No material defaults: Overview, definition, and example
What is "no material defaults"?
"No material defaults" is a contractual representation that confirms a party has not failed to meet significant obligations under existing agreements, laws, or financial commitments. This clause ensures that a party entering into a new contract is in good standing and not in breach of any major contracts or obligations that could impact its ability to perform under the new agreement.
It is commonly included in loan agreements, mergers and acquisitions (M&A) contracts, and business transactions to provide assurance that a company is financially stable and legally compliant.
Why is "no material defaults" important?
This clause protects all parties in a contract by ensuring that no undisclosed financial, operational, or legal issues exist that could interfere with performance under the agreement. Lenders, investors, and business partners use this clause to verify that a company is not facing lawsuits, unpaid debts, or breaches of contract that could jeopardize their ability to fulfill obligations.
If a party is in material default under another contract, it may signal financial distress or legal risks that could impact the transaction. Failure to disclose material defaults can lead to legal consequences, contract termination, or financial penalties.
Understanding "no material defaults" through an example
Imagine a company is applying for a business loan. The loan agreement includes a "no material defaults" clause, requiring the company to confirm that it has not defaulted on any significant contracts or debts.
If the company has missed several large loan payments to another bank but does not disclose this information, it could be in breach of the new loan agreement. If the lender later discovers this default, it may demand immediate repayment or terminate the loan.
An example of a "no material defaults" clause
Here’s an example of how this clause might be written in a contract:
“The Borrower represents and warrants that it is not in material default under any agreement, financial obligation, or legal requirement that would reasonably be expected to have a material adverse effect on its business, operations, or ability to perform its obligations under this Agreement.”
Conclusion
The "no material defaults" clause provides assurance that a party is in good financial and legal standing before entering into a new agreement. It helps protect lenders, investors, and business partners from undisclosed risks that could impact contract performance.
Before signing a contract with this clause, businesses should review their existing obligations carefully—because failing to disclose material defaults can lead to serious legal and financial 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.