Default is the occurrence of an event which the lender seeks protection against. The borrower will generally be allowed a period of time (known as a grace period) in which to cure a default. If the default remains uncured at the end of the relevant grace period it will usually become an event of default. An event of default will create certain contractual rights for the lender under the loan agreement.
Unless a loan agreement is payable on demand, it will contain a (usually large) number of events of default. A loan agreement that is payable on demand will generally not contain any events of default. The lender’s protection in a loan agreement that is payable on demand is the fact that the lender can call the loan at any time (regardless of whether there is any risk of the borrower not repaying the loan).
Types of event of default
There are two types of event of default:
- Actual default, for example the failure to pay principal or interest when it falls due for payment; and
- Potential default, for example when payment is not yet due, but it is clear that it will not be capable of being paid when it does fall due.
Both are important but often only the occurrence of an actual default will create contractual rights for the lender, unless the lender negotiates otherwise.
Events of default
The following are typical examples of events of default:
- the borrower does not pay any money due for payment by it under the loan agreement (or any security document or guarantee) in accordance with its terms and conditions;
- the borrower does not comply with any other obligation under the loan agreement (or any security document or guarantee) and, if that default is capable of remedy, it is not remedied within [5 Business Days (or such longer period agreed by the Lender)] after its occurrence or the borrower does not, during that period, take all action which in the lender’s opinion is necessary or desirable to promptly remedy that default;
- a representation, warranty or statement made or deemed to be made by the borrower under the loan agreement is untrue or misleading;
- the loan agreement (or any security document or guarantee) is void, voidable or otherwise unenforceable by the lender or is claimed to be so; and
- an administrator, provisional liquidator, liquidator or person having a similar or analogous function under the laws of any relevant jurisdiction is appointed in respect of the Borrower or any action is taken to appoint any such person and the action is not stayed, withdrawn or dismissed within [5 Business Days].
Whether or not an event of default has a grace period and, if it does, the extent of the grace period will depend on the bargaining position of the parties. The more likely a borrower is to default, the more tightly it will be controlled. The same applies to the number and extremity of events of default.
Consequences of an event of default
The lender’s rights as a consequence of an event of default may arise either as soon as an event of default has occurred or if an event of default has occurred and is continuing. There is an important distinction to make here. The former creates rights in favour of the lender as soon as the event occurs, regardless of whether the borrower cures the default very quickly thereafter. The latter is more favourable to the borrower, as it gives the borrower an opportunity to remedy the default. Only if the default is continuing does the lender have rights.
Following an event of default the lender will usually have the following rights:
- if the Principal has not yet been lent, not to lend the Principal to the borrower;
- if the Principal has already been lent, to make the loan and any other money owing by the borrower to the lender under the loan agreement (for example any unpaid accrued interest and fees) immediately due for repayment; and
- if the loan is secured, the lender may enforce its security to ensure it is repaid in full for all monies owing by the borrower.
Due to the importance to the lender of knowing whether an event of default (actual or potential) has occurred, the lender may ask the borrower to provide it with some or all the following:
- A statement in each drawdown notice to the effect that no event of default (actual or potential) has occurred or is continuing;
- If it becomes aware of an event of default (actual or potential), a certificate setting out details of the event of default; and/or
- A certificate, at its request, stating that no event of default (actual or potential) has occurred and is continuing.
There are many important clauses in a loan agreement. We have already explored some of them with you and will be exploring some of the other clauses over the coming weeks.
To find out more about loan agreements, or for any other finance law related matters, please contact us on 1300 544 755. One of our finance law specialists would be delighted to assist!