Cross-Default Clause: Threshold, Trigger and a Worked Case

A business that has stopped paying one creditor has told every other creditor something. A lender also has a more direct concern. If one financier can enforce, seize assets or negotiate a private repayment while the others are still waiting for a test date, the order of recovery is set by who moved first. A cross-default clause gives each lender a seat when any lender has a problem.

For the borrower the same clause is a contagion risk. A dispute with a small equipment financier can become a default under all its debts, including those that are being paid on time. The negotiation is about how much warning and room the business retains before that happens.

The first component is the debt covered. Most clauses reach borrowed money across the borrower and its group, and some extend to leases, asset finance, guarantees and hedging. The second is the trigger, which forms a ladder from wide to narrow: other debt is not paid when due; other debt could be accelerated because a default exists; other debt has been declared due; or the other creditor has started enforcing.

The third is the threshold, a minimum below which the clause does not apply. Thresholds are common in negotiated facilities, but many smaller bank letters have none. What is measured matters as much as the figure: the amount actually overdue, or the whole of the debt affected. Grace periods matter too, because a clause often does not count a missed payment until the grace period in the other document has expired.

Hedging has its own version. The ISDA Master Agreement contains a cross-default provision at section 5(a)(vi). It applies if the parties elect it in the schedule, and it generally covers default on borrowed money above a Threshold Amount they set there. A bank's loan and its swap can therefore carry different thresholds for the same customer.

A forestry harvesting contractor, constructed for this page like every figure in it, owes its bank US$4.6m: a US$4.2m term loan and US$0.4m drawn on an overdraft. A plant financier is owed US$1.6m on two harvesters. A dealer is owed US$0.18m on a loader. A mill slows its payments, and the contractor misses a US$48,000 instalment to the plant financier. The financier's contract gives five days' grace, which passes. The financier then writes, but does not accelerate.

The US$250,000 is the example's, chosen to show how the measure works, and is not a suggested level. Version 3 and version 2 use the same number and reach opposite results. A borrower who negotiates the figure and leaves the measure to the lender's drafting may have won nothing.

Under versions 1 and 3 the bank may act at once, and the question becomes whether it should. It has every reason to ask why a mill's late payment has reached a financier's instalment, and little reason to accelerate US$4.6m against a contractor still trading. Under version 4 it has no right to act unless the financier accelerates. If the financier does so a month later, the bank arrives after the machines have been repossessed, which is the outcome the wider clause is meant to prevent.

Cross-acceleration is the narrow end of the same ladder, as in version 4: it applies only after another creditor has declared its debt due. A lender gives up early warning in exchange for a clause that cannot be set off by a minor technical default. Many borrowers ask for this, and it is more common for stronger credits.

Other terms sound similar and do different work. Cross-collateralisation means one set of security secures several debts. A cross-guarantee means group companies guarantee each other's obligations. Neither makes a default on one debt a default on another, though all three commonly appear together. An all-monies clause extends what a security secures. Cross-default concerns when a lender's rights arise; those concern what it can look to when they do.

DEFINED IN ONE PARAGRAPH → · EVENT OF DEFAULT → · ISDA SCHEDULE →

A cross-default clause means a borrower in difficulty cannot manage its lenders one at a time. A waiver from one is of little use if another document has already been tripped by the same event, so a restructuring tends to begin with a map of every agreement and which of them has been triggered. A bank reading a new borrower's accounts wants to know who else is owed, on what terms and with what thresholds, because its own position depends on theirs.

Australian small-business lending has a specific limit. Under the Banking Code of Practice, a subscribing bank's action under a standard-form small-business loan, for a default other than a missed payment, is confined to listed events, apart from tailored covenants on specialised loans. Those include another creditor bringing enforcement proceedings, or early repayment or default-based action under a separate arrangement with that bank. A default owed to some other lender, without more, is not on that list. Negotiated facilities and larger borrowers fall outside the limit, and the Code covers only subscribing banks.

READING YOUR FACILITY LETTER → · CORPORATE LENDING AND CREDIT RISK →