Acceleration clauses in business loans (and in real estate loans) are protections for the lender so they can request the borrower repay the total remaining balance immediately if the borrower has defaulted on payments or significantly violated the loan contract, such as failure to maintain collateral, insurance, or other key terms. Here’s a list of situations where an acceleration clause might be activated:
- The borrower sells assets promised as collateral.
- The borrower fails to maintain required insurance coverage.
- The borrower files for bankruptcy.
- The borrower allows business property or machinery to fall into disrepair.
- The borrower violates any other clauses defined in the agreement that could put the lender’s ability to collect payments at risk.
These clauses are common. You should read the acceleration clause carefully before signing any loan agreement. Make sure you understand what constitutes a default and what actions could cause the clause to be invoked. Most clauses are reasonable, but awareness prevents accidental breaches.
If you take an emergency financing loan after a natural disaster, the clause may specify that money needs to be used to renovate and rehabilitate the property only. If you plan on using it to replenish inventory, make sure the other use of funds is allowed in the agreement before you sign, or you may need to take a separate loan. Otherwise, you may be in breach of the contract, and the lender can invoke their right to the acceleration clause. If they do, it’s a pretty simple process.
The Acceleration Clause Process
Acceleration clauses typically follow a four-step process when triggered.
- The borrower breaches the loan agreement triggering the clause.
- The lender sends a notice of intent to trigger the clause to the borrower.
- An acceleration letter is sent to the borrower.
- The borrower pays the remaining balance back, negotiates new terms, or the lender begins seizing assets.
Defaulting on a business loan generally occurs when multiple payments are missed or when the borrower violates significant non-payment terms, such as maintaining insurance or collateral. Lenders typically assess the severity of the breach before deciding to enforce acceleration.
If the breach is severe enough, the lender will send a notice of intent that they consider the loan terms breached and will enact the acceleration clause. If the lender decides to follow through and enforce the clause, they will typically send the borrower a letter via certified mail or delivery that requires a signature.
The letter will include the:
- Loan agreement terms that have been breached.
- Amount that must be paid.
- Specified date that payment is due.
- Consequences if payment is not made in full and on time.
If this happens, you may have options, so don’t panic.
What to Do If You Get an Acceleration Letter
If your lender sends you an acceleration letter, look for the cause of the breach and verify if it is legit or not. If the lender claims the breach is from not being insured, but you have an insurance policy, contact your insurance provider and get a statement with the date and time and submit it to the lender.
In situations where defaulting on the business loan is accurate, set up a meeting with the lender to discuss alternate options. It is expensive to seize and sell assets as well as go to court, so there is a reasonable chance the lender will negotiate a different payment structure or a workaround to help reduce fees and administrative costs.
When the lender will not negotiate and defaulting is inevitable, your best bet is to talk to a licensed attorney and see if you have any recourse. Do not begin selling or hiding assets from the UCC filing, as this can create a much larger problem.
Acceleration clauses exist to protect the lender from risk and to clarify the borrower’s obligations. As long as the borrower meets the requirements of the loan (including having insurance, maintaining equipment, repairing damage, making payments, etc.), it’s unlikely that a lender will begin enacting the acceleration clause. If they do, you can always try to negotiate new loan terms and avoid going into full default.
SmallBusinessLoans does not provide tax, legal or accounting advice. This material has been prepared for informational purposes only. You should consult your own tax, legal and accounting advisors.
