy only senior debt instruments (rather than
subordinated mezzanine loan instruments). Subordinating collateral can help to
solve this problem.
For example, the borrower has two loan facilities, A and B. Claims under the A facility are
unsubordinated (senior). Claims under the B facility rank pari passu with claims under the
A facility. The B facility instruments therefore rank as senior debt. If the security support
provided for the B facility is subordinated to the security support provided for the A facil-
ity, the B facility instruments can still be said to rank as a senior debt. Through the second
ranking security, the second lien B facility instruments rank ahead of unsecured debt (such
as trade debt) and any structurally subordinated debt (for example, most high-yield or junk
bonds).^68
Second lien debt. Second lien debt is debt that benefits principally from the same
security as secured senior debt, on a second ranking basis. Because of higher risk,
(^64) See Diem A, op cit, § 38 number 4: “Regelmäßig wird eine Sockelverzinsung aus dem
anwendbaren Referenzzinssatz (EURIBOR, LIBOR) zuzüglich einer Marge vereinbart.
Diese Zinsen sind jeweils spätestens am Ende einer Zinsperiode fällig und werden –
trotz des Nachrangs – auch ausbezahlt.”
(^65) Dyer R, op cit, pp 154–155.
(^66) Diem A, op cit, § 38 number 20 and § 40 number 9.
(^67) See Wells C, Devaney N, Is the Future Secure for Second Lien Lenders in Europe,
JIBLR 22(8) (2007) pp 443–447.
(^68) See Sharples R, United Kingdom: How Europe is stretching debt packages, The IFLR
guide to Mergers and Acquisitions 2005.