Default interest provisions are often included in subscription credit facilities, and there are various ways parties can handle default interest in the loan documentation. In this Legal Update, we share the different types of default interest provisions and walk through practical considerations and best practices regarding default interest.

What Is “Default Interest”?

Default interest refers to any increase in interest payable by the borrower due to a breach under loan documentation. Default interest provisions can vary significantly depending on the relationship between the lender and borrower, the number of lenders, and the jurisdiction of the parties.

The applications of default interest vary with the level of risk a borrower presents and the lender’s motivation. On the one end of the spectrum, default interest is a transactional remedy used as an incentive for the lender to make a loan; on the other end, when the parties have a long-standing relationship, default interest is about relationship management.

Default interest can be used as a reward or punishment depending on the relationship between the parties. “Default interest” may be used for various purposes, such as:

• Deterring late payments
• Promoting compliance with loan documentation
• Compensating a lender or lenders for the increased risks associated with lending to a borrower that has defaulted on its obligations
• Accounting for the opportunity cost to a lender for loaning money to a defaulting borrower

When default interest is used as a “reward,” it often won’t be applied automatically in the event of a default; instead, the application of default interest will require an affirmative action by the lender or group of lenders. As a punishment, however, default interest will be incurred automatically in the event of a borrower’s default without action by the lender or lenders.

Types of Default Interest Provisions

The most significant distinction is whether the...