Event of Default

Event of Default refers to a situation where borrowers seem to fail to make timely payments toward a loan, thereby leading to the breach of the loan agreement. These scenarios are common where loan repayments and debt instrument transactions are involved. Lenders include this clause in the loan or financial contract to make sure they have the right to demand full payment from borrowers when in doubt.

Under the event of default clause, the lenders seize borrowers' properties to back the loan amount. The inclusion of this condition in the loan contract makes borrowers more alert, and hence, they try to be on time whenever the repayments are scheduled, as they never want to get involved in any kind of unnecessary legal dispute or loss of property. 

• An event of default results when the borrower seems to violate the provisions of the loan agreement by not making timely payments as required by the loan agreement.
• If the borrower defaults on the loan under this clause, it is easier for the lender to place a lien upon that collateral security. 
• Any violation of the terms of the agreement is considered a default, while only the partner lending the borrower the money can facilitate an event of default.
• The following occurrences are frequently listed in loan agreements that constitute default triggering events as failure to pay the equivalent monthly payments & payment of loan balance after the due date, etc.

An event of default clause in a loan agreement is a breach by the borrower when they default on debt payment. Certain events include deliberate non-payment of the loan, due interest or breaking of the bond covenant, or even insolvency. Although it literally means that lenders immediately ask for full repayment of a loan by virtue of this clause, they always exercise restraint in going for such immediate and punitive actions. In most cases, lenders allow sufficient time to borrowers or issue notices of default beforehand, reminding them of the required repayments.

The potential event of default is what makes lenders include such clauses, enabling them to ask for complete repayment rightfully at once. If the lender feels that the borrower's action has invoked the event of default, then it has the legal right to demand full and final repayment of the loan from the borrower. It is defined in the loan agreement by the lender with the consent of the borrower. This provision lets lenders take up borrower's property to act as collateral in case of defaults. In this arrangement, they can see the collateralized property and recover the loan amount on which one defaults.

Following are the scenarios that make lenders issue notice of event of default:

• Non-payment of the equated monthly installments (EMIs)
• Payment of loan amount beyond the date 
• Cross default
• Breach of specific covenants
• Breach of inaccurate representation of material nature
• Breach of warranty
• Material adverse change (MAC)
• Insolvency
• Using funds for other than the purpose of the loan taken
• Misrepresenting the stock data
• Non-submission of stock data regularly
• Forged documents 
• Forged land or house deeds.
• Bankruptcy
• Merger without assumption.

If the borrowers meet any of the conditions, the clause becomes active, leading the lender to ask for full payment of the loan at once.

Let us use the following examples to understand the topic even better:

Example #1

According to an October 2023 report, Chinese Property Developer Country Garden missed making its repayment to lenders for the first time since its operation. It detailed that the real estate ace failed to make the interest payment worth $15.4 million by the initial deadline of September 17, 2023, on a bond amount of $500 million. This triggered the event of a default clause, which formed the basis of Citigroup International's notice to Country Garden.

Example #2

Suppose a company, XYZ, took loan credit from a lender. It agrees to repay in full in 5 years. While it made timely payments for the first 3.5 years, it consecutively defaulted on loan repayments for the next 1.5 years, given the significant losses incurred continuously. This, in turn, raised concerns among the lender, making it rightfully ask for full repayment at once at the end of 5 years in the event of a default clause that is included in the contract. The borrower, therefore, which revived from its bad phase already, capably made the complete payment at once within the given time.

While the event of default and default seem to be terms that could be synonymously used, they are not so. They differ in meaning to a great extent, and hence, it becomes important to explore the differences between the two:

• Any breach of contract is termed as default. On the other hand, the event of default only indicates the possibility of one party defaulting on payments toward a loan or debt.
• Default occurs when any one of the parties fails to honor the contract, while an event of default is the circumstance where one party suspects the other party of defaulting on repayments.
• Defaults appear to have a direct effect on lenders who lose out on their money and have to struggle through legal ways to recover the same. On the other hand, including the event of default clause in the loan agreement allows lenders to ask for immediate payment of the dues, thereby also giving them the right to end the loan agreement at the same time. 

This article has been a guide to Event Of Default and its meaning. Here, we compare it with the default and explain it with its examples. You may also find some useful articles here -

• Default Rate
• Debt Default
• Exposure At Default