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What is an Acceleration Clause in a Loan Contract?
Loan contracts and promissory notes may include an acceleration clause. It allows lenders to ask for immediate clearance or repayment of the loan amount if certain conditions are not met by the borrower. For example, if the loan repayment was agreed to for a period of 20 years, invoking this clause will mean that the whole amount is due immediately.
This provision states how and when a lender can accelerate the repayment in full. It is a way of ensuring lenders that borrowers will not breach contracts or miss payments. In business loans, the ‘Defaults and Acceleration Clause’ describes the consequences of defaulting on the loan. It contains details of the fines and penalties that will be imposed.
Acceleration Clauses and Startups
In a startup environment, acceleration clauses are usually found in stock option agreements, employment contracts, and stock option vesting. Accelerated vesting works on certain things such as retirement plans and stocks of the company. Valuable members of the company might be granted stock or options but the equity grants usually have a vesting schedule to ensure that the person sticks around. These persons benefit from the acceleration clause as the vesting on their equity is accelerated upon the occurrence of a triggering event.
The clause is generally a part of a vesting schedule and is meant to keep valuable members of the company safe from unprecedented events such as termination, the merger of the company, and so on.
For startup vesting agreements, there are generally 2 types of acceleration clauses
i.) single-trigger
ii.) double-trigger
Single-Trigger Acceleration: This means that the clause has been triggered due to a single reason or due to the occurrence of a single event. This is mostly, the sale of a company or transfer of ownership.
Double-Trigger Acceleration: Under this clause, two of the aforementioned events must occur in order for the acceleration clause to get triggered. This is mostly, the sale of a company or transfer of ownership along with an unjustified termination of the vesting individual.
Which of the two occurs more commonly?
Both types of acceleration triggers are quite common and can be used together.
An Example of Acceleration Clause
For instance in real estate, if a homeowner is unable to carry through with the terms of their mortgage agreement, they will be notified that the lender has invoked the acceleration clause meaning that the homeowner will have to make the repayment of what was borrowed along with the interest that accrued in whole. This can be helpful to lenders by helping them avoid foreclosure.
Why are Acceleration Clauses important in a contract?
While requesting a bulk repayment might sound like a big call, an acceleration clause is important as it can protect lenders, especially when dealing with a large sum of money. For example, if a borrower fails to make multiple payments, the lender would be forced to sue every month for the delayed payment. This would be a hassle and financially inconvenient too. So, acceleration clauses in a contract reduce the risk of the borrower’s default and work to guarantee that the repayment will be made making it very important and crucial to include.
Are Acceleration Clauses legal?
Yes, they are. Acceleration clauses are triggered when a borrower has defaulted on their obligations and failed to adhere to the conditions that were previously agreed upon and signed in an agreement. So, it is a lender’s legal right to exercise the clause. However if the clause is found to be punitive or exceeds the legitimate interest of the lender, it would be appealed for and hence unenforceable. However, without these provisions, the legal system would be flooded as the lenders would have to sue a borrower for every missed payment, and doing so every month after month would be simply taxing.
What triggers an Acceleration clause?
The most common reason for an acceleration clause to be triggered is failed installment repayment of the loan. In fact, a single missed payment can also result in the clause being triggered but most lenders only resort to it when there are multiple failed payments. However, acceleration is also allowed when a contract is breached. Apart from these, some common triggers for the acceleration clause are:
Cancellation of home insurance in mortgage loans: lenders require homeowners to have insurance so the property can be repaired and its condition of it kept as it was before any damage. This way, lenders get the best value out of the home in case the homeowner defaults.
Delayed payment or not paying property taxes: local authorities can place a lien and eventually seize property if the taxes are not cleared. Hence this is another key reason for the acceleration clause to be used.
Unauthorized transfer of property without approval from the lender: this can also trigger an acceleration clause.
Bankruptcy: This threatens a lender’s ability to exercise their rights and so it can trigger an acceleration clause.
How does an Acceleration Clause Work?
No matter what the reason is, these clauses mostly do not go into effect automatically and lenders can decide if they want to use them, and when as well. Firstly, the lender will notify the borrower and also state the reason for the acceleration. It will mention the balance, plus any unpaid interest along with a due date.
What Is an Acceleration Letter?
When a lender triggers an acceleration clause, an official letter is sent to the borrower, called an acceleration letter. It mentions the reason for the acceleration, the lender’s contact details and the balance, interest owed up to that point, and a final due date for the payment to be made. It is generally a demand for payment and specifies a date by which the payment is due.
What can you do when you received an acceleration letter?
- Send in the full payment and receive a clean title in the mail.
- Try and work out a payment agreement.
- Discuss and try to resolve problems like unpaid property taxes.
- Restructure your loan and make modifications
- Reinstate your mortgage and avoid foreclosure.
How To Avoid Loan Acceleration?
If you are in a tight spot as a borrower, you can avoid acceleration by working out a loan modification with your lender by making a new repayment plan.
Considerations for lenders before enforcing the Acceleration Clause
Interest payable: For mortgage acceleration, the borrowers are only required to pay the interest owed to the lender up to the point of acceleration along with the outstanding principal balance. In such a case, the borrower does not have to pay the future interest and so the lender could lose out on years worth of interest payments.
Risk: The point of acceleration is to get the money back, but if the borrower has missed payments because they don’t have money, chances are they will not be able to pay even after acceleration, which when calculated is a loss to the lender.
Advantages and disadvantages of acceleration clauses
It clearly defines the conditions for the debt and what will make it a bad debt which helps lenders recover bad debts. So, it reduces the risk when lending money. Also, if full payment is made following the clause, the borrower does not have to make future interest payments.
However, as a borrower, it is an unfavorable clause as it can force one to make a payment of a large sum of money on short notice. Additionally, the terms and conditions stipulated can be quite confusing for a regular person to understand.
Conclusion
Acceleration Clauses are provisions on a contract that are based on payment delinquencies and it allows lenders to enforce repayment of the borrowed sum in full when a borrower fails to keep up with the pre-agreed conditions of the loan contract. These are legal and help reduce risks for the lenders and protect them while also ensuring that borrowers stick to their responsibilities. They are usually The clause is mainly found in the real estate sector and in mortgage loans.
