What are Default Clauses in a contract?
How does it work?
What are the essential elements you should know!
In this article, we will break down the legal definition of Default Clauses so you know all there is to know about it!
Keep reading as we have gathered exactly the information that you need!
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What Are Default Clauses
A default clause (or default provision) is a legally binding contractual clause where the parties mutually agree what may result in a contractual default and the consequences associated with it.
For example, in a lease agreement, the landlord may state that if the commercial tenant fails to pay rent by the 5th day of the calendar month, it will be considered in default triggering the default clauses.
As a consequence, the tenant will be exposed to fines or even eviction.
Businesses and individuals should pay close attention to the default provision found in their contract so they are aware of what events may potentially lead to a default.
Those who are unsure should consult a contract lawyer and get professional assistance to avoid making a costly mistake.
It’s also important to make sure that you are properly drafting the contractual clauses relating to default to avoid ambiguity and interpretation challenges potentially leading to further dispute.
Purpose of Default Provisions
The main purpose and objective of default contract language is to provide certainty to both parties as to what may be considered a “default” but also define the procedures and processes that may apply when the event of default takes place.
Businesses and individuals sign contracts to execute their obligations in good faith.
However, in real life, things may not always work as we intended them to.
By having contract default clauses, the parties can agree, in advance, on what may be considered a default allowing them to govern themselves in a way to avoid the consequences agreed between them.
What’s also important is that when an event of default occurs, the parties have a legally binding document to leverage to try to resolve the issue and find a common ground.
The default provisions may provide details about notification obligations, the delays the defaulting party may have to cure a breach, and the possible consequences of the default such as fines, injunctive relief, liquidated damages, or termination of contract.
Elements of Default Clauses
Every contract may define default clauses in a different way.
For example, in a loan agreement or debt contract, you may find the following elements:
- Definition of events leading the borrower to be considered in default (non-payment of capital and interest payments)
- Consequences of the event of default (additional interest charges, fees, or other financial charges)
- Non-defaulting party’s rights upon event of default (right to terminate contract, acceleration of maturity, right of redemption, charge late fees)
- Notice of an event of default (written notice given by lender to the borrower advising of the event of default and demanding the issue to be cured)
- Event of default procedures (notification requirements, minimum or maximum cure period delays)
Events of Default
An event of default is a situation or circumstance that contracting parties define to result in a contractual default.
For example, in the context of a service agreement, the client and service provider may agree that should the service provider fail to render services achieve a project delivery milestone resulting in a delay, it will be in default.
The parties can even choose to qualify a certain event that may not objectively appear as important as “material default”.
For example, in large construction projects where there are many subcontractors and the success of the overall project will depend on how each subcontractor perfectly respects its own delivery timelines, the general contractor may define a two-day delay as a “material breach”.
This can be a reasonable “event of default” when the general contractor depends on the subcontractor to deliver the entire project and wants to ensure the subcontractor is mindful of the requirement for the rapid execution of its obligations.
Here are some examples of events of default:
- Non-performance of obligations
- Failure to respect covenants
- Failure to respect intellectual property obligations
- Cross-default scenarios
- A party’s insolvency or bankruptcy
- A material adverse change
- Inaccurate representations
- Breach of warranty
Default Clause Example
The most common example we can use to provide you with an example of a default clause is with regards to commercial leases and commercial lease contracts.
Typically, the landlord will include various “default clauses” outlining the acts, conduct, or omissions of the tenant that may result in a contractual default.
Commercial Lease Agreement
For instance, if the tenant damages the landlord’s property, the tenant will be required to fix the damages caused or compensate the landlord.
If the tenant does not perform the necessary repairs, the landlord may exercise the default provisions in the contract such as imposing a fine or doing the work at the tenant’s expense along with additional fees and administrative charges.
Fixed-Price Supply And Services
Section 52.249-8 of the Federal Acquisition Regulation in the United States provides a good example of what may be considered a “default” and the consequences of the default in the government’s relationship with a contractor.
The government may request that the contractor deliver the suppliers or render the services within a specific timeline and make progress to avoid endangering the performance of its obligations.
If the contractor fails, the government may terminate the contract within ten days after the contractor has received a notice of default from the government.
Default Provision Takeaways
So, what are default provisions in contracts?
Let’s look at a summary of our findings.
Contract Default Clause
If you enjoyed this article on Default Clauses, we recommend you look into the following legal terms and concepts. Enjoy!
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