Cross Default Clauses in Loan Contracts – Finance and Banking


Turkey: Cross-default clauses in loan agreements

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Due to the desire of financial institutions to involve new players and accelerate the flow of money, loan operations and contracts dealing with these operations are multiplying every day. While creating opportunities for natural or legal persons, these institutions need to secure their interests against problems that may arise as a result of loan extension operations. One of the most common mechanisms used by financial institutions to achieve this is the drafting of loan agreements with cross-default clauses.

Cross-default is essentially a provision of a loan agreement that puts the borrower in fault if the borrower defaults on another loan. In other words, if the borrower defaults on a loan, he will be deemed to be in default on his other loans and debts arising from other loans will become immediately due and payable even if there is no breach. other loans. . For example, if a borrower defaults on their bank loan, the cross-default clause would also put them in default on their mortgage. Thus, cross-default clauses in loan agreements can easily create a domino effect for borrowers.

Default can occur in a loan agreement in several ways. This can happen in case the borrower does not pay the agreed value as well as in cases where the borrower violates the positive or negative clauses of the agreement. A positive covenant forces the borrower to perform certain transactions while a negative covenant forces the borrower to avoid certain transactions. A cross default clause related to the payment of the value of the agreement is called “Cross default payment” and a cross default linked to the performance of other contractual obligations is called “The Cross Default Alliance”.

Although cross-default clauses are frequently used in loan agreements between various financial institutions and natural or legal persons, it is not possible to include these clauses in agreements to be concluded with public institutions. There are some reasons that prevent public institutions from entering into loan agreements with cross-default clauses. First, the obligation of public institutions to conduct public policies may prevent these institutions from fulfilling their contractual obligations arising from the loan contract. Second, the limitations placed on the budgets of public institutions and the non-independent structure of these institutions may prevent them from freely fulfilling their contractual obligations. Finally, such institutions, whose reputation is based on their solvency and their solvency, would not wish to enter into such risky and costly agreements which could cause them to lose their solvency and their solvency.

As briefly mentioned above, cross-default clauses are strongly in favor of the debtors of the agreements as they are sufficient to minimize the risk of default in the agreement, however these clauses can have quite negative effects on the borrowers. For example, due to the domino effect created by cross-default clauses, a borrower who has secured multiple loans may default on all of their loans due to a default on a single loan and lose all of their financial advantage and leverage. to be able to. In order to protect borrowers from such negative situations, the parties need to negotiate and take certain actions.

First, the borrower can mitigate the risk of default by limiting the events of default. For example, the parties may decide that the cross-default clause will only be triggered if the borrower does not pay a certain amount of money or comply with certain clauses of the agreement. Also, the parties may decide that the default clause will only trigger loans from the borrower resulting from the same agreement or loans obtained from the same creditor. In this way, the borrower can minimize the risk of being in default on other agreements with third parties. In addition, default actions may be limited to those resulting from gross negligence or intention of the borrower.

Another option for the borrower to minimize the risk of default would be to determine as much as possible any grace periods in the agreement that could prevent the borrower from defaulting on their payment obligations. Finally, the provisions relating to cross default conditions in the agreement should be spelled out clearly and away from any subjectivity in order to avoid any litigation arising from this issue.

In conclusion, cross-default clauses are essential for debtor parties to loan agreements in terms of their function of preventing borrowers from frequently defaulting on contractual obligations. However, as mentioned above, these clauses can lead to huge disadvantageous situations for borrowers. At this point, the fairest way for both parties would be to negotiate on these clauses and mitigate them to the benefit of both parties, as cross-default clauses are likely to be preferred and demanded by debtors.

The content of this article is intended to provide a general guide on the subject. Specialist advice should be sought regarding your particular situation.

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