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Loan Agreements: The Dark Side (Part III of III)

In Part I of this series we took a look at the contracting parties to a loan agreement and the commercial details of a loan. In Part 2, we looked at important loan terms like representations, warranties, undertakings, qualifications and exceptions. Now, we look into default provisions.

With the contracting parties’ focus on the commercial details and operational workability of the loan, they seldom spend time on default provisions.

This unconcerned attitude has caused many a lender and borrower to find their interests unprotected, and the lending relationship – in particular the existence of a default – to become the centrepiece of litigation.

Default provisions generally include a detailed list of events and circumstances which, when they occur, will constitute an event of default for purposes of the loan; and the remedies available to lenders in such instances.

 

 

Events of default

Events of default are included in loan agreements to allow the lender the right to re-evaluate the risk profile of the borrower and the loan, and should it wish, to take advantage of the remedies available under the loan agreement and in law.

The standard events of default required by lenders include:

  • non-payment when an amount becomes due and payable
  • breach of financial covenants
  • breach of other obligations including the various undertakings given by the borrower
  • misrepresentation of facts or financial information
  • cross-default should the borrower default under another agreement
  • insolvency of the borrower and possibly a security provider

It is important that events of default clauses strike a fair balance between the parties’ interests, for example to avoid the borrower being unable to optimally conduct its business fearing a premature repayment responsibility or the lender realising that its risk has become commercially or financially unviable.

Standard remedies

When a borrower becomes aware that an event of default has occurred, it will usually be obliged to notify the lender of such event and provide information on the event and any steps taken to remedy the breach.

If an event of default occurs, a lender will have various remedies available to it, including the ability to, without any prejudice to any other rights it may have under applicable law:

  • accelerate the loan by claiming immediate payment of all amounts owing under the loan agreement
  • demand and be entitled to receive specific performance of the obligations breached
  • take steps to enforce or perfect applicable security interests
  • immediately cancel the loan facility
  • claim payment for any losses incurred as a direct result of the event of default

Lenders must be mindful of grace periods that may apply before they will have the right to exercise their remedies.

Alternative remedies

When faced with a defaulting (or potentially defaulting) borrower, lenders should keep in mind that declaring an event of default and subsequently pursuing their contractual and legal rights in relation to such default may not be the only way forward. The parties can also negotiate:

  • a waiver in terms of which the lender waives the breach (which may be subject to certain conditions)
  • the conclusion of an amendment to the loan agreement in which the applicable provisions are revised to prevent the borrower from breaching the agreement again
  • the lender requiring additional collateral
  • the lender charging a higher interest rate for as long as the default continues

Understanding these provisions of a loan agreement are therefore crucial for both borrowers and lenders in order to steer clear of the dangers that may lurk in the darkness of default.

Nadia Smith

Nadia has a BCom and LLB and was admitted as an attorney in 2006 after having completed her articles at Jan S De Villiers Attorneys (now Werksmans). Nadia then joined Freshfields Bruckhaus Deringer LLP in Amsterdam as an associate for 4 years before returning to ENS Africa as a senior associate in the banking and finance department. Nadia joined Caveat in 2015 focusing on corporate and finance law.

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