Events of Default in a Loan Agreement

There is typically an ‘events of default’ clause in every loan agreement, except for those loan agreements relating to an overdraft facility only. (An overdraft facility is simply repayable on demand by the lender so no events of default are required.)

The events of default clause sets out the events or circumstances that will give the lender the right to accelerate the repayment of the loan (i.e., declare the loan due and payable before the scheduled repayment date), cancel any further loan installments due under the loan agreement and/or declare the loan immediately due and payable. In addition, the lender will have the right to enforce any security. These are clearly drastic powers which should only be exercisable while a default is continuing, and should cease once the default has been remedied or waived.

There may be a large number of triggering events or circumstances – perhaps twenty or more – listed in the events of default clause. Typically, the clause would include at least the following as events of default:

• non-payment of any amount due under the loan agreement;
• breach of the financial covenants or any other obligation in the loan agreement or any security documents;
• cross-default (a default between a third party and the borrower in relation to any other financial indebtedness);
• insolvency; and
• material adverse change.

This article explores two key events of default from the above list – cross-default and material adverse change – in further detail.

Cross-Default

A cross-default provision allows the lender to call a default under the loan agreement when there is a default between a third party and the borrower in relation to any other agreement, even if such third party does not choose to exercise its right to call a default under the other agreement. The lender could be in a difficult position if the borrower defaults under other agreements (particularly other facility agreements) and the lender is unable to protect its own position. The lender will clearly need to know that the borrower is in default under the other agreements, therefore, the information undertakings in the loan agreement should include requiring the borrower (i) to notify the lender if there is a default under the loan agreement, and (ii) to confirm to the lender (following a request from the lender) whether there is a default at such time.

For the borrower, it is important to ensure that the scope of this provision is limited appropriately because a technical breach of one agreement could trigger cross-defaults in other agreements, creating a domino effect with serious consequences. The borrower should ensure that the provision is subject to a threshold de minimis amount (which amount would depend on the borrower, the size of the loan and the other agreements). The cross-default provision should also be limited to other agreements relating to borrowings, or perhaps to a wider class of financial indebtedness, but should exclude trading contracts where there could be late payments or other breaches in the ordinary course of performance of those contracts. There should also be no default if the relevant debt is being disputed in good faith, or is paid within applicable grace periods, and there should be time to pay amounts repayable on demand.

Material Adverse Change

However, from the borrower’s perspective, the uncertainty that a material adverse change provision introduces can be problematic and, while it may rarely be used by the lender to call an event of default, there are occasions where such provisions have been used to freeze facilities. At the very least, it can give the lender leverage (e.g., to impose a tough deal or higher pricing) in negotiations with a borrower which is in a difficult situation. Generally, a borrower should seek to ensure that any material adverse change provision (i) is not triggered by deterioration in the condition of individual companies, but only by deterioration in the condition of the group as a whole, and (ii) is limited to something which materially affects the ability of the borrower to comply with its payment obligations under the loan agreement.

The material adverse change provision is usually very broadly drafted to protect the lender from any unforeseen adverse change. There will often be specific events of default to cover the areas of concern that the lender can foresee. The broad nature of this provision means that a lender is often reluctant to call a default based on it, as it is not clear-cut whether it has been breached or not. Lenders usually prefer to call a default following a non-payment as there is no room for discussion as to whether the payment has been made or not – it is just a question of fact.