A topping agreement is a legal agreement between a borrower and a lender that gives the lender priority over other creditors in the event that the borrower defaults on their loan. Essentially, it ensures that the lender will be the first in line to receive payment if the borrower`s assets are liquidated.
Topping agreements are commonly used in the world of finance, particularly in lending transactions such as leveraged buyouts and structured finance deals. They are also utilized in industries such as real estate, where lenders may require a topping agreement to mitigate their risk.
To understand how a topping agreement works, it`s important to understand the concept of “priority” when it comes to creditors. When a borrower is unable to make payments on their debt, their assets may be sold off to repay their creditors. However, not all creditors have equal rights to the assets. Secured creditors, such as those with a lien on real estate or other assets, are typically given priority over unsecured creditors. In other words, they get paid first.
A topping agreement is a way for a lender to ensure that they are considered a secured creditor and given priority in the event of a default. The agreement may stipulate that the lender`s loan must be repaid first before any other debts can be settled. It may also include provisions for the lender to take control of certain assets in the event of a default, such as through a foreclosure process.
From the borrower`s perspective, a topping agreement may increase their borrowing costs. If lenders perceive that there is a higher risk of default, they may require a topping agreement as a condition of lending. The borrower may also lose control over certain assets if they default on their loan.
However, for lenders, topping agreements are an important tool for managing risk. They provide a layer of protection that can help ensure that the lender is repaid in the event of a default. This can be particularly important in high-risk lending situations, such as those involving leveraged buyouts or other complex financial transactions.
Overall, topping agreements are an important legal tool in the world of finance. While they may come with added costs and restrictions for borrowers, they provide a valuable layer of protection for lenders to mitigate risk and ensure that they are repaid in the event of a default.