6.3 Loan-based Mezzanine Instruments 299second lien debt is more expensive than senior bank debt. However, unsubordi-
nated second lien debt is significantly less expensive than traditional subordinated
debt. Furthermore, institutional investors and hedge funds that are unable to invest
in contractually subordinated debt may invest in second lien debt as the lender is
only subordinated on enforcement of security.
US practices, covenants, repayment rights. There have traditionally been dif-
ferences between the US and Europe.^69 Second lien debt makes up a significant
segment of the US capital markets.
In the US, second lien loans have been developed to appeal to US institutional
investors that cannot participate in subordinated debt and are typically lent at the
same level as a senior asset-based loan. They will usually contain the same cove-
nants and repayment rights as the senior loans (although second lien bonds will
have no maintenance covenants or cross-default provisions).^70
European practices. Second lien debt is relatively new in Europe. With no
harmonised European insolvency regime, there is currently no standard form for
second lien financings.^71 In Europe, the overwhelming majority of second lien
deals form part of refinancings or recapitalisations after an LBO (sections 10.5
and 20.5.3). Second lien issuance is increasingly being used to finance primary
LBOs.^72
Subordination terms. A second lien arrangement requires an agreement not on-
ly between the security giver and the lenders but also an agreement between the
senior (first lien) lenders and second lien lenders. The senior (first lien) lenders
and second lien lenders agree that on enforcement of the security, the senior lend-
ers will be paid in full from the realisation proceeds before the second lien lenders
receive anything.^73
Typical second lien security subordination provisions will usually include un-
dertakings from the second lien lenders: not to take enforcement action while sen-
ior secured debt is outstanding (permanently or for a limited period); not to chal-
lenge enforcement actions of senior security holders; not to challenge the validity
or priority of senior security; to waive or limit (usually for a specified time) other
typical secured creditors rights as regards the senior security holders (for example,
whether and when to exercise remedies against the secured assets, the order in
which to foreclose on which secured assets, the type of sale in which to sell se-
cured assets, and the appropriate price for, and buyers of, secured assets); and/or
automatic release of second lien security rights over any collateral upon a sale of
that collateral pursuant to a senior security enforcement.^74
(^69) Wells C, Devaney N, op cit, p 445.
(^70) Ibid, pp 443–447.
(^71) See ibid, pp 446–447.
(^72) Ibid, pp 443–447.
(^73) Ibid, pp 443–447.
(^74) Sharples R, United Kingdom: How Europe is stretching debt packages, The IFLR guide
to Mergers and Acquisitions 2005.