What is an ‘Event Of Default’
An event of default is a predefined circumstance that allows a lender to demand full repayment of an outstanding balance before it is due. In many agreements, the lender will include a contract provision covering events of default to protect itself in case it appears that the borrower will not be able to or does not intend to continue repaying the loan in the future. An event of default enables the lender to seize any collateral that has been pledged and sell it to recoup the loan.
BREAKING DOWN ‘Event Of Default’
An “event of default” is a defined term in loan and lease agreements. The following would constitute a default event in a typical credit agreement clause:
- non-payment of any amount of the loan (including interest)
- financial covenant breach
- material representation inaccuracy or warranty breach
- material adverse change (MAC)
The clause can contain more circumstances that would permit the creditor to invoke its rights in the event of default. These events would be custom-tailored for the unique situation of the borrower. Although a creditor can legally demand immediate repayment in the event of a default, in practice it rarely does so. Instead, it usually works with the distressed borrower to rewrite the terms of the loan agreement. If the parties agree, the lender would produce an amendment to the loan agreement that contains tighter terms, and in most cases, raise the interest rate of the loan and collect an amendment fee.
Example of an Event of Default
On January 10, 2018, Sears Holdings Corp. entered into a $100 million term loan credit agreement with various lenders. Section 7.01 comprises 11 different events of default, including the ones cited above except MAC, for the struggling retailer. Unambiguous terms are customary in a properly-drafted credit agreement, but the agreement for Sears is particularly detailed and restrictive because the lending syndicate is taking extra precaution to protect its interests.