Cross defaults are arrangements where a debtor with multiple debt obligations defaults on one of the debts, triggering an automatic default on all other debts held by the same creditor.
Cross-defaults are provisions in which a debtor with multiple debt obligations defaults on one of the debts, triggering an automatic default on all other debts held by the same creditor. The inclusion of a cross-default clause is not uncommon for many banks, especially if the bank specializes in providing multiple loans and lines of credit to businesses. This type of cross default acceleration protects the interests of the creditor by making it act immediately before any default on other debt instruments can occur.
Because cross-default clauses are so common, they are often included in the terms and conditions of any basic loan agreement. However, there are lenders who choose not to include any sort of accelerated default clause in their loan agreements. Lenders who take the provision as a matter of course usually bring the borrower’s attention to the clause before processing any new loans to the individual or business.
It is important to note that a cross-default action also applies to loans obtained through subsidiaries, in the event that the parent defaults on a loan issued by a common lender. At the same time, the default of a debt obligation by the subsidiary may also cause any loans granted to the parent company to default, at the creditor’s discretion. From this perspective, it is in the borrower’s interest to make sure that all obligations are met on time, or to try to make payment arrangements with the creditor before any of the obligations default.
Although a cross-default agreement protects the interests of the creditor, the clause is generally not activated automatically. Because of the expense involved in trying to collect a delinquent loan, the lender will likely try to work with the borrower to come up with an alternative solution. If the borrower is unwilling or unable to work with the lender to reach a mutually acceptable solution, the cross-default clause is invoked and legal action follows shortly.
Once the cross-default clause is invoked, borrowers are unlikely to have many recourse options. Depending on the size and number of loans held by a single lender, the expense of defaulting on loans can seriously hamper the operation of a business. Collectively defaulting on two or more loans can also seriously damage the company’s reputation and credit rating, making it difficult for the company to find resources elsewhere to pay off the debt claim.