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Many loan agreements contain an ‘events of default’ clause. This type of clause is designed to protect the lender from non-repayment of the loan and provide them with contractual rights under the loan agreement. As a borrower, events of default clauses can have significant financial consequences. Therefore, there are certain considerations to be aware of when entering into a contract with an events of default clause. This article will explore:

  • what events of defaults are;
  • how events of default protect the lender from non-repayment; and
  • what you should be aware of when entering into an agreement containing an events of default clause.

What Is an Event of Default? 

Events of default are usually serious events that indicate that you are experiencing financial or other difficulties and may not be able to repay a loan. These events will usually be listed in an event of default clause in your loan agreement.

Common events of default include:

  • failure to make a repayment on time;
  • not complying with an undertaking, representation or warranty;
  • insolvency or bankruptcy (not applicable to some loans entered into after 1 July 2018);
  • failing to comply with other obligations under the loan agreement, such as the provision of financial information;
  • the occurrence of an event of default under a cross-secured loan agreement, where a default under other facilities provided by the lender to the borrower will automatically cause a default; and
  • certain changes in your circumstances, such as a decrease in profits or loss of value in a secured property.

Many loan agreements provide a period of time to allow you to correct your failure before it becomes an event of default. This is known as a grace period. The availability and length of the grace period may vary depending on the type of failure and its severity. Importantly, some events cannot be fixed once they occur.

How Do Events of Default Protect the Lender From Non-Repayment?

As a borrower, you may experience financial difficulties that prevent you from repaying your lender. The longer the lender waits for your repayment, the less likely they are to be able to get their money back. This is because more and more people may start seeking money from you if you are struggling to pay your debts. 

However, an event of default protects a lender from non-repayment. Usually, a lender cannot ask you to repay a loan before the agreed loan period ends. However, if you commit an event of default, then the lender can do just that. Loans that are payable on demand may not have events of default clauses. This is because the lender can already ask for their money back any time they want.

What Are the Consequences of an Event of Default?

If an event of default occurs and you are unable to fix the issue within the grace period, then you will have defaulted under your loan agreement. This can have a number of serious consequences which your loan agreement will list.

If you default under a loan agreement, the lender can usually:

  • refuse to lend you more money;
  • ask for immediate repayment of any money they have lent;
  • take possession of any secured property and sell it to repay the loan; or
  • ask anyone who has guaranteed the loan to repay it on your behalf.

What Should a Borrower Be Aware of Before Signing a Document Containing Events of Default?

It is unlikely that you will be able to negotiate the removal of an events of defaults clause completely from a loan contract. However, there are still several ways you can protect yourself as much as possible.

Review Any Clauses Which Will Trigger an Event of Default Carefully 

It is important to review a loan contract carefully, especially any events of default clauses. This is to ensure that you can comply with the possible consequences if an event of default were to occur.

There may be times where you cannot comply with an undertaking listed in a loan agreement. If this is the case, do not agree to keep it in the loan agreement.

Ensure That Any Events of Default Are Events That You Can Control

It is important to ensure that any events of default clauses in your loan agreement are events that you can control. This will provide you with greater security and guarantees that the loan agreement is protecting your rights.

For example, you cannot control the market value of your house. Therefore, if your loan requires an annual valuation and it is an event of default for your loan to value ratio to fall below a certain percentage, you may find yourself in default due to events outside of your control.

Ensure That You Have Sufficient Grace Periods

Having insufficient grace periods can cause serious financial repercussions if you were to make a mistake or fall into financial difficulties. Therefore, make sure that your contract has sufficient grace periods to fix your mistake or get back on track with your payments.

If you miss a repayment by mistake, ideally you would be able to fix your mistake by making the payment the next day without having your whole loan become due.

Check the Notice Provisions

Notice provisions can often cause borrowers to default under a loan agreement. Many grace periods begin from the time that your lender has sent a notice, not from when you receive the notice. Ideally, the notice period should begin at the time you receive the notice. This will prevent any unforeseen events to cause a default.

If the notice clause refers to an old address and you do not receive the notice, you could default under your loan agreement without realising it.

Key Takeaways

A lender will almost always require an events of default clause in a loan agreement. This is because these clauses are designed to protect them from non-payment. They do this by allowing the lender to recover the money as soon as you are facing financial difficulties. However, as a borrower, there are ways you can protect yourself. You should review the clause carefully to ensure that you understand what each event of default is and, if possible, that it is under your control. You should also ensure that the clause has a sufficient grace period. If you believe that an event of default has occurred, take action or seek legal advice as a matter of urgency. To find out more about loan agreements contact LegalVision’s banking and finance lawyers on 1300 544 755 or fill out the form on this page. 

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