Key Takeaways:

  • A default clause outlines the rights and remedies available to a non-breaching party if the other party fails to meet contractual obligations.
  • Events of default typically include non-payment, breach of warranties, insolvency, and material adverse changes.
  • Well-drafted default clauses define specific triggers for default, available remedies (e.g., damages, termination, or specific performance), and any applicable cure periods.
  • Notices and cure periods protect both parties by allowing a defaulting party an opportunity to remedy the breach before further action is taken.
  • Including liquidated damages, cross-default provisions, and mitigation measures strengthens enforcement and clarifies outcomes if default occurs.

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 to 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
  • Cross-default
  • Inaccurate material representation or warranty breach
  • Insolvency
  • Material adverse change (MAC)

Common Types of Remedies for Default

When a default occurs, the default clause specifies the remedies available to the non-breaching party. Common remedies include:

  • Termination of the Agreement: Allows the non-breaching party to end the contract and pursue other business opportunities.
  • Acceleration of Payments: Particularly in loan agreements, the lender can demand immediate repayment of all outstanding amounts.
  • Right to Seize Collateral: If the contract is secured by collateral, the non-breaching party can repossess and liquidate it.
  • Monetary Damages: The defaulting party may owe compensation for losses caused by the breach.
  • Specific Performance: In some cases, courts may require the defaulting party to fulfill their contractual obligations.

Including these remedies in a default clause ensures the non-breaching party can act swiftly and legally if a default occurs.

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 that 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.

Best Practices for Drafting Default Clauses

When drafting a default clause, clarity and enforceability are crucial. Consider the following best practices:

  1. Define Default Events Clearly: Specify exactly what constitutes a default—late payments, performance failures, insolvency, or cross-defaults with other agreements.
  2. Include Cure Periods: Offer the defaulting party a reasonable time to remedy the breach before legal action is taken.
  3. Add Liquidated Damages (If Applicable): Pre-determined compensation simplifies enforcement and discourages breach.
  4. Address Cross-Defaults: If a party defaults under a related agreement, it can trigger a default under this contract.
  5. Align with Governing Law: Ensure the clause complies with state law and any industry-specific regulations.
  6. Use Catchall Provisions: Include a statement that any breach not explicitly listed still qualifies as a default, ensuring comprehensive coverage.

These measures reduce ambiguity and strengthen the enforceability of the clause in a dispute.

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 notice 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.

Enforcing a Default Clause

Once a default occurs, enforcement steps depend on the contract terms and applicable law:

  1. Provide Written Notice: Most contracts require a formal notice outlining the default and the actions required to cure it.
  2. Observe Cure Periods: If the contract specifies a cure period, the non-breaching party must wait until that period ends before pursuing legal remedies.
  3. Invoke Remedies: If the breach is not cured, the non-breaching party can terminate the contract, accelerate obligations, or seek damages.
  4. Consider Negotiation: In commercial relationships, parties often renegotiate or amend contracts rather than proceed directly to litigation.
  5. Document All Steps: Maintaining clear records of notices, responses, and enforcement actions strengthens the non-breaching party’s position if the dispute escalates to court.

Frequently Asked Questions

1. What is the purpose of a default clause in a contract? It defines what constitutes a breach and the actions the non-breaching party can take, such as termination, damages, or collateral seizure.

2. What are typical events of default? Common events include missed payments, insolvency, breach of warranties, and cross-defaults with related agreements.

3. Why are cure periods included in default clauses? Cure periods give the breaching party time to remedy the default before legal action or termination occurs.

4. Can a default clause include financial penalties? Yes, contracts can include liquidated damages or penalties if they are reasonable and compliant with state law.

5. How is a default clause enforced? Enforcement typically involves sending formal notice, allowing for cure periods, and then pursuing remedies like damages, termination, or litigation.

If you need help with a default clause in a contract, you can post your legal need on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.