A letter from your lender says your business loan has been accelerated, and the full balance is due now. If this has already happened to you, you’re probably in a bit of a panic. You don’t have that kind of money right now. So what do you do? For starters, don’t panic.
Loan Acceleration Clause
A loan acceleration clause is a provision in a loan agreement that allows the lender to demand immediate repayment of the outstanding loan balance if the borrower defaults on the loan. In other words, when the loan accelerates, you owe everything you owe. It might sound like a bad news phrase, but it’s a standard part of many loan contracts. Routine or not, when you are the borrower, it can feel like a death sentence.
So what counts as a default? A default on the loan is when the borrower fails to follow the terms of the loan. That covers a failure to pay, late payment of principal or interest, breach of a loan covenant. Covenants are terms that require the borrower to follow certain rules or conditions, such as maintaining financial stability. You have to read your contract carefully to find out what it says.
How does a business end up here? Cash flow is the lifeblood of every business, but when it dries up, the consequences can be swift and severe. Maybe you borrowed to expand, but growth has been slower than expected. Or maybe it’s a hiccup in cash flow. Business is good, but then it’s not. An economic downturn, a shift in your market or plain mismanagement can all do it. While you might have ample collateral to secure your loan, you may not have the cash on hand to pay it back.
Acceleration rarely comes out of nowhere. If you miss a payment, the lender will likely notify you. Your loan document may give you a “grace period” in which to make up the missed payment or fix the covenant violation. If you don’t, the bank can then send a formal “notice of default.” The document outlines the specific terms you violated and the specific actions the borrower must take to put things right. If you haven’t cured the default by then, the bank can then accelerate the debt. The default notice is the start of a process, not an end. If the default still isn’t resolved, the lender may go to court, which can end in asset seizure or a judgment lien on business assets. Often the bank asks for a receiver to be appointed, someone who manages your company in place of you.
Debt Restructuring
The worst thing to do is nothing. Ignoring a default notice is a great way to hurt your credit score and get sued. Businesses in trouble often go quiet with the people they owe, and a lender that hears nothing tends to move from notices to demands to legal action. Don’t be afraid to call them up. Explain the situation. You can improve your chances by being able to explain the default and what you can do to remedy the situation. If you can come up with a plan that might work, you might be able to convince the bank to accept it. The earlier you talk, the more options you keep. Admit you need help.
If a loan is accelerated, there may be a chance to renegotiate the loan terms with the lender. If you aren’t able to make your payments, ask the bank for a forbearance or a restructuring of your loan. Debt restructuring refers to the process of reworking the terms of a borrower’s debts so that they can meet the obligations that are specified in the loan agreement. Banks may also consider a deferral, a modification or a waiver. A loan modification is an agreement between a business and its lender to change the terms of an existing loan. Each of these has pros and cons. It’s worth considering your options before rushing into anything. Remember, though, that it’s the lender who will call the shots.
Asset sales involve selling some of your assets to generate cash that can be used to pay the bank. Here, it is necessary to identify and sell assets that aren’t necessary for the ongoing operation of the company.
Cutting costs works the same way. Is there anything you could eliminate, reduce or defer? Be honest. Can you postpone your annual sales conference or trade show?
The worst-case scenario is that you end up having to file for bankruptcy, and while that’s not an outcome you want to consider, it is a serious option. It can stop creditors and buy you time, but it costs money, and it only works if the business underneath has a viable model to reorganize around. There are legal ramifications and reputational risks associated with bankruptcy, so it should only be pursued as a last resort.
Understanding the Consequences
Understanding the consequences of accelerated business loans is crucial for business owners who are struggling to keep up with their loan payments. Late fees and penalties can drain the cash you need to operate. If the loan was secured, the lender has the right to take the collateral, often the equipment or property that generates the income required to pay the loan. Losing it makes recovery that much harder.
Without question, a default will dent your credit rating. That makes future financing harder to get, and it can follow you into dealings with landlords, suppliers and vendors. Defaulting on a loan can have serious financial, legal, and reputational consequences for the business. Suppliers may demand catch-up payments or move you to cash in advance or cash on delivery. Customers who hear about it may also avoid the business because they may think that the business is a financial risk or may not be around in the future.
Once you are through this, put safeguards in place. Understand how your company is doing in real-time so that you can make informed decisions. That means real forecasting and budgeting, financial controls that flag trouble early, and a contingency plan. If one customer or product carries the business, diversify as much as you can.
It’s natural to feel scared and concerned when facing a business loan acceleration after defaulting on your payments. But you can manage the situation and work towards a resolution by taking proactive steps to address the issue. Understanding your loan agreement and the consequences of defaulting on your payments is crucial. Once you realize you have defaulted on your loan, reaching out to your lender and being honest about your situation is the best approach. Know your rights, your strengths and your exposures, and get professional advice. Bring in a CPA or business attorney to help negotiate terms.
