This is the second in a two-part series on waterfalls in syndicated and private credit. This Legal Update examines how the waterfalls distribute value among competing creditor classes and security structures, and highlight the primary legal risks to consider when structuring and negotiating deals. For an overview of how payments are applied within a single facility, see the first installment in this series, The ABCs of Credit Agreement Waterfalls.

Introduction

In this Legal Update, we look at how waterfalls allocate value in multicreditor structures, recent court decisions that affect priority protections, and key negotiation and drafting considerations for lenders. When multiple lender classes share a borrower, collateral package or credit structure, the waterfall begins allocating shared recoveries among groups whose interests may directly compete. In these situations, waterfall protections are among the most heavily negotiated—and potentially litigated—provisions in the deal. For lenders, whether in broadly syndicated facilities, private credit or fund finance, understanding how value is allocated among competing classes is essential to protecting priority.

Intercreditor Waterfalls

Intercreditor waterfalls determine how value is allocated among creditor constituencies that share a borrower, collateral package, or credit structure. These waterfalls most often appear in an intercreditor agreement (“ICA”). In contrast, unitranche facilities typically include the analogous allocation in an agreement among lenders (“AAL”). Unlike a borrower-level payment waterfall, which governs the application of payments within a single facility, an intercreditor waterfall allocates proceeds, payments or other recoveries across creditor classes.

The discussion below considers four recurring settings: (i) first-lien and second-lien lenders sharing the same collateral; (ii) ABL and term loan lenders holding alternative priority liens on separate collateral pools; (iii) first-out and last-out tranches within a unitranche facility; and (iv) other subordination arrangements, from mezzanine debt to guarantor recovery provisions.

First Lien vs. Second Lien:When first- and second-lien facilities share...