What it means
Almost every commercial loan, mortgage and bond indenture contains one, because without it a lender could only ever sue for the instalments already missed. The clause converts the whole debt into a single immediately payable obligation once a defined event of default occurs.
Triggers go well beyond missed payments. Breaching a financial covenant, selling a major asset, a change of ownership, misstating information in the accounts or defaulting on a different loan can all qualify, depending on how the agreement is drafted.
Cross-default provisions make this far more dangerous than it first looks. If one lender accelerates, a cross-default clause in another agreement can allow the second lender to accelerate too, so a single breach can bring down an entire financing structure within days.
Lenders do not always pull the trigger, and in practice most prefer a waiver or an amended covenant to a forced insolvency. But the right to accelerate is what gives them the bargaining power to renegotiate terms, raise the margin or demand extra security.
The accounting consequence arrives immediately. If a covenant is breached at the balance sheet date and no waiver is in place, the whole loan must be reclassified from long-term to current liabilities, which can turn healthy working capital into a large deficit overnight.
In practice
Real-world examples
Example 1
A restaurant chain breaches its net debt to earnings covenant after a poor quarter. The bank has the right to accelerate $12,000,000 of term debt but instead grants a waiver in exchange for a 0.75 percentage point increase in the margin and monthly rather than quarterly reporting.
Example 2
A property developer sells a site that had been pledged as security without seeking consent. The acceleration clause covers unauthorised disposals, and the lender demands full repayment of the $4,500,000 facility within ten business days.
Example 3
A manufacturer defaults on an equipment lease of $200,000. A cross-default clause in its main $8,000,000 bank facility is triggered, and the company suddenly has to negotiate with two lenders at once over a comparatively small original problem.
Think of it
Imagine playing a board game where you normally pay rent in small amounts each turn. The acceleration clause is a rule that says if you knock over the board, you must hand over all your money right now.
Formula
Calculation
Accelerated amount due = outstanding principal + accrued interest + fees and prepayment charges
A distribution business borrowed $500,000 over ten years and, after three years of payments, has $380,000 of principal outstanding at an interest rate of 7%. It breaches its coverage covenant and the lender chooses to accelerate.
Interest accrued since the last payment date one month earlier is $380,000 x 7% / 12 = $2,216.67. The agreement also allows a default administration fee of $1,500.
The total demanded is $380,000 + $2,216.67 + $1,500 = $383,716.67, payable at once rather than over the remaining seven years. Because the business holds only $90,000 in cash, the practical outcome is a refinancing, an asset sale or a negotiated standstill.Case study
Seen in the real world
This is an illustrative and clearly fictional scenario. Loxley Print Group, an invented commercial printer, held a $6,000,000 term loan with a covenant requiring interest cover of at least 3.0 times. A large customer moved its work in-house, operating profit fell from $2,700,000 to $1,050,000, and against interest costs of $420,000 the cover ratio dropped from 6.4 to $1,050,000 / $420,000 = 2.5.
The lender did not call the loan, but it clearly had the right to. Because the breach existed at the year end and no waiver had been signed before the accounts were approved, the auditors required the full $6,000,000 to be shown as a current liability, turning reported working capital from a $1,900,000 surplus into a $4,100,000 deficit.
In this fictional case the bank agreed a twelve month waiver three weeks later in return for a higher margin and a $500,000 reduction in the facility. The illustrative point is that the clause did real damage to Loxley's balance sheet and its banking discussions even though no money was ever actually demanded.
Watch out
Common mistakes
- Assuming a lender will always negotiate rather than accelerate, when the decision depends on the security available and the lender's own position.
- Reading only the payment default trigger and missing the covenant, cross-default and change of control triggers elsewhere in the agreement.
- Leaving a covenant breach unwaived at the year end, which forces the whole loan into current liabilities regardless of the lender's intentions.
Questions
People also ask
Can a borrower do anything once a loan has been accelerated?
Usually yes in practice, through a waiver, a standstill agreement or refinancing, though the lender is under no obligation to agree to any of them.
Does acceleration apply to consumer mortgages too?
Yes, and it is the mechanism that precedes repossession, normally after a defined number of missed payments and a formal notice.
What is a cure period?
A window written into the agreement, often 15 to 30 days, during which the borrower can fix a breach before the lender is allowed to accelerate.