Acceleration Clause or Covenant Definition
An acceleration covenant or an acceleration clause refers to provision used by a lender to demand repayment of all outstanding loans if the borrower breaches the terms on the contract. This covenant is often used in debt contracts or loan arrangements between the two parties.
A lender cannot just apply the acceleration covenant in any situation, there are certain criteria for accelerating repayment. A breach in the terms of a loan contract often triggers the use of an acceleration covenant, in this situation, the lender decides to accelerate the repayment of loan.
A Little More on What is Acceleration Covenant
Certain debt instruments make use of the acceleration covenant or clause, an example is swap agreement. This clause provides a lender with an option to hasten the repayment of loans if a borrower defaults the terms of repayment outlined in the debt contract. A borrower that violates a term of the contract can be asked to repay all of an outstanding loan before the maturity date.
An acceleration covenant protects lenders from breaches of term of covenant that they might suffer from borrowers. Usually, every loan arrangement has certain credit requirements that the borrower must agree to, if a borrower defaults, the lender can use the acceleration covenant requesting that the borrower repays the loan before the specified date.
How an Acceleration Covenant Works
An acceleration clause or covenant is majorly used in mortgage loan agreements, swap agreement and real estate loan contracts. However, there are slight differences in how acceleration clauses work in different contract settings. Since not all acceleration covenants are the same, how they work also differ.
An overdue payment or lateness in payment is one of the factors that triggers the application of the acceleration clause. This lateness in payment is called payment delinquency. The terms of the contract determines when the acceleration clause will be applied. Some contracts might permit a borrower to be delinquent or miss some payments before the acceleration clause takes effect while some contracts do not permit this. A contract breach also cause an acceleration covenant to take effect.
Reference for “Acceleration Covenant”
Academics research on “Acceleration Covenant”
Evidence on the determinants and economic consequences of delegated monitoring, Beatty, A., Liao, S., & Weber, J. (2012). Journal of Accounting and Economics, 53(3), 555-576. We delve into a critical understudy of delegated monitoring while looking at its determinants and the significance of adding cross-acceleration provisions in public debt contracts. We discover that the use of cross-acceleration arrangement is hinged on borrowers’ going concern concerning debt repayment, liquidation values, credit quality, and financial reporting quality. It means the adoption of cross-acceleration provisions goes up at the time the cascading defaults expenses are lower; discrepancies between creditor classes are higher and the benefits of delegating monitoring by banks increases.
Strength of Bond Covenants and Bond Assessment Framework, Yahanpath, N. (2010). Available at SSRN 1660865. Bond covenants of 29 New Zeland bond released before the 2008 securities market act were examined in this paper. The outcomes of the study show that bondholders have weak and limited protection provision.
Financial covenants in commercial loan documentation: Uses and limitations, Lloyd, R. M. (1990). Tenn. L. Rev., 58, 335. This paper examines the uses and limitation of financial covenants in commercial loan documentation.
Acceleration Clauses in Mortgages: Misuse During Periods of Tight Money, Henkel, J. W., & Seltzer, G. (1979). Am. Bus. LJ, 17, 441. The focus of this paper is how Acceleration clauses are misused during the period of tight money.