In finance, a default occurs when a debtor has
not met its legal obligations according to the debt contract, in the
sense that it has not made a scheduled payment, or violated a
covenant or conditions of the debt contract. A default tends to
occur if the debtor is either unwilling or unable to repay
their debt. This can occur with all debt obligations including
bonds, mortgages, loans as well as promissory notes.
The term default should however be distinguished
from the terms insolvency and bankruptcy. 'Default' essentially
means that a debtor has not paid a debt. On the other hand,
'Insolvency' is a legal term meaning that a debtor is unable to pay
his debts while 'Bankruptcy' is a legal finding that imposes the
court's supervision over the financial affairs of those who are
insolvent or are in default.
In corporate finance, the holders of the debt
will normally seize the collateral securing the debt, or file in
court to force bankruptcy immediately after a default occurs, or
both. A technical default is an almost meaningless term, since all
defaults invariably involve a technical breach of the debt contract,
but could also indicate that the debt holders do not consider the
default to be serious or else, that they expect to be able to
collect more by negotiating an informal bankruptcy than by going
through the legal system. In most cases of debt, including corporate
debt, mortgages and bank loans, the total amount owed becomes
immediately payable on the very first instance of a default of
payment. Typically, if the debtor defaults on any debt to any
lender, a covenant in the debt contract states that that particular
debt would also be in default and this is referred to as a cross
default. Sovereign borrowers generally are not subject to bankruptcy
courts in their own jurisdiction, and hence may be able to default
without any legal consequences or implications.
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