No one every takes out a loan and plans on failing to make the payments. But bad things can and do happen so you should always understand the default provisions for commercial loans that you sign.

When you are requesting commercial loans for a property purchase, it is likely that the main collateral for the loan will be the property you are buying. But there are some cases where the lender feels that there is an addition level of risk and they require more collateral for the loan. This additional collateral could be inventory, vehicles, equipment or even your accounts receivable. The perceived additional risk could be due to your businesses stability, the amount of the loan or even the overall volatility of your industry. The length of time in business can also be a big factor in determining the risk involved in the loan.

You will also want to determine if the loan is a recourse loan or a nonrecourse loan. A recourse loan requires that an individual, usually the owner or owners, to sign a personal guarantee in case the business fails. This is a way for the lender to be assured of getting paid even if the business closes its doors. A nonrecourse loan does not require you to personally guarantee the loan. In the event of a default, the lender can foreclose on the property but you are not personally responsible for any remaining balance that is due on the loan.

If you have multiple commercial loans with the same lender you will want to verify if there is cross collateralization among the loans. This means that the lender ties the collateral used on any one loan to all of the loans that they hold for you. What this means for you is that if you default on any one loan then the lender can foreclose on any of the collateral on any of the loans. It is to your advantage to seek a lender who does not impose cross collateralization.

Beware of Cross Default Clauses

Another clause that your lender can include if you have multiple loans is called a cross default clause. This ties all of your loans together in the event of a default on any loan. So if you default on a single loan then the lender has the right and ability to increase your fees and rates on any or all loans and they can also demand immediate payment on all of your loans. Again, this is a big disadvantage for the borrower and you should try to avoid commercial loans that include this clause.

Beware of Operational Covenants

Operational covenants are clauses that are included in the loan terms that limit or dictate how you must handle certain situations or how you must run your business pertaining to certain aspects or functions. Some clauses might limit your ability to seek additional loans during the term of the existing loan. Another common type of clause eliminates your ability to enter into new business agreements or leases without the approval of the lender. These covenants can be negotiated before you sign the loan documents but if you are unaware of a covenant and fail to abide by it then you have defaulted on the terms of the loan and are in default. Be certain to understand all aspects of a loan document prior to signing it.