Acceleration Clause: Everything You Need to KnowStartup Law ResourcesVenture Capital, Financing
An acceleration clause gives the lender the right to require the borrower to pay off the entire loan amount immediately under certain circumstances. 4 min read
What Is an Acceleration Clause?
An acceleration clause (also called an acceleration covenant) is a provision, often written into loan agreements and promissory notes, that gives the lender, under certain circumstances, the right to require the borrower to pay off the entire loan amount immediately. Acceleration clauses are most commonly found in mortgage contracts and real estate loans. In the case of a mortgage, the acceleration clause is often triggered when the borrower (mortgagor) fails repeatedly make his payments on time.
Acceleration Clauses and Startups
In regard to startup businesses, acceleration clauses can be found in employment contracts, stock option agreements and other related financial documents, but are typically only offered to company executives. They concern the accelerated vesting (i.e., right to a portion of ownership) of rights to certain assets, such as company stock and retirement plans. More specifically, an acceleration clause is commonly part of a vesting schedule, and is meant to protect certain individuals (company executives, valuable employees) when an event occurs (such as an unjustified termination or the sale or merger of a company) that might otherwise result in the forfeiture of the individual’s rights to unvested assets (such as a stock option or retirement benefit.)
There are two basic types of acceleration clauses in the case of startup vesting agreements: single-trigger and double-trigger.
Note: while the term “trigger” is commonly used when describing an acceleration trigger event, you may not find the term explicitly used in the actual language of an acceleration clause.
Single-Trigger Acceleration: Single-trigger acceleration means that the acceleration clause is triggered by the occurrence of a single event, commonly the sale or ownership transfer of a company. For example:
Assume that a company founder has a vesting schedule that provides for full vesting in company stock at the end of four years, and that the schedule includes an acceleration clause that provides for a one-year acceleration in the event of the sale of her company.
Assume also that the founder has two years vested at the time of the company’s sale.
Then, the acceleration clause is triggered with the sale of the company, and the founder is immediately vested for three of the four years.
Double-Trigger Acceleration: Under a double-trigger acceleration clause, two stated events must take place in order for acceleration to occur. In most cases, the two events are the sale or ownership transfer of the company, and the unjustified termination (termination without cause) of the vesting individual. A double-trigger clause is normally found when a company executive’s continued participation or employment is expected following the company’s sale or transfer of ownership. If, however, the executive is terminated by the company’s new owners, without cause, then the acceleration clause is triggered.
A Sample Acceleration Clause
A typical acceleration clause will look something like this:
“In the event of default in the payment of any of the said installments or said interest, when due as herein provided, time being of the essence hereof, the holder of this note may, without notice or demand, declare the entire principal sum then unpaid immediately due and payable.”
What Other Types of Actions Might Trigger an Acceleration Clause?
Apart from default or consistent late payments on a loan, an acceleration clause may be “triggered” (put into effect) if the borrower attempts to to sell or transfer his loan. This is also known as a “due-on-transfer” clause. However, the acceleration clause is normally not triggered in such a case if the sale or transfer the loan is made due to the death of the borrower and the transfer is made to the heirs of the deceased’s estate.
An acceleration clause may also be triggered by events outside of the loan agreement. Events that might trigger an acceleration clause in such a case include: indications of financial insolvency, such as falling behind on property tax payments; a lapse in insurance coverage on a property; the borrower fails to make on-time payments on another mortgage assessed on the same subject property.
What Will You Owe if an Acceleration Clause Goes into Effect?
Notification that an acceleration clause will go into effect is often the first step in the foreclosure on a loan or mortgage. If your lender notifies you that an acceleration clause has been triggered, you become immediately responsible for paying the remaining unpaid principal on your loan, plus whatever interest has accrued to date. You will not be responsible to pay any interest that would have accrued if the loan had gone to full term. These rules are governed by state law and vary significantly from state to state, so be sure to check the relevant laws in your state.
Legal Advice for an Acceleration Clause
Whether a lender or a borrower, you should always seek out legal and financial advice before signing any long-term legal agreement. The legal professionals at the UpCounsel's marketplace are some of the nation's best lawyers. UpCounsel’s lawyers are graduates of top law schools, like Harvard and Yale, and average 14 years of practice experience. Our lawyers have advised some of the top companies in the US and are now available to help you. Take advantage of UpCounsel’s services and get all the facts regarding your rights - before it's too late.