Cross-default clause: Overview, definition and example
Why is a cross-default clause important?
A cross-default clause is important because it connects separate agreements by linking default events. If a party defaults on one contract, this clause triggers a default on another related agreement, protecting the non-defaulting party from greater financial risk.
For example, in a business loan agreement, a cross-default clause might mean that if a borrower fails to repay one loan, it automatically puts them in default for other loans with the same lender.
This clause provides lenders or creditors with a tool to manage risk, ensuring that financial problems in one area don’t spread unchecked. For businesses, understanding a cross-default clause is critical to avoiding a domino effect of defaults across multiple agreements.
Understanding a cross-default clause through an example
Imagine a company takes out two loans from the same bank—one for operating expenses and another for new equipment. Both agreements include a cross-default clause. If the company misses a payment on the equipment loan, the bank can declare the operating loan in default too, even if the payments for that loan are current. This allows the bank to take action to secure its position, such as demanding full repayment or seizing collateral.
For the company, this means financial trouble in one area can quickly escalate, making it essential to manage payments carefully and avoid triggering the clause.
An example of a cross-default clause
Here’s how a cross-default clause might look in a contract:
“An Event of Default under this Agreement shall constitute an Event of Default under any other agreement between the Borrower and the Lender. Upon the occurrence of such Event of Default, the Lender may, at its discretion, exercise all rights and remedies available under this Agreement and any other agreements in effect.”
Conclusion
A cross-default clause links financial agreements, ensuring that issues in one contract don’t spiral out of control. It’s a way for lenders to manage risk, but for businesses, it underscores the importance of staying on top of all obligations to avoid a chain reaction of defaults.
Understanding how cross-default clauses work is key to managing financial agreements effectively. It ensures you’re aware of the broader implications of missing a payment and helps you protect your business from unintended consequences.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.