In most lending scenarios, there’s a straightforward relationship between a borrower and a mortgage lender. But when a deal requires more financial flexibility or purchasing power, mezzanine financing can play a pivotal role.

This mid-level financing solution introduces a secondary lender—known as the mezzanine lender, who works alongside the primary mortgage lender to support the borrower. However, this arrangement requires careful coordination and legal clarity between all parties involved.

The Role of the Intercreditor Agreement

To ensure smooth communication and define procedures in case of borrower default, lenders establish an intercreditor agreement. This document outlines how the primary and mezzanine lenders will interact, especially if the borrower runs into trouble.

While some conduit lenders may hesitate to sign such agreements, others recognize that mezzanine financing can enhance the borrower’s buying power and improve overall returns. When both lenders agree, their terms are formalized within the intercreditor framework.

Typically, these agreements grant the mezzanine lender the right to be notified immediately if the borrower defaults, and often the first opportunity to resolve the issue. In some cases, the mezzanine lender may take control of the property to avoid foreclosure by the primary lender. However, full foreclosure rights are rarely granted to mezzanine lenders, as this can disrupt tenant confidence and property stability.

How Mezzanine Financing Is Structured

Mezzanine loans are designed to limit the borrower’s ability to default or declare bankruptcy. To protect the mezzanine lender’s interest, a special holding company is often created. This entity holds the property and is governed by strict covenants that regulate how the borrower and other parties operate.

These structures can be complex, but they’re essential for ensuring that the mezzanine lender’s stake in the property is secure.

What Borrowers Need to Know

If you’re considering mezzanine financing to boost your purchasing power or cash flow, it’s crucial to understand the legal and operational framework. This type of funding comes with specific rules, responsibilities, and protections, and success depends on your ability to navigate them.

Despite the added complexity, mezzanine financing remains a valuable tool in commercial real estate and business funding. Those who thrive with this strategy are well-informed, legally prepared, and aligned with experienced lenders who understand the nuances of the agreement.