If your business has fallen behind on a loan, there is one word in the paperwork you need to understand, and it is acceleration. Acceleration is exactly what it sounds like: when a loan goes into default and the lender accelerates or hastens the point at which it needs to be repaid in full. When the lender chooses not to accept these monthly payments and instead calls in the entire remaining balance of the loan, that is considered acceleration. When that happens, you need to pay the full balance of the loan immediately, including interest and principal, which is often impossible.
Take an example. Say the lender holds a $400,000 mortgage over thirty years at 7%, so the monthly payment, before escrows, is $2,661.21. The borrower misses January, February and March. Setting late charges aside, the arrears come to $7,983.63. If the lender decides that working things out would be futile, or has some other compelling reason to end the relationship, it often can declare acceleration and demand the entire balance of the mortgage. Rather than wait thirty years for its $400,000, it wants the money now. In effect it says: we don’t want your installments, we don’t want the $7,983.63, we want the full $400,000 and we want it immediately. That is, the lender is talking about acceleration. By accelerating the loan, it is as if the lender waves a magic wand: instead of needing to pay $2,661.21 a month, the borrower now owes all of it. But make no mistake: by declaring acceleration, the lender can demand the balance of the loan even though the borrower owes only three payments.
Think about what that means for a small business. The business falls two or three months behind on a loan it cannot afford. The lender calls that an acceleration and the business is required to pay the total amount of the loan immediately, although it owes only two or three payments. The business, unable to keep up with payments and now facing the entire balance of the loan, goes out of business. Again, that is what the word acceleration means in loan documents. That’s why understanding the word is critically important.
It is worth slowing down on this point, because a lot of owners don’t grasp the extent of what has happened when they get a letter saying that their loan has been “accelerated.” They say: oh, so, I have to pay the extra installment? If you think that way, then you are in trouble. That is, an acceleration letter is not a demand for the normal balance of the loan, but full, immediate payment of everything.
How Does a Lender Actually Do It
How does a lender actually do it? In New York, and generally, courts look for some clear, overt act by the lender to demonstrate that the lender has elected to get paid in full. One option is to file a foreclosure complaint that declares the acceleration, and courts do not find that to be particularly problematic. The more common approach is to send the borrower a letter demanding full payment, which declares the loan accelerated. As with the lawsuit approach, the letter should state unequivocally that the borrower owes the entire balance of the loan.
Many owners assume there must first be a warning that acceleration is coming. There usually isn’t. The notice of acceleration is the letter that accelerates the loan, it does not give notice that an acceleration is about to take place. So the lender is not required to give a separate “notice of acceleration.” The lender need only send a notice declaring the acceleration. That’s it. No additional, hyperbole-laden “pre-acceleration notice,” I am afraid.
The courts agree. In a 2007 New York case, Charter One Bank v. Leone, the borrower argued that the bank had not sent notice of acceleration before suing. The court rejected the argument: under the acceleration provisions, notice of default and demand for payment are not prerequisites to foreclosure. The act of acceleration was enough.
Notice to Cure
In New York and most states, no statute or case law requires a lender to warn you before accelerating. But the loan contract can. It is only when it either promises to or expressly contracts to give notice that it is required to do so. The Fannie Mae/Freddie Mac uniform instrument, for example, requires a thirty-day notice to cure first, and when the documents say that, notice must come before acceleration. A notice to cure is a request that you fix the problem that will result in the acceleration of your loan. The intention of a requirement that the lender can accelerate only after giving notice to the borrower is to provide the borrower with some time to cure whatever defaulted condition triggered the acceleration, and to thereby avoid the acceleration. A demand to cure, or a notice to cure, or a notice of default is different from a demand for payment once the loan is accelerated. If the letter is a default notice, you are usually given a short time to cure any current default. If the letter declares the loan accelerated, you are not.
So the courts will not require a breach letter if there is no requirement in the loan agreement. The action the lender takes depends on the documents you signed. They may not inform you of your default first. That is why it is so important for people to know and understand the loan documents. All businesses should know what they have agreed to when they sign a loan.
What Should You Do
So what should you do if a letter like this lands on your desk? Reread the terms of your loan agreement. What are the proper terms for acceleration? Does it require notice before the lender can accelerate? When did it accelerate? Were you given advance notice? Even though you may not be entitled to notice, you may still communicate with the lender. You may have more options than you think. Don’t think you are the first person that has defaulted. It happens all the time. If your business has been struggling financially and you feel that you are unable to make the loan repayments then you may need to discuss a repayment plan with the lender. You should know there are times where the lender may not be willing to talk to you about a repayment plan as they might not believe your business has a future.
Better still, act before the letter comes. Do not let things get into arrears and, if they do, deal with them immediately. Understand what acceleration means, including the consequences of a lender’s declaration of acceleration. It is the difference between a business with cash flow and no cash flow.
