Loan Agreement Events of Default
It has already been seen that the purpose of the event of default mechanism is to give a lender the opportunity to pursue two vital remedies on the occurrence of the event. Those remedies are:
to refuse to advance further funds if requested to do so, and
to call for immediate repayment of any funds already advanced irrespective of the scheduled maturity of the loan.
The process of enforcing these remedies is known as acceleration. It has also been noted that the power of these remedies is such as to render most of the normal contractual remedies irrelevant. For instance, if a borrower were late in making a payment the position without the event of default mechanism would be that the lender would only be able to sue for the amount of the late payment unless he could show that the borrower's actions amounted to a repudiation of the contract in which case he could treat the facility as terminated.
The events of default will ordinarily include:
default on any payment of interest or repayment of capital
it transpiring that a representation or warranty was incorrect
an evergreen representation or warranty being breached
a breach of any covenant
the borrower becoming insolvent
the commencement of insolvency proceedings against the borrower
the appointment of administrative receivers of the borrower's assets
cessation of the borrower's business
breach of any other term of the loan contract
breach of the cross-default clause
The last mentioned merits further comment.
It must be remembered that lenders are strongly motivated by their position comparative to other lenders. Banks never like to suffer a loan going bad but even worse would be the sight of other banks recovering similar loans from the same borrower. The negative pledge covenant is aimed at preventing this from happening and so is the cross-default clause.
The clause typically provides that if the borrower defaults on any other loan commitment so that the other lender accelerates that loan, then an event of default will have occurred on this loan also . In other words say B borrows from L1 and a cross-default clause is included in that agreement. B also borrows from L2 and commits an event of default on that loan which leads L2 to accelerate that facility. The cross-default clause in the contract between B and L1 will then permit L1 to accelerate that facility also even though no other event of default has occurred on the L1 loan. The clause can even go further and provide that any event of default on another loan will trigger the cross-default, even if the other lender declines to accelerate that facility. The clause may also extend to defaults on other loans by guarantors and subsidiary companies of B.
In the case of a company which has loans from a number of banks and syndicates of banks, then if all the lenders have cross-default clauses in their loan contracts with that borrower any event of default (or acceleration following it) can lead to accelerations by all the lenders. This of course can mean that one default can lead to a rapid demise of the borrower as lenders swiftly follow each other to call in their loans. Equally it can deter lenders from accelerating their facility as they know what the consequences will be if they do. They may see a negotiated rescheduling as preferable to an immediate liquidation of the borrower. Political considerations of not wishing to be seen to be the instrumental cause of the liquidation and consequent redundancies of the workforce will increase this effect.
Waiver by the lender
If a lender knows that an event of default has occurred he is not bound to accelerate the loan facility. He may choose to waive his right to do so. In the case of a late payment by the borrower which the lender accepts without further comment, the borrower may dispute the lender's right to accelerate on the basis of that late payment. By analogy with cases on payment of rent to a landlord, it seems that a lender would retain his right to accelerate but only when the interest was payable in arrears , and not when it was payable in advance. A lender would, however, be wise to accept the late payment on a 'without prejudice' basis. In the Mardorf Peach case the payee promptly rejected a late payment when he came to know of it but not before his bank had taken steps to credit it into his account. It was held that no question of waiver by acceptance could arise when the payee had acted thus.
Where a lender knows of an event of default and simply takes no action for a significant period of time before deciding to accelerate, it might be argued that he has lost his right to do so. The borrower's case is stronger when he has acted to his detriment in the light of the lender's inaction, an application of the law of promissory estoppel . If he is unsure at first whether or not to waive, a lender would be wise to express his right to do so in the future. Where the lender is not aware of the facts which constituted the event of default, his rights will not be affected but they may be if he was aware of the facts but did not appreciate that they amounted to an event of default under his contract.
It is well established in English law that acceptance of a reduced payment or of payment by instalments does not prevent the payee from later claiming the full sum at any time he chooses. This rule is subject to a number of exceptions, however, most obvious is that of the agreement being executed as a deed .
Loan contracts often include a waiver clause which states that no waiver will have taken place unless it is in writing by the lender. It is not wise to rely on this clause, however, as a lender who has acted in such a way as to encourage a borrower that he is waiving a breach could be said to have also waived the waiver clause, with the effect that the waiver by conduct has still occurred despite the inclusion of the clause.
Waiver by conduct has an ill-defined scope. If a payment of interest is late and the lender acts in such a way that amounts to a waiver by conduct, it is unclear whether just the right to accelerate based on that late payment is waived or whether the right to accelerate following any late payments in the future is waived. A lender who has decided to forgive an event of default is wise to put the matter beyond doubt by writing a letter of waiver saying exactly which breach is waived and that this does not constitute a waiver of future breaches.
Finally, it should be noted that the above discussion is limited to the lender's ability to enforce the remedy of acceleration provided by his contract. It is much easier for him to lose his right to the general contract law remedies such as the right to rescind the contract and inaction will frequently have a fatal effect on those remedies .
This is the title of a clause in loan contracts which states that the acceleration remedy provided for in the contract is in addition to all the normal rights that a lender enjoys under contract law such as rescission, seeking specific performance, an injunction etc. This would probably be the case anyway but the clause seeks to put the matter beyond doubt.