Negotiating Events of Default on a Loan Agreement – What Should a Borrower Beware of?

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Events of default are most often found in the context of loan agreements and are similar to termination rights that can be found in trade agreements, although with potentially different consequences. An Event of Default is an event or circumstance concerning a borrower or its activities which will give rise to a right for a lender to refuse to make further advances, to demand immediate repayment of a loan, to return a loan to term refundable on request and / or enforce its security.

Below is a brief borrower’s guide to navigating default events that are commonly found in real estate financing documentation, and some advice on typical negotiating points.

Default

Common default events in a real estate finance transaction:

Non-payment

If a borrower does not pay an amount when it becomes due under the loan agreement, this will constitute an event of default. Lenders are very unlikely to negotiate this. It may be possible for a borrower to request the inclusion of a reasonable grace period within which the overdue amount must be paid, before the default becomes an event of default. Normally, this grace period does not exceed a few working days.

Breach of the financial pact

A financial covenant is a promise made by the borrower to meet and maintain an agreed financial position, during the term of the loan. In real estate financing transactions, financial covenants are generally linked to the market value of the underlying asset and / or the level of income derived from the asset. For example, a “loan to value” (or “LTV”) clause will require that the loan amount does not exceed a certain proportion of the property’s market value (based on the bank’s most recent appraisal). These commitments are most often tested on each interest payment date (or “IPD”) and any violation would trigger an event of default. Quite often, a breach of a restrictive covenant is a warning sign to a lender that a borrower may have trouble paying the interest and / or repaying the loan. Negotiation is likely to be around an agreement on the threshold at which the borrower’s financial position becomes a violation and triggers an event of default. Quite often, remedial rights are agreed upon to allow a borrower to “fix” a breach of a restrictive covenant in order to avoid triggering an event of default.

Breach of other obligations

In addition to breach of payment clause and breach of financial covenant, a more general event of default will often be included to capture a breach of all of the borrower’s other obligations under the loan agreement, such as breaches of commitments. The borrower may wish to seek to limit the Event of Default to “material” defaults and / or negotiate a grace period within which the default can be corrected before the Event of Default occurs. It is therefore important for the borrower to carefully consider all of their obligations under the loan agreement, including with regard to any restrictions on their ability to manage the property (such as rental, disposal and development). and to borrow additional sums from third parties. party lenders. The various representations, guarantees and covenants may therefore need to be changed to ensure that they do not interfere with the smooth running of the borrower’s business, or interfere with his intentions for the good.

False declaration

This event of default will be triggered if any statement or statement made (or deemed to have been made) by the borrower under the loan agreement (or sometimes also other related financial documents) is found to be incorrect or misleading. Statements may be given on the date of agreement only, or may also be deemed to be repeated every day for the life of the loan (or certain dates such as draw dates, ITAs, or dates of any repayment or repayment. anticipated). The borrower could seek to limit the Event of Default by inserting a materiality statement so that the Event of Default only occurs when the misrepresentation has a material effect only on the borrower’s capacity. to fulfill its obligations under the loan agreement. The borrower will also want to ensure that representations are limited to written statements in the loan agreement only, and not to verbal discussions or other correspondence between the parties.

Cross default

A cross-default event will be triggered if the borrower defaults under another agreement, either with the lender or with a separate third party. The borrower should therefore carefully consider what other arrangements he has in place and the likelihood of default. Where appropriate, the borrower may seek to insert exception language exempting certain agreements from being covered by this provision. For example, it is quite common to see a de minimus value included with respect to a default under another agreement. Borrowers should also ensure that the wording of such Event of Default does not prevent or interfere with the efficient conduct of its business.

Insolvency

This event of default will almost always appear in a loan agreement in one form or another. Depending on how it has been drafted, an Event of Default will be triggered when an insolvency situation (however defined in the loan agreement) arises with respect to the borrower. Sometimes the mere threat of insolvency proceedings against the borrower can be enough to trigger this event of default. As such, this provision can become quite heavily negotiated as the borrower will want to limit the significance of an insolvency event as much as possible, while the lender will likely want the ability to trigger an event of default and demand repayment. immediate loan, at the first indication that the borrower is in financial difficulty.

Borrower’s notification obligation

If a borrower learns that an event of default has occurred or is likely to occur, they will generally be under an obligation to promptly notify the lender and provide relevant details, including actions, if any. , which were taken to remedy it. any violation.

Consequences of default

Following an event of default, the lender will have a number of options, which will be set out in the “Acceleration” clause of the loan agreement. These will typically include the ability to:

  1. immediately cancel any unused part of a loan;
  2. report all outstanding loans immediately due and payable;
  3. report all outstanding loans payable on demand; and or
  4. declare all or part of its security right enforceable (this may include, for example, any legal charge, personal guarantee or charge of action entered into, in favor of the lender).

Following an Event of Default, the lender will have no particular obligation to exercise its rights under the Acceleration provisions, and it may agree to waive the Event of Default entirely.

The lender may choose to issue a “reserve of rights letter” to the borrower following an event of default (or sometimes following a breach of the loan agreement, but before the event of default. is triggered, (often known as a “fault”)). Under the reservation of rights letter, the lender will seek to reserve any rights or remedies that it may have under the loan agreement in connection with an event of default (or breach), even if it does not. ‘has not taken immediate or prompt action regarding the same. This should avoid a situation where the borrower can argue that the lender has waived the event of default (or breach) and therefore protects the lender’s ability to take action later.


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