Defaulting lender waterfall: Overview, definition and example
What is a defaulting lender waterfall?
A defaulting lender waterfall refers to the hierarchy or sequence of payment allocations and rights adjustments in a loan agreement when one or more lenders fail to fulfill their obligations, such as funding their share of a loan or providing required payments. This provision ensures that the remaining lenders or participants in the agreement are protected and that the defaulting lender's rights, such as receiving payments or fees, are adjusted accordingly. The waterfall outlines the priority in which payments and recoveries are distributed to address the default.
This mechanism is common in syndicated loans or other multi-lender arrangements, ensuring fairness and order when a lender defaults.
Why is a defaulting lender waterfall important?
A defaulting lender waterfall is important because it provides a structured approach to managing defaults, protecting the non-defaulting lenders and borrowers. It ensures that critical funding or operational obligations are met despite a lender's failure to perform, minimizing disruption to the loan or project.
For borrowers, this provision clarifies how obligations are redistributed in the event of a lender default, ensuring continuity of the loan arrangement. For lenders, it establishes safeguards and accountability, discouraging defaults and ensuring a clear process for resolving them.
Understanding a defaulting lender waterfall through an example
Imagine a group of banks participates in a $100 million syndicated loan to finance a construction project. Each bank is responsible for funding $25 million. If one bank fails to provide its share of the funds, the defaulting lender waterfall clause in the loan agreement kicks in. The waterfall prioritizes payments to non-defaulting lenders who stepped in to cover the defaulting lender's share. Additionally, the defaulting lender may forfeit its rights to interest payments or voting privileges until it remedies the default.
In another example, a company relies on a revolving credit facility with multiple lenders. If one lender defaults on its obligation to provide its portion of the credit, the waterfall provision specifies that repayments will first go to the non-defaulting lenders, ensuring they are compensated before the defaulting lender receives any recovery.
An example of a defaulting lender waterfall clause
Here’s how a defaulting lender waterfall clause might appear in a loan agreement:
“In the event of a Defaulting Lender, all payments received under this Agreement shall be applied in the following order of priority: (a) first, to reimburse Non-Defaulting Lenders for any amounts advanced on behalf of the Defaulting Lender; (b) second, to cover any fees, interest, or principal payments due to Non-Defaulting Lenders; (c) third, to the Defaulting Lender only after all obligations to Non-Defaulting Lenders and Borrower have been satisfied. The Defaulting Lender shall forfeit any voting rights under this Agreement until the default is remedied.”
Conclusion
The defaulting lender waterfall is a vital mechanism in loan agreements, ensuring fairness and protecting the interests of non-defaulting lenders and borrowers when a lender fails to meet its obligations. By establishing a clear hierarchy for payment allocations and rights adjustments, this provision minimizes disruptions, promotes accountability, and provides a structured approach to resolving lender defaults. Including a well-defined defaulting lender waterfall clause ensures transparency and reduces the risk of disputes.
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.