UK: Acceleration Without Due Care May Lead To A Bumpy Ride

Last Updated: 25 April 2014
Article by John Simpson, Martin Brown and Robin Acworth

A recent South African decision serves as a valuable reminder of the care that should be taken when exercising a right of acceleration.

Rights of acceleration

In debt finance transactions, it is common to expressly provide in the loan or facility agreement for the lender to have a right to accelerate the debt before the scheduled repayment date, usually as a result of an event of default occurring, thus making the full balance of the debt payable immediately. Such a mechanism is necessary in order for the lender to be able to enforce its security, for instance by exercising a right of sale under a mortgage over any assets, so as to recover the full balance of the debt upon the occurrence of an event of default.

Under English law, acceleration clauses are enforceable so long as they provide only for the acceleration of the unpaid principal amount. A provision requiring for the immediate payment of all future interest that would have been payable under the loan agreement will generally be void as a penalty. It will not be a penalty, however, for the borrower to agree to indemnify the lender against the loss incurred by the lender as a result of the early repayment following acceleration. So, where the borrower is aware that the lender is liable under a payment obligation of its own in respect of the funds borrowed by the borrower, a provision requiring the borrower to indemnify the lender for such liability in the event of an acceleration of the loan will generally be enforceable.

Under most loan agreements, before the lender can exercise a right of acceleration, the lender will be required first to give notice to the borrower of the event of default. The exact requirements, and any period during which the borrower is allowed to remedy the default, will depend on the specific terms of the agreement.

Combined Developers v. Arun Holdings

In the recent decision in Combined Developers v. Arun Holdings and Others, the High Court of the Western Cape Division demonstrated the risk under South African law of exercising a right of acceleration in a manner inconsistent with the specific requirements of the contract and public policy.

The case concerned a loan agreement which required repayments to be made on the last day of each calendar month. Shortly before the end of the month in question, the lender sent the borrower a statement of the amount due that month. When the payment was not made by the end of the month, the lender sent an informal reminder. The borrower then paid the amount specified in the lender's statement. The borrower failed, however, to pay "mora" interest that had accrued on the amount, in the sum of R86.57 (roughly US$ 8.00), on account of the late payment. This sum had not been included in the lender's statement and had not been demanded by the lender. Nevertheless, the lender issued a notice to the borrower contending that the failure to pay the interest was an event of default and that it was exercising its right of acceleration such that the full balance of R7.6 million (around US$ 700,000) plus interest was immediately due and payable.

The South African Court held that the reminder did not meet the requirements of a demand under the loan agreement, which was a prerequisite to exercising the right of acceleration. In particular, the reminder did not refer to the "mora" interest or specify the amount of such interest. Accordingly, the interest had not been demanded and, until it had been, the lender had no right of acceleration. The Court also found that to interpret the reminder as a demand, such that the right of acceleration could be exercised in circumstances where the borrower was not notified that the "mora" interest was due, or of its amount, would be so draconian and unfair that it must be a breach of public policy, and some communication to remind the borrower that it remained in arrears must have been required.

Risks associated with rights of acceleration

It is likely that a similar conclusion would have been reached had the case been considered under English law, although the analysis may have differed and, for instance, it is unlikely that public policy would have played such a significant role in the interpretation of the relevant contractual provisions. Leaving aside the differences between the rules of construction under English law and South African law, which are beyond the scope of this article, the clear message to be taken from the decision in Combined Developers is that any right of acceleration must be exercised carefully and strictly in accordance with the requirements of the particular contract.

The liability to which a lender could be exposed in the event of a wrongful acceleration of a loan could potentially be substantial if the lender proceeds to enforce any security it may have over the borrower's assets on the basis that the full amount of the loan is immediately due. In the context of ship mortgages for instance, a wrongful arrest of the mortgaged vessel could entitle the borrower to damages in respect of its potentially considerable losses caused by the wrongful arrest.

The risk of getting it wrong will be greater where the default and acceleration provisions are unclear or ambiguous and this risk can be minimised by careful drafting at the time of the transaction. In the event of any subsequent default by the borrower, any doubt concerning the rights of acceleration and enforcement can potentially be alleviated by consulting a suitably qualified lawyer.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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