Indebtedness cross-default: Overview, definition, and example
What is indebtedness cross-default?
Indebtedness cross-default is a provision in a loan or credit agreement that triggers a default on one debt if the borrower defaults on another debt. This means that if a borrower misses a payment or fails to meet the terms of any of their other loans or financial obligations, it can cause a default across all of their debts, even if the borrower is not specifically in default on those other loans. It is a way for lenders to protect themselves by ensuring that a failure to meet any obligation doesn’t go unaddressed and allows them to call the entire debt due.
In simpler terms, indebtedness cross-default means that if a borrower doesn’t pay one loan on time, all their other loans may also be considered in default.
Why is indebtedness cross-default important?
Indebtedness cross-default is important because it protects lenders from the risk that a borrower may be unable to meet their financial obligations. If a borrower defaults on one loan, it may signal financial trouble that could affect the ability to pay other debts. This provision allows the lender to accelerate payment demands, making the borrower pay all outstanding debts immediately or face serious legal consequences. For borrowers, understanding cross-default provisions is crucial, as it can have significant financial implications if they fail to meet any debt obligations.
For SMB owners, understanding how cross-default provisions work is essential when taking out loans or credit, as failing to meet one obligation could lead to the acceleration of multiple debts, impacting cash flow and business operations.
Understanding indebtedness cross-default through an example
Imagine your business has two loans: one from a bank for equipment and another from a supplier for inventory purchases. If your business defaults on the equipment loan by missing a payment, and the loan agreement includes a cross-default provision, the supplier could immediately demand the repayment of the inventory loan as well, even if you haven’t missed any payments to them. This is because the failure to meet one financial obligation has triggered a default on the entire set of loans.
In this case, the cross-default clause helps the bank and the supplier mitigate their risk by ensuring that a single missed payment on one loan can lead to consequences across all outstanding debts.
Example of an indebtedness cross-default clause
Here’s an example of what an indebtedness cross-default clause might look like in a loan agreement:
“In the event that the Borrower defaults on any of its other financial obligations or loans, whether with this Lender or any third party, such a default shall be considered an event of default under this Agreement, and the Lender may accelerate all outstanding amounts owed under this Agreement and demand immediate payment in full.”
Conclusion
Indebtedness cross-default is a key provision that helps protect lenders by ensuring that any default on a borrower’s obligations triggers defaults across all other debts. For SMB owners, understanding this provision is essential when managing multiple loans or credit agreements. It emphasizes the importance of keeping up with all debt obligations to avoid triggering broader financial consequences that could threaten the business’s stability. By being aware of cross-default clauses, businesses can manage their debt more effectively and minimize the risk of financial disruption.
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.