In credit and equity investment transactions in Brazil, one of the most critical contractual sections for lenders and investors is the “Events of Defaults”.
Whether in bilateral or syndicated loan agreements, convertible loans, issuance of debentures, CRIs or CRAs, structured finance, among others, carefully thinking about the situations that will entitle the creditor to accelerate the debt and demand the outstanding amount immediately is key to reducing the inherent risks.
See below 5 events of default that financial institutions, fintechs, funds and investors should consider in their contracts with borrowers / target companies:
1. Non-Performance of Key Obligations: This is the first event in any events of default section.
In credit agreements, for example, the main obligation of the borrower is to pay interest and principal on the due dates. If you fail to comply with them, the contract must provide that the debt will be declared immediately due automatically, regardless of judicial or extrajudicial notification. This provision will give the creditor the right to choose between protesting and executing the debt, or renegotiating with the debtor, if it is in its interest.
2. Non-compliance with Ancillary Obligations: In addition to the main obligations, credit or investment agreements contain several other ancillary obligations for the borrower / target company, such as providing periodic financial and operational information to the lender / investor, so that it can monitor the life of the company and measure the evolution of the risk of the operation, or restore collateral whose market value may have deteriorated for any reason.
In the event of default on these types of covenants, the contract may provide for a period of 15/30 days for the borrower / target company to comply with the accessory obligation before the creditor / investor has the right to declare it defaulted.
3. Default of “Crossed” Obligations: A forgotten event in many credit and investment contracts, to provide that in the event of default by the borrower / target company in other credit, investment, commercial contracts, among others, with third parties, it will give the right to the creditor / investor to, at its discretion, accelerate the maturity of the outstanding balance.
With the sophistication of funding transactions by companies, lenders / investors must pay attention not only to the compliance of obligations in their contracts, but also to instruments entered into with third parties, which may be defaulted at any time.
4. Insolvency Events: Creditors and investors should be aware of signs that may indicate that the borrower / invested company is entering a potential situation of insolvency (such as an increase in the volume of protests, executions or bankruptcy filings by third party creditors), or has already entered (evidenced by filing for judicial recovery or self-bankruptcy).
One of the most serious mistakes in credit and investment agreements is when, in the events of default section, the clause gives the creditor / investor the right to declare default on the debt only “after the company is declared bankrupt” or after the “processing of judicial recovery”. In both cases, the most appropriate language to protect the creditor’s interests is to have the right to accelerate the outstanding debt “at the date of filing of the request” for judicial recovery or self-bankruptcy.
5. Reputational Events: With the evolution of legislation on business conduct to avoid acts that constitute corruption, money laundering, violation of commercial sanctions imposed in international trade, among others, it is important for lenders / investors to provide as an event of default if the borrower / invested company becomes subject of administrative or judicial proceedings for acts of corruption, money laundering, violation of international sanctions, among others.
It is increasingly relevant for lenders / investors to pay attention to reputational risk in their portfolios in order to mitigate not only credit risk but also being subject to investigation and penalties by their own regulators / investors. The events of default above are not exhaustive, but are intended for lenders and investors to consider in their loan agreements, convertible debt, issuance of debentures, CRIs or CRAs, structured credit, among others, to seek to reduce risks related to scenarios of default.
