What is a Cross Default?

Cross defaults are provisions in which a borrower with multiple debt obligations defaults on one of the debts, triggering an automatic default on all other debts held by the same lender. The inclusion of a cross default provision is not uncommon with many banks, especially if the bank specializes in providing multiple loans and lines of credit to corporations. This type of default cross acceleration protects the interests of the lender, making it to take immediate action before any defaults on other debt instruments can take place.

Because cross default clauses are so common, they are often included in the terms and conditions of any basic loan contract. However, there are lenders that choose to not include any type of accelerated default clause in their loan contracts. Lenders who do include the provision as a matter of course often call the clause to the attention of the borrower before processing any new loans for the individual or company.

It is important to note that a cross default action will also apply to loans that are obtained through subsidiaries, in the event that the parent company defaults on a loan issued by a common lender. At the same time, a default on a debt obligation by the subsidiary can also make any loans issued to the parent company move into default, at the discretion of the lender. From this perspective, it is in the best interests of the borrower to make sure all obligations are honored on time, or attempt to make payment arrangements with the lender before any of the obligations move into default.

While a cross default covenant does protect the interests of the lender, the clause generally does not activate automatically. Because of the expenses involved with attempting to collect on a defaulted loan, the lender is likely to try working with the borrower to come up with an alternate solution. If the borrower is unwilling or unable to work with the lender to come up with a mutually agreeable solution, the cross default provision is invoked and legal action follows in short order.

Once the cross default provision is invoked, borrowers are not likely to have many options for recourse. Depending on the size and number of the loans held by the single lender, the expense of defaulting on the loans could seriously hinder a business operation. The collective default on two or more loans can also seriously damage the reputation and the credit rating of the company, making it hard for the business to find resources elsewhere to settle the debt action.