Cure Period: How a Breach Becomes a Default

A facility agreement can be breached in small ways: a payment file rejected by a bank's system, a set of accounts that arrives a week late, an insurance renewal missed by a broker. If every slip gave the lender the right to demand repayment, an administrative error could put a sound borrower into default and set off cross-default clauses in its other contracts. Neither side wants that. So agreements commonly separate the breach from the event of default and allow a stated time between the two. Many use "Default" for a breach still inside its period and "Event of Default" for one that has run out of time.

The lender's rights are held back during that time, not removed. The agreement commonly requires the borrower to report the breach promptly, and a breach still running may stop new drawings, because a lender does not want to advance more money into a problem while it waits to see whether the problem is fixed.

These are common shapes, not rules, and each line is negotiated. Three drafting points decide how much the time is worth. The first is when the clock starts: on the breach itself, on the lender's notice, or on the borrower becoming aware, and a lender will often ask for the earlier of the last two. A clock that starts on the breach can be half spent before anyone has noticed. The second is the condition that the breach be "capable of remedy". Some breaches cannot be undone, and an agreement that does not say who decides leaves room for argument. The third is what counts as the fix: delivery of something late, or delivery in the required form.

Australia adds a floor for some borrowers. Under the Banking Code of Practice, which binds its subscribing banks, a Small Business borrower (one below limits on turnover, staff and total debt) generally gets 30 days' notice of a missed payment before full repayment is demanded. On standard-form loans the Code also limits the non-payment defaults a bank may act on, and confines financial-indicator covenants to specialised lending.

A mattress manufacturer, constructed for this page like every figure in it, has a term loan of US$9.4m and a revolving line. Its agreement allows three business days for a missed payment caused by administrative error, ten for late reporting, and twenty for any other undertaking that can be remedied, counted from the earlier of the bank's notice and the borrower's awareness. Financial covenants have no remedy period. These periods are the example's and are not offered as a market norm. In one year the business has four breaches.

The first three breaches cost nothing under the contract, and that is the clause doing its job. The instalment shows what it is worth: with no grace, a rejected file would have been an event of default on the whole US$9.4m, with a default margin (2% on the whole balance here; many agreements charge it only on the overdue sum) running at about US$515 a day until the bank waived it, and possibly a cross-default under the equipment leases. The insurance lapse came closest to the line. Cover was reinstated and the broker confirmed no loss in the gap, which satisfied this bank.

The fourth is different in kind. The test period has closed and the ratio has been measured. Waiting does not change a number that is already history, and a better next quarter does not rewrite this one. The business can ask for a waiver, or inject money under an equity cure if its agreement has one. Time alone does not help it.

A cure period gives time. An equity cure gives the borrower a way to answer a financial covenant with money, on the terms and the number of occasions the agreement sets. A waiver is the lender's decision to give up its rights over a particular breach, and the borrower cannot require it. A standstill comes later still, after default, when creditors agree to hold off enforcing while a plan is worked out. Only the first two are rights a borrower holds in advance.

None of these is the notice a lender must give under the general law before selling mortgaged land. In New Zealand, sections 119 and 120 of the Property Law Act 2007 generally bar a mortgagee from taking possession or selling on default until it has served a notice allowing no less than 20 working days from service to put the default right. Australian states have notice rules of their own for land. In England and Wales the Law of Property Act 1925 builds a notice period into the statutory power of sale, but a mortgage deed can vary it, and commercial deeds commonly do. Those rules govern enforcement; a contractual cure period governs when the default arises at all.

DEFINED IN ONE PARAGRAPH → · EQUITY CURE, WORKED → · LOAN COVENANTS, EXPLAINED →

The clause is settled at the term sheet, and the useful argument is usually about fit. A borrower with a small finance team needs reporting periods it can meet in a bad month. A lender wants payment periods kept short, because a missed payment is the breach least likely to have an innocent explanation. Moving the start of the clock from the breach to the borrower's awareness can be worth more than adding days.

After signing, a cure period protects the contract position and leaves the credit reading where it was. A lender can note that a breach was remedied in time and still conclude something from the pattern: reports that arrive near the end of the period every quarter say something about the finance function, whatever the agreement says about default. An on-demand overdraft sits outside the protection in practice, since it can be called with no breach to point to. A borrower relying on its cure rights checks first which of its facilities are committed, and reads the clause for each one in the facility letter.

READING YOUR FACILITY LETTER → · THE EVENT OF DEFAULT →