Given the increasing prevalence of intercreditor agreements in commercial finance transactions, lenders and counsel should be aware of an important 2017 Illinois appellate court decision, Bowling Green Sports Center v. C.A.G. LLC, in which the court ultimately determined that in certain circumstances a senior lender’s modification of terms with its borrower could jeopardize its priority status relative to junior lenders.
In Bowling Green Sports Center, the senior lender made a $3.4 million loan to finance the purchase of a bowling alley, which was supplemented with a $405,000 loan by the junior lender. The senior and junior lender entered into an intercreditor agreement that provided, among other things, that the senior lender would not amend, modify, or otherwise change the terms of its promissory note or loan agreement without the junior lender’s prior consent. Only a few months after the original loan, the senior lender and the borrower entered into a modification agreement, pursuant to which the senior lender increased its loan by $51,000. Importantly, the junior lender was not notified of the modification, and did not consent to the increased loan.
In a case of first impression, the court in Bowling Green Sports Centeranalyzed whether the senior lender breached the intercreditor agreement by increasing its loan without first obtaining the junior lender’s consent, and if so, whether the senior lender lost its priority status as a result of that breach. The court determined that the senior creditor did in fact breach the intercreditor agreement, and that the breach resulted in a forfeiture of the senior lender’s priority status to the extent of the additional loan. That is to say, the senior lender had priority status as to its original $3.4 million loan, but the additional $51,000 lent to the borrower a few months later was now subordinated to the junior lender’s second position. The court also acknowledged, however, that a senior lender whose modification “substantially impairs” the junior lender’s security interest runs the risk of losing its priority status entirely. In other words, the court acknowledged that there was a possibility that a court could swap the positions of the senior and junior lenders altogether if a senior lender makes a unilateral modification that substantially impairs the junior lender’s rights.
The Bowling Green Sports Center court declined to define what exactly constitutes “substantial” impairment, only noting that the senior lender in that case had not substantially impaired the junior lender’s position when it increased its loan by less than 1.5%. Instead, the Bowling Green Sports Center court cited to two examples where out-of-state courts held that a senior lender substantially impaired the junior lender’s security interest so as to justify judicial rearranging of the lenders’ priority positions: (i) where a lender increased its loan from $2.2 million to $20 million and (ii) where a lender increased the interest rate from 6.25% to 10%, and shortened the maturity date from 30 years to 10 months.
Intercreditor agreements should be drafted carefully so as to clearly delineate when a senior lender can modify loan terms without a junior lender’s consent, which of those terms can be modified, and the effect of any such modifications on the senior lender’s priority. The Bowling Green Sports Center decision suggests that Illinois courts may read a consent requirement into any intercreditor agreement that is silent on the issue. The decision also suggests that senior lenders should not simply rely on general catch-all language stating that no change in terms shall affect the senior lenders’ priority. Given the ambiguity about what may constitute “substantial impairment,” it would be prudent, when feasible, for senior lenders to obtain junior lenders’ consent before modifying terms with a borrower in a multiple lender scenario.