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If your company has defaulted on a loan agreement, you may not know what this means for your company. Depending on your loan agreement, the bank could terminate the agreement, as well as demand immediate payment of the outstanding principal amount. Either way, an event of default can have widespread ramifications for your business. Hence, this article will explain the consequences of an event of default and how your company may rectify the situation.
What is an Event of Default?
An event of default refers to circumstances in a loan agreement that, if they arise, release the bank from any obligation it owes your company. These circumstances include:
- late payments;
- material misrepresentations;
- breaches of undertakings; and
- and change of ownership.
An event of default almost always entitles the bank to accelerate the loan, which means it can demand immediate repayment of the outstanding amount.
What Actions Can the Bank Take?
An event of default typically grants a lender the option to take several different rights. These include:
- the right to terminate any existing and future obligations;
- the right to demand immediate payment of the outstanding principal amount and any interest owed throughout the course of the loan; and
- enforce its security interest in your company’s property.
Technical Defaults
It is important to note that just because your company is in default does not mean that the bank will take immediate action. Instead, an event of default gives the bank the right to choose to take specific actions. Whether or not it will take any action depends on the circumstances surrounding the event of default.
For instance, most loans contain a provision called a “change of control” clause, which states that if your company’s owners change, it may constitute an event of default. However, a change of control provision can create unforeseen consequences.
Commercial Considerations
In many cases, companies cannot afford to repay the entire outstanding amount earlier than anticipated. If this is the case, the bank would have to enforce its security over the company’s assets, which takes considerable time and resources. Therefore, most banks are prepared to work with a company that has defaulted, provided the bank is confident that the business is fundamentally sound.
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How Can I Remedy Events of Default?
The terms of most loan agreements tend to have several contractual provisions that give the bank and borrower the time and resources to rectify an event of default before the bank takes any final action.
Grace Periods
Your facility agreement may stipulate that the company has a specific amount of time after certain events of default have arisen to rectify the situation. These are called grace periods.
During a grace period, your company is unlikely to be able to draw on additional committed funds. Still, the bank will not have any right to demand immediate payment or enforce its security.
Potential Events of Default
Some facility agreements also structure the definition of an event of default so that there is an in-built grace period. The effect is essentially the same as a grace period.
Waivers
In some cases, if you cannot remedy the situation that has caused the default, your company can ask the bank for a waiver. Banks will usually grant waivers in exchange for some further concession from your company. For instance, if you breach a financial covenant, the bank may grant a waiver but impose a new covenant that your company must abide by.
Key Takeaways
An event of default refers to any circumstance that arises under the loan agreement that permits the bank to cancel the loan immediately. The effect of an event of default is that the bank has the right to demand immediate repayment of any outstanding amount plus interest. In addition, the bank can also refuse to honour any other commitments it owes your business, such as loaning you additional money. The list of events that constitute an event of default depends on the commercial loan agreement. However, late payments, material misrepresentations, breaches of undertakings, and change of control are typical examples of events that may constitute a default.
If you need assistance with your loan agreement, our experienced business lawyers can assist as part of our LegalVision membership. You will have unlimited access to lawyers to answer your questions and draft and review your documents for a low monthly fee. So call us today on 0808 196 8584 or visit our membership page.
Frequently Asked Questions
Under a loan agreement, an event of default is a term that specifies certain circumstances that, if they come to pass, mean the bank can end the loan. This means they will immediately demand your business pay back any outstanding amount. It will also release your bank from any future obligations it owes your business.
Late payments, material misrepresentations, breaches of undertakings, and change of control are common examples of events that may constitute a default.
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