Net Asset Value (“NAV”) facilities (loans secured by a fund’s underlying investments, rather than by investor commitments) are increasingly being used at the fund level, often alongside subscription facilities that are already in place. Following last week’s article in this publication by Devon Tucker, “Subordinated Tranches: An Increasingly Mainstream Tool in the Subscription Finance Toolkit," it seemed timely to take a step back and look a bit more closely at some of the fundamentals on priority and subordination (i.e., how different lenders rank against each other).1
In the past most funds just used subscription credit facilities (loans backed by investors’ unfunded capital commitments) but for various reasons that are beyond the scope of this article, fund finance today has evolved into a much more diverse product and today NAV facilities (loans secured by a fund’s underlying investments), hybrid facilities (a mix of subscription and NAV features), and various forms of back-leverage (extra debt placed lower down in the structure, often at the portfolio-company level) now often sit side by side in one fund. As more layers of debt are added, the question “who gets paid first if something goes wrong” becomes more important and the answer can have a material impact on how a new facility is structured.
In leveraged finance, lawyers usually reach for intercreditor agreements (contracts between lenders that set out who gets paid first and who has first claim on collateral) to build lien and payment waterfalls (the order in which lenders get repaid) however, fund finance has frequently reached the same result by placing different lenders at different levels of the fund’s own structure.
Structural vs. Contractual Subordination
Before looking at how priority works in practice, a brief summary of the two main legal methods may be helpful:
Contractual Subordination (i.e. priority created by an agreement between lenders) comes in two main forms:
- Lien subordination (ranking who gets paid first out of shared collateral) means that when two lenders both hold a security interest in the same assets. The senior lender’s claim is paid first from the enforcement proceeds of those assets, and the junior lender receives what remains after the senior lender’s claim has been settled. The seniority of each lender is agreed upon between lenders as a negotiated position and documented in the relevant facility agreement or intercreditor agreement.
- Payment subordination can take a few forms, but it generally stops a junior lender from being paid before, or at the same time as, a senior lender. This is often implemented through either a payment waterfall, in the relevant document, which sets out the order in which lenders would be paid, or a turnover arrangement which requires a junior lender to handover any amounts received before the senior lender is repaid in full. Related to these mechanics, though technically a form of enforcement subordination, is a standstill requirement. A standstill requires the junior lender to pause any enforcement action for a certain period of time, allowing the senior lender the chance to take enforcement action and recover as much as it can before the junior lender can start its own proceedings. As above, this would be a negotiated position and documented in the relevant facility agreement, subordination agreement or intercreditor agreement.
Structural Subordination
Structural subordination is different in that it doesn’t depend on any agreement between lenders because each lender (and its corresponding debt and security) sits within a different level of the fund’s structure. By way of example, a subscription lender lends to the fund itself, while a NAV lender may lend to a subsidiary SPV of that same fund. The NAV lender would have a direct claim on the underlying assets for its repayment while the fund level lender would proceed against the uncalled commitments of the fund. In this way priority simply follows from how the corporate structure is built.
Given that most fund finance has traditionally been provided to different levels of the fund, lenders have been able to steer clear of formal intercreditor agreements.
It’s also worth noting that the collateral package for subscription facilities has become fairly standard. It typically covers the limited partners’ unfunded capital commitments and related rights. There can of course be some more complex considerations depending on how the fund and its investor commitments are structured, but the basic package is one market participants know well.
NAV facilities are different in that they come in many shapes and sizes, and collateral packages are less standardized and often depend on the fund’s specific needs. Security could include equity interests in portfolio companies, distribution accounts, intercompany loan receivables, or some mix of these.
Structuring Considerations
When advising on a new facility that will sit alongside existing or planned debt, fund finance counsel should keep the following points in mind:
1. Check the Existing Debt First
Before adding a new facility, counsel should carefully review all the debt already in the fund structure. This means looking not only at debt that’s actually been drawn, but also undrawn committed facilities, letters of credit, guarantees, and other contingent obligations. The goal is to build a full picture of who has a claim on what, to understand where the new facility will sit in the pecking order and whether that order is set structurally, contractually, or both.
2. Use Debt Covenants to Protect Priority
When there’s no formal intercreditor agreement, indebtedness covenants (contract terms controlling how much more debt a borrower can take on) can operate in a similar way, including the following:
- Debt caps can limit how much total leverage is allowed.
- Permitted indebtedness baskets can set out what additional borrowing is allowed without lender consent.
- Notice and consent requirements can also add another layer of protection, requiring the borrower to tell, or get approval from, existing lenders before taking on certain new debt.
These tools may be sufficient protection for a lender to protect its position without needing a full intercreditor agreement.
3. Consider Insolvency-Remote Structures
In back-leverage deals, lenders often require the fund to borrow through an insolvency-remote special purpose vehicle, or SPV (a standalone entity structured to be protected from the sponsor’s or fund’s own bankruptcy risk). This is another structural (not contractual) way of managing priority. By keeping the leveraged assets in a insolvency-remote entity with limited-recourse (debt that can only be repaid from specific assets, not the fund generally), the back-leverage lender gets priority over those particular assets without needing to negotiate with lenders elsewhere in the structure. Using an SPV borrower can therefore achieve similar priority protection to a negotiated intercreditor agreement, without the need for one.
Checklist
When a new facility will sit alongside existing or planned debt, here are a few questions to ask:
- Is priority between this facility and other debt in the structure set structurally (by where things sit in the fund’s organization) or contractually (through a subordination or intercreditor agreement)?
- What debt covenants exist in the fund’s other loan agreements and does the new facility fit within the existing permitted debt baskets?
- What consent rights do existing lenders have over new debt and have those consents been obtained or waived?
- Does the new facility’s collateral overlap with existing facilities’ collateral and if so, how is priority between the security interests set?
- How do creditor groups stay informed about each other through information-sharing terms, cross-default triggers, or notice requirements?
Conclusion
Structural subordination is still the main way priority is set in fund finance and has worked well for the market, especially where collateral packages are well understood and debt sits at clearly defined levels.
However, with the evolving product landscape funds may now have debt at multiple levels, NAV facility collateral is often custom-built, and as explained in last week’s article, multi-tranche facilities are becoming more common. As a result, priority and intercreditor questions deserve careful thought at the structuring stage and are central to any credit analysis.
1 For further reading on the complexities of intercreditor agreements, please see John Donnelly’s January 2026 Fund Finance Friday article “Intercreditor Issues for Fund Finance Lawyers in Europe.”