Legal Definitions - cross-default clause

A cross-default clause is a specific provision commonly found in loan agreements or other financial contracts. It states that if a borrower fails to meet their obligations (defaults) on one particular debt or agreement, this failure automatically triggers a default on other, separate debts or agreements they have, often with the same lender or even different lenders. Essentially, a default on one financial commitment can cause a cascade of defaults across multiple related obligations.

Here are a few examples to illustrate how a cross-default clause works:

• Example 1: Small Business Loans

  Imagine a small business, "GreenTech Solutions," has two separate loans from "Capital Bank." Loan A is for purchasing new machinery, and Loan B is a working capital line of credit. Both loan agreements contain a cross-default clause. If GreenTech Solutions misses several payments on Loan A due to unexpected market changes, even if they are still making payments on Loan B, the cross-default clause in both agreements means that their default on Loan A automatically puts them in default on Loan B as well. This allows Capital Bank to take action on both loans, such as demanding full repayment, even if Loan B's specific terms haven't been violated yet.

• Example 2: Corporate Bonds and Bank Credit

  Consider "Global Logistics Corp.," a large company that has issued corporate bonds to investors and also maintains a revolving credit facility with a consortium of banks. Both the bond indenture (the contract governing the bonds) and the credit facility agreement include cross-default clauses. If Global Logistics Corp. breaches a financial covenant (a promise to maintain certain financial ratios) in its bond indenture, leading to a technical default on its corporate bonds, the cross-default clauses will automatically trigger a default on the bank credit facility. This occurs even if Global Logistics Corp. has not yet missed any interest payments or principal repayments on the bank loan, allowing the banks to declare their loan immediately due and payable.

• Example 3: Real Estate Development Projects

  A property developer, "Urban Sprawl LLC," secures a construction loan from "Metro Bank" for a new residential complex. Urban Sprawl LLC also has a separate land acquisition loan from "Regional Trust" for another, unrelated project. The construction loan agreement with Metro Bank includes a cross-default clause that references any other significant debt obligations of Urban Sprawl LLC. If Urban Sprawl LLC defaults on its land acquisition loan with Regional Trust because that project stalls, this default on the Regional Trust loan will automatically put Urban Sprawl LLC in default on the construction loan with Metro Bank, due to the cross-default clause. Metro Bank can then exercise its rights under the construction loan, such as stopping further disbursements or demanding immediate repayment, to protect its investment, even if Urban Sprawl LLC was current on payments to Metro Bank.