Default Clause in a Contract: Everything You Need to Know
A default clause in a contract provides for the actions the non-breaching party can take in the event of default by the other party.3 min read
A default clause in a contract provides for the actions the non-breaching party can take in the event of default by the other party.
What Are Events of Default?
An event of default is a circumstance allowing a lender to demand full repayment of any balance due before the due date. In general, a default clause lets the non-breaching party do one of the following:
- Terminate the agreement
- Request damages
- Execute a course of action
Default lets the lender seize collateral that's been pledged and sell it to recoup the amount of the loan. Usually, the clause includes defaulting on loan agreements or notes, failing to perform contractual duties, or violating any warranties and representations.
A lot of clause examples also contain a catchall term that includes a breach or other default of any other term in the contract. The clause may have other circumstances that will let the creditor invoke its legal rights in case of default. These events can be tailored for the borrower's specific situation.
While a creditor is legally able to demand full and immediate repayment when default occurs, it usually doesn't take such action. Normally, a creditor works with the borrower to rewrite the loan agreement's terms. If both parties agree, then the lender can make a change to the agreement that includes tighter terms. In most instances, the lender will collect a fee for amendment and increase the interest rate.
Events of default are usually established between parties and outlined in the security agreement. Events of default may include any of the following:
- Payment- or performance-related default
- Non-payment of any loan amount
- Failure to properly maintain or enforce intellectual property (IP) rights
- Inaccurate material representation or warranty breach
- Material adverse change (MAC)
How to Write a Contract Default Clause
Before writing a default clause into a contract, review your state's laws regarding contract construction. Study how default clauses are usually written in your jurisdiction. It's often a good idea to consult with an attorney when writing a contract since contract law can be complicated.
Think about what will happen if the other party breaches the contract. How will the project or your performance be affected?
Make a list of reasons for a potential breach or delays that could prove detrimental to the project. You should also list potential remedies to a breach of contract. Common remedies include the following:
- Specific performance
- Monetary damages
- The right to bring in a new party to finish the project
Draft the default clause to state explicit actions which spell out default. Don't forget to include available remedies to the aggrieved party if the other party defaults.
You may also want to add a liquidated damages clause in the default clause. This gives the non-defaulting party monetary relief in addition to other relief as spelled out in the default clause.
Notices: Accepting or Rejecting an Offer
Provisions that address breach and default rely heavily on notice.
It's common to provide a cure period to handle a default. In these instances, the non-breaching party sends a written notice to the breaching party, detailing the default. If the breaching party fails to cure the default within a set timeframe, the non-breaching party is entitled to terminate the agreement. Having a clear, unambiguous notices provision is important in this case.
At times, a contract may state that if the offering party sends a notice outlining a particular proposal to the other party, that proposal is considered automatically accepted unless a rejection (or counteroffer) is sent by the receiving party within a specific timeframe. In these cases, the offering party wants to be sure it has validly delivered the notice, in the event the receiving party doesn't respond. By doing so, the offering party seeks to prevent the other party from arguing that the offer notice was either nonexistent or improper, which would make the proposal invalid.
Likewise, a receiving party that acknowledges its receipt of an offer notice wants to ensure that any rejection of the proposal is actually delivered to the offering party. Defaults can happen, and the party that's not at fault naturally wants to make sure it's protected in some way.
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