While in the US market, mezzanine finance is typically provided by means of high-yield bonds, in Europe it is usually a senior loan facility secured on a second-ranking basis to the senior debt.  Unlike bonds, mezzanine loans normally contain maintenance financial covenants that must be met every quarter, whether or not action is taken.

Mezzanine debt is contractually subordinated under an agreement that is separate to senior secured loans, maturing after senior debt in the same finance structure and with somewhat less demanding financial covenants than the senior loans.  It is structurally subordinated in that it is advanced to the parent of a company group and then downstreamed to the principal borrower.  It is often secured by a pledge of the parent’s shares in the principal borrower, besides any collateral in the company.

[European mezzanine] is largely a photocopy of the senior loan facility agreement in substance, other than that the financial covenants are typically rolled back approximately 10 per cent.

In order to ensure that the senior lenders are paid off ahead of the mezzanine lenders, an intercreditor agreement (ICA) is used to set out when payments may be made to the mezzanine lenders and other creditors.  The ICA assumes that the shareholding parent company and each senior borrower guarantees both the obligations of each senior borrower and the obligations of the mezzanine borrower, as specified in a guarantee clause in each the senior facility agreement and the mezzanine facility agreement.  However, the senior debt is not guaranteed by the mezzanine borrower and does not share in the “mezzanine only security”.

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