Knowledge Hub
for Growth

Second lien debt

Second lien debt is a type of secured debt originating from the United States. Although historically US-centric, European second lien financing have seen somewhat of a resurgence since the credit crunch, particularly in funding dividend recapitalisations.

What is second lien debt?

Second lien debt is a type of debt that ranks equally with senior debt as to payment before acceleration and that shares the same security package to senior debt. However, second lien debt ranks behind senior debt following a debt acceleration. In Europe (but not the US) it is also common for second lien debt to rank behind senior debt with respect to unsecured claims against the borrower and guarantors.

Second lien debt is considered riskier than senior debt but less risky than junior debt.

Second-lien loans may be either cash-flow loans (determined as a multiple of EBITDA) or asset-based loans (using appraisal valuations). Loans generally mature after five years but not before the first-lien lender’s loan. Second-lien loans may feature bullet payments or limited amortisation provisions.

How did second lien finance develop?

Second lien debt developed in the US in the late 1990s. The term ‘lien’ in the United States, means something akin to ‘security interest’. The term second lien finance was used to refer to debt that was a second-ranking security.

Second lien finance developed in the US as a method for companies with existing high yield bonds to raise relatively inexpensive debt. It was common for high yield bonds to contain ‘anti-layering’ clauses - provisions that prohibited a company from incurring new debt ranking between the senior and the bonds. However, these anti-layering provisions only prohibited debt subordination and not lien subordination. Second lien debt circumvented these provisions by only subordinating how the proceeds of the shared collateral was applied between creditors and not the right to payment.

Debt subordination means a lender must turn over payments received from a borrower to a senior lender. Lien subordination only requires the lender to turn over the proceeds from shared collateral, it does not include blockage provisions.

How does European second lien financing differ from the US?

When second lien financing came to the European market it developed slightly differently than in the US. This was largely because the European market already had an established mezzanine debt product, which was similar to the US second lien market.

In Europe, second lien financings have historically been documented in the same facility as the senior debt facility, whereas in the US second lien debt is usually documented separately. However, as the European second lien market has developed it has adopted separate loan agreements for many transactions. If the second lien debt is in the same agreement, then it is common for it to be syndicated with the senior debt. In the US, second lien debt may be syndicated separately. For more information on syndication, please see syndicated finance and loan syndication.

In the European debt markets, it is common for second lien debts to benefit from covenants that are identical to the senior debt covenants. In the US, by contrast, second lien debt usually has less strict or fewer covenants than senior debt.

The right to receive interest on European second lien debt may be subject to payment blockage and turnover provisions similar to those found in mezzanine debt. For more information on mezzanine debt please see mezzanine financing.

When is second lien financing used?

In the United States, second lien financing originated out of restructurings. It developed as a product for borrowers in financial difficulty that needed to raise capital quickly. These days, second lien financing may also be used in leveraged buyouts and, more occasionally, in plain vanilla deals.

In leveraged buyouts, a second lien loan may be used to fill small gaps between the financing needs of the borrower and the maximum thresholds senior secured lenders may lend up to.

Is a second lien loan secured or unsecured?

Second lien loans are a form of secured debt. Unlike unsecured debt, second lien loans benefit from a pledge of specific assets of the borrower (e.g. buildings, equipment).

Second lien loans will normally rank ahead of junior debt but behind senior (‘first lien’) debt.

Second lien debt vs mezzanine debt

The key difference between second-lien debt and mezzanine debt (apart from cost) is that second-lien is lien subordinated only, not debt subordinated like mezzanine debt. Debt subordination means a lender must turn over payments received from a borrower to a senior lender. Lien subordination only requires the lender to turn over the proceeds from shared collateral, it does not include blockage provisions.

The other major difference between second lien debt and mezzanine debt is the price. Second-lien loans are a form of senior loan and as such charge an interest rate comparable with senior loans (e.g. LIBOR plus 6%). Mezzanine loans are much riskier and tend to charge a much higher rate of interest. Mezzanine debt may charge a fixed coupon rate of between 15% and 18%.

Mezzanine finance may also include a ‘payment in kind’ (PIK) where the amount of principal can be increased in lieu of payment by the borrower. Mezzanine financings are also often unsecured by the assets of the borrower. If security is taken by a mezzanine lender then it will normally be deeply subordinated to the security interests of other lenders.

Is second lien debt subordinated?

Second lien loans are subordinated to first-lien loans on the capital pledged to secure the loan. However, second lien loans are not debt subordinated to first-lien loans. This means that second-lien lenders do not need to turn over payments received from a borrower to a senior lender. Although second lien loans are more junior than first-lien loans, they rank more senior than mezzanine loans and unsecured lenders.

Financial covenants for second lien debt

Covenants in European second-lien loans are identical to the senior debt covenants. However, if the senior lien is documented separately from the senior facility, there may be some additional headroom in the financial covenants.

The second lien debt will usually become repayable six months after the date from which the final instalment is due on the senior debt. Payments of principal will not be allowed before the senior debt is paid off. There may also be ‘call protection’ that requires a borrower to pay a prepayment fee for any amount repaid during the beginning of the loan.

Second lien lenders will only be allowed to accelerate the loan if there is a second lien debt payment default or an ‘insolvency event’ occurs.

What next?

Our finance and investment solicitors have advised borrowers who have used second lien finance and can help you achieve a smooth transaction. You can be assured that our team of financing solicitors will work with your team and representatives to understand your business objectives, and to represent your interests at each stage of the transaction, from concept to completion. Also, due to our experience in the finance and investment sector.

Complete the contact form or call us on 0800 689 1700.

Your data will only be used by Harper James Solicitors. We will never sell your data and promise to keep it secure. You can find further information in our Privacy Policy.

Our offices

A national law firm

A national law firm

Our commercial lawyers are based in or close to major cities across the UK, providing expert legal advice to clients both locally and nationally.

We mainly work remotely, so we can work with you wherever you are. But we can arrange face-to-face meeting at our offices or a location of your choosing.

Head Office

Floor 5, Cavendish House, 39-41 Waterloo Street, Birmingham, B2 5PP
Regional Spaces

Stirling House, Cambridge Innovation Park, Denny End Road, Waterbeach, Cambridge, CB25 9QE
13th Floor, Piccadilly Plaza, Manchester, M1 4BT
10 Fitzroy Square, London, W1T 5HP
Harwell Innovation Centre, 173 Curie Avenue, Harwell, Oxfordshire, OX11 0QG
1st Floor, Dearing House, 1 Young St, Sheffield, S1 4UP
White Building Studios, 1-4 Cumberland Place, Southampton, SO15 2NP
A national law firm

Like what you’re reading?

Get new articles delivered to your inbox

Join 8,153 entrepreneurs reading our latest news, guides and insights.


To access legal support from just £145 per hour arrange your no-obligation initial consultation to discuss your business requirements.

Make an enquiry