Acceleration clause

Definition

An acceleration clause allows the lender or creditor to demand immediate repayment of the entire outstanding balance or take other specified actions if the borrower fails to meet certain obligations outlined in the agreement. 

What is an acceleration clause?

An acceleration clause grants the lender the right to accelerate the repayment schedule, making all remaining payments due immediately.

The primary purpose of an acceleration clause is to protect the lender’s interests by providing a mechanism to address borrower default or breaches of contract. By accelerating the repayment schedule, the lender can reduce potential losses and take timely action to recover funds or collateral.

Acceleration clauses typically specify the circumstances or events that trigger the acceleration of the loan or contract. Common triggering events may include:

• Default on loan payments: Failure to make timely payments of principal or interest as required by the loan agreement.
• Breach of covenants: Violation of specific terms, conditions, or covenants outlined in the agreement.
• Bankruptcy or insolvency: Filing for bankruptcy or insolvency proceedings by the borrower, which may jeopardise the lender’s ability to recover the outstanding debt.
• Material adverse change: Significant adverse changes in the borrower’s financial condition, creditworthiness, or ability to repay the debt.

Acceleration clauses pose significant risks for borrowers, as they can result in immediate repayment obligations or negative consequences in the event of default. Borrowers should carefully review and understand the terms of any loan agreement or contract containing acceleration provisions before signing to reduce potential risks and liabilities.

Example of an accelerated depreciation

ABC Corporation borrows $1 million from XYZ Bank to finance the expansion of its manufacturing facility. The loan agreement includes an acceleration clause that dictates the following:

“If ABC Corporation fails to make three consecutive monthly payments on the loan, XYZ Bank has the right to declare the entire outstanding balance of the loan due and payable immediately.”

Now, suppose ABC Corporation misses three consecutive monthly payments on the loan due to financial difficulties. In this case, XYZ Bank invokes the acceleration clause, demanding immediate repayment of the entire $1 million outstanding balance, plus any accrued interest.

In this example, the acceleration clause allows the lender (XYZ Bank) to accelerate the repayment schedule and demand immediate payment of the loan if the borrower (ABC Corporation) breaches certain conditions specified in the loan agreement.