Events of default and other risks for borrowers

Events of Default - commercial loans

Commercial loan agreements are often drafted by the lender such that a technical default can result in severe consequences for the borrower.

Examples of potential events of default which are often express terms in loan documents :-

• Non-payment - failure to make timely payments of principal or interest.

• Breach of covenant - violation of any financial or operational covenants included in the loan agreement.

• Financial distress - indicators of financial difficulties, such as bankruptcy or insolvency proceedings.

• Material adverse change - a significant negative event affecting the borrower's business or financial condition. There can be a wide range of events included depending on the loan and the borrower, it’s business and the sector it is in. Financial changes which can be defined as material advance changes can include debt to equity ratio, interest coverage, working capital.

• Conversion risk: where the loan is a convertible loan, the terms of the  loan may give the lender the right to convert the loan into equity, potentially diluting the borrower's ownership stake even to the point the borrower may end up as minority shareholder.

• Interest rate risk: The risk that interest rates may rise, increasing the cost of the loan.

Consequences of an event of default being triggered

Potential consequences include :-

• Lender demands immediate repayment - including principal and accrued interest. At worst this can trigger insolvency.

• Lender enforces security - if the loan is secured, the lender can enforce its security interest.This may involve seizing and selling assets, such as property or equipment, to recover the outstanding debt.

• Default interest - lender be entitled to charge a higher interest rate on the outstanding debt.

• No further advance - lender may terminate any undrawn facilities, preventing the borrower from accessing further funds.

• Receivership - the loan agreement may specify other remedies, such as the right to appoint a receiver or to take control of the borrower's business.

Other risk clauses for borrowers

• Cross-default: Provisions that allow the lender to accelerate the loan if the borrower defaults on other obligations.

• Negative pledge clause: A provision that restricts the borrower's ability to pledge assets as security for other loans.

• Guarantees: Personal guarantees provided by the borrower's directors or shareholders.

• Security interests: Collateral pledged to secure the loan, such as property or equipment.

How we can help

It's crucial for borrowers to carefully review the terms of their loan agreements and understand the potential risks associated. By proactively addressing risks, borrowers can help mitigate their exposure and improve their chances of successfully managing their loan obligations.

We have a team of highly experienced commercial and dispute resolution lawyers Our role is to ensure our clients understand fully the detail and implications of lender drafted loan documentation and where possible to negotiate to reduce the risks. We also advise where lenders allege there has been a default.