In this article, you’ll learn about First Lien and Second Lien Lender and the Turnover Clause and Loan covenants.
Learn what each of these terms means and why you should know them. You can also use the information to negotiate a loan that suits your needs.
After all, the more you understand these terms, the better prepared you’ll be for negotiations and negotiation.
What are the main differences between First Lien and Second LIne lenders? The main difference between the first lien and second lien lenders is the scope of their rights.
First lien lenders control the collateral, and second lien lenders have the right to exercise their remedies against the same. A second lien aims to prevent the first lien lender from obtaining a higher interest rate on the collateral.
Second-lien lenders are generally more aggressive than first-lien lenders, so they should only lend on properties that are not worth as much as the first-lien loan.
The difference between a first lien and a second lien lender is in the form of risk. First-lien loans are less risky, and second-lien loans are more expensive.
However, second lien loans can provide borrowers with additional time to improve their business. In some cases, second-lien debt can even replace senior unsecured debt.
Second Lien lenders should not be confused, however. While first-lien loans can be a risky option, the benefits and risks make them an excellent choice for many borrowers.
Some second lien lenders offer random payment due dates. Others allow you to skip the first payment. Some second lien lenders require that you become a credit union member at closing.
While membership is free, it can be challenging to maintain consistently, especially if you have no savings or checking accounts. However, the benefits of being a member outweigh the disadvantages.
First, second lien financing is advantageous to borrowers and lenders. Because second lien loans do not dilute ownership, they are preferred by growing middle-market businesses.
Second lien loans can be used for many purposes, such as paying down senior debt, acquiring new companies, and leveraged buyout financing.
A second lien loan also offers borrowers the benefit of ensuring that a deal is attractive. This flexibility makes the second lien lending a more viable option.
A typical covenant package may have a turnover clause that allows a borrower to form new entities or reorganize existing ones. It may also permit an entity to invest in another one of its members.
This may mean that the entity holding specific critical assets changes over time, impacting the second lien lender’s interests. Therefore, a turnover clause is vital to avoid potential disputes.
The answer to this question will depend on the wording of the turnover clause. Usually, this clause is spelled out in an inter-creditor agreement and requires the second lien lender to turn over funds to the first lien creditor.
As a result, first-lien lenders generally put themselves ahead of second-lien creditors, but the turnover clause may also prevent the latter from recovering any foreclosure proceeds.
Therefore, first-lien creditors must understand how turnover clauses work to protect them from losses.
Loan covenants are a vital element of loan documentation. First lien lenders often agree to a specific covenant package that restricts the first lien lender’s rights to the collateral under the loan.
Second lien lenders, on the other hand, agree that the borrower must be able to refinance his existing first lien credit facility. This may prove to be a challenging task or even impossible.
Thus, second lien lenders include debt under the refinancing credit facility in the borrower’s obligations under the first lien loan.
Second lien loans are generally short-term in nature. Their typical duration ranges from 12 to 36 months.
This type of lending can be very advantageous to companies in the middle market because it enables borrowers to get additional capital to meet their short-term needs.
Second, lien loans differ from mezzanine financing, which is debt subordinated. The senior lien holders are the first to receive repayment if the borrower defaults or if the collateral is sold or impaired.
Cap on the first-lien debt
The cap on first-lien debt does not apply to unsecured second lien bonds or unsecured term loans. This limitation is based on the baskets negotiated by lenders. Typically, the cap on first-lien debt amounts to a maximum leverage ratio or a financial test.
It may also apply to a portion of secured debt or the entire secured debt. There are a few exceptions to this rule. If you qualify, you may be able to get away with a cap on first-lien debt.
A cap on second-lien debt is a more difficult proposition to make. Some states have introduced legislation that will limit the amount of debt a consumer can have. But in other states, there is no such legislation.
In the meantime, the cap on second-lien debt is an ongoing issue. Its use in collateralized loan obligations makes them a more liquid asset in the market. So, what can you do to avoid it? Listed below are some standard exceptions to the cap on first-lien debt.
Rights of first-lien lenders in bankruptcy
Under Bankruptcy Law, creditors have certain rights in the assets subject to their Liens. In the Bankruptcy Code, “collateral” includes all property or assets the borrower has pledged as security for his loan.
These rights include the right to sell the collateral, repossess it, and sue the borrower for the collateral value. A lien remains even after the debtor declares bankruptcy.
In some cases, the automatic stay prevents a lender from bringing a direct claim, but an exception for the doctrine of “unclean hands” does exist.
Second lien holders have relied on this doctrine to assert a bad faith claim against a debtor by asserting breaches of their second lien indenture, fraud, and other claims against the debtor.
Despite a legal exception, it is difficult to determine whether a lender can pursue equitable relief in bankruptcy.
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