Default occurs where a borrower breaks a contractual promise to a lender. The borrower will generally have a period of time (known as a grace period) in which they may cure the default. If the borrower is unable to uphold their promises to the lender by 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 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

An event of default may be:

  • actual default (for example, the failure to pay principal or interest when it falls due for payment); or
  • 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. However, often only the occurrence of an actual default will create contractual rights for the lender, unless the lender negotiates otherwise.

Events of Default

Examples of events of default include where:

  • the borrower does not pay any money due for payment 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 a set period;
  • 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 similar person is appointed in respect of the borrower.

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 the lender will want to control it. 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. 

This is an important distinction. The former creates rights in favour of the lender as soon as the event occurs, regardless of whether the borrower remedies 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 right:

  • not to lend the principal to the borrower (if the principal has not yet been lent);
  • to make the loan and any other money owing by the borrower to the lender under the loan agreement immediately due for repayment (if the principal has already been lent); and
  • to enforce its security to ensure it is repaid in full for all monies owing by the borrower (if the loan is secured).

Example

Consider the example of a bank loan to a business. Choice Bank is loaning $200,000 to John’s landscaping company, Greenly Growing Pty Ltd. John needs the money to cover some of his operational costs after a larger-than-expected downturn in revenue over winter. The loan is drawn up with:

  • a two year term;
  • an interest rate of 4% per annum; and
  • a monthly repayment schedule.

Importantly, the bank secures their loan against some of the landscaping machinery John’s company owns.

The loan initially provides John with the working capital he needed to reinvigorate his business. However, after a year he starts struggling to make repayments. Unfortunately, John defaults on the loan and fails to come good within the five day grace period. As a result, Choice Bank issues John’s company with a notice stating that the unpaid portion of principal, as well as the unpaid accrued interest and fees that he owes, are immediately due for repayment.

John is unable to immediately repay this amount. As a result, Choice Bank enforces its security interest over Greenly Growing Pty Ltd’s machinery and equipment. After liquidating this machinery and equipment, John makes the full repayment and he is discharged from any further obligations under the loan.

Notices

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 a:

  • statement in each drawdown notice to the effect that no event of default has occurred or is continuing;
  • certificate setting out details of the event of default, if it becomes aware of an event of default; and
  • certificate, at its request, stating that no event of default has occurred and is continuing.

Key Takeaways

Default occurs where a borrower breaks a promise to a lender. There are various situations which may amount to an event of default. The occurrence of an event of default will generally create contractual rights for the lender. To find out more about loan agreements, contact LegalVision’s banking and finance lawyers on 1300 544 755.

COVID-19 Business Survey
LegalVision is conducting a survey on the impact of COVID-19 for businesses across Australia. The survey takes 2 minutes to complete and all responses are anonymous. We would appreciate your input. Take the survey now.

About LegalVision: LegalVision is a tech-driven, full-service commercial law firm that uses technology to deliver a faster, better quality and more cost-effective client experience.

The majority of our clients are LVConnect members. By becoming a member, you can stay ahead of legal issues while staying on top of costs. For just $199 per month, membership unlocks unlimited lawyer consultations, faster turnaround times, free legal templates and members-only discounts.

Learn more about LVConnect

Thomas Nickoll
Need Legal Help? Get a Free Fixed-Fee Quote

If you would like to receive a free fixed-fee quote or get in touch with our team, fill out the form below.

  • By submitting this form, you agree to receive emails from LegalVision and can unsubscribe at any time. See our full Privacy Policy.
  • This field is for validation purposes and should be left unchanged.
Our Awards
  • 2019 Top 25 Startups - LinkedIn 2019 Top 25 Startups - LinkedIn
  • 2019 NewLaw Firm of the Year - Australian Law Awards 2019 NewLaw Firm of the Year - Australian Law Awards
  • 2020 Fastest Growing Law Firm - Financial Times APAC 500 2020 Fastest Growing Law Firm - Financial Times APAC 500
  • 2020 AFR Fast 100 List - Australian Financial Review 2020 AFR Fast 100 List - Australian Financial Review
  • 2020 Law Firm of the Year Finalist - Australasian Law Awards 2020 Law Firm of the Year Finalist - Australasian Law Awards
  • Most Innovative Law Firm - 2019 Australasian Lawyer 2019 Most Innovative Firm - Australasian Lawyer
Privacy Policy Snapshot

We collect and store information about you. Let us explain why we do this.

What information do you collect?

We collect a range of data about you, including your contact details, legal issues and data on how you use our website.

How do you collect information?

We collect information over the phone, by email and through our website.

What do you do with this information?

We store and use your information to deliver you better legal services. This mostly involves communicating with you, marketing to you and occasionally sharing your information with our partners.

How do I contact you?

You can always see what data you’ve stored with us.

Questions, comments or complaints? Reach out on 1300 544 755 or email us at info@legalvision.com.au

View Privacy Policy