Cross-Defaults and Cross Collateralization are two concepts that are often misused and interchanged by lenders, and in some cases, they are used to describe something different completely. A cross-default provision transforms a lender’s or its affiliate’s default on one loan to a borrower, guarantor, or their respective affiliates (“Borrower Parties”) into a lender’s or its affiliate’s default another loan to a Borrower Party. A cross-collateral provision turns collateral for one loan from a Lender Party to a Borrower Party into security for another loan from the same Lender Party to the same Borrower Party.
When a borrower’s and its affiliates’ business strategy focus on purchasing, rehabilitating and developing several real estate properties over time, cross-default and cross-collateralization provisions are most prevalent. The lender is safeguarded from a borrower and its affiliates, prioritizing payment of one debt above payment of another by cross-defaulting the loans. All subject loans will default if the borrower tries to service one debt while neglecting the others.
The conditions should be written broadly enough to include all loans made to the borrower, guarantor, and their respective affiliates by the lender and its affiliates. It is critical to use appropriate terminology, especially because many borrowers will seek to eliminate or reduce the scope of the relevant portions. A lender should disclose specific lender affiliates, borrower and guarantor affiliates, loans, and properties where linked loans have been or will be made in addition to keeping the cross-sections broad.
Many lenders misunderstand the cross-default and cross-collateralization terms in their loan papers. Then, when it comes time to enforce them, they discover that the restrictions do not apply to the loans and parties they thought they were protecting. To read more about these provisions, click here.
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