Cross-default – What it is, definition and concept | 2022

The cross-default is a clause of a debt contract that allows the creditor to demand the cancellation of the debt if the debtor breaches another debt contract that he has signed.

In other words, the cross default clause can be used in contracts where bonds or loans are issued. This obliges the debtor in cross-default to that, if he fails to comply with a payment obligation, this breach affects all the obligations contracted in a cross way

Undoubtedly, this cross default clause is placed to especially protect the interests of creditors. Since, this clause gives all creditors the right over the assets of a debtor in the event that the debtor defaults on the obligation to pay a loan. Because all creditors have the right to be returned what the debtor has lent immediately due to a cross-default condition.

For example, if a debtor has a contract with cross default at the time that he suspends the payment of the debt of a car, it is also considered a default in the payment of the mortgage of his house or a property. Since, all creditors have the same rights to the assets of a borrower who defaults or suspends payments.

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For this reason, the debtor must be careful not to enter into a suspension of payments process. Otherwise all creditors will demand that you pay off all loans immediately.

Cross Default 1
What is cross default ?

Why is the cross default clause used?

Naturally, this type of cross default clause is being used more recently. This is because financial institutions try to involve more people in this market. For the purpose of accelerating the flow of money from financial transactions. For this reason, contracts are needed that better respond to the needs of the participants.

Of course, in this way better opportunities are generated for all stakeholders. These actors need to guarantee their interests in the face of any problems that may arise in the future. For this reason, contracts include cross-default clauses. This clause favors the interests of creditors. Since, it places the borrower in default, if he defaults on another loan.

How can a breach occur?

Non-compliance can occur in the following ways:

  • That the debtor does not pay the value that was agreed.
  • The debtor violates the positive clauses of the contract or that the debtor does not carry out certain required operations.
  • The borrower violates the negative clauses of the contract or the debtor avoids carrying out certain operations.
  • Cross breach of other contractual obligations.
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Cross default
How can a breach occur?

Who uses cross default clauses?

Generally, these clauses are used in loan contracts. These contracts are made between financial institutions and private individuals or legal entities that contract the loan.

However, they cannot be applied in loan contracts where public sector institutions are involved. The reasons why they cannot be used are as follows:

  • Public policies: First, the implementation of public policies could prevent the public institution from fulfilling its obligations. Affecting established loan contracts.
  • Limitation of the public budget: Second, the limitations of the public budget. Since the public institution depends on said budget. Reason for which it could prevent them from fulfilling their contractual obligations.

Effects of cross default for the debtor

Indeed, as we mentioned earlier, this clause It is very favorable for creditors, because they minimize their risks. While, for debtors or borrowers it could affect them in the following ways:

  • A domino effect is created: Because when you default on an obligation, you immediately default on all loan obligations.
  • You may lose your financial advantage: Since, at the moment of defaulting on a single obligation, it automatically affects all the other loans contracted.

Actions that the debtor must take to prevent the cross default from affecting him too much

First of all, the conditions of cross-default must be clearly and precisely established to avoid subjective criteria coming into play. This is to be able to rely on the most objective criteria possible when any problem or dispute arises.

When considering this clause within a contract, the debtor must know how to negotiate to obtain the best conditions. For example, it should be made clear that the cross default will only take effect when:

  • The debtor does not pay a specific amount of money or does not comply with certain requirements of the agreement.
  • The breach will only affect the loans derived from the same contract or because they are granted by the same creditor.

In conclusion, it can be said that the cross default is an essential clause to ensure the interests of creditors when drawing up a loan contract. Since, the purpose is to prevent debtors from failing to comply with their contractual obligations. But, clearly, it can be considered as a great disadvantage for debtors. Therefore, it is necessary that the conditions be negotiated in the most equitable way possible so that both parties benefit.

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