UK Accounting Glossary
Default in economics can be referred to as a condition that arises when any debtor is unable to pay back the debt in accordance with the legal obligations of the debt contract. Any organization or individual can be termed as a defaulter if it is unable to pay a scheduled sum of money or desecrated a credit agreement. Condition of default can arise in any kind of debt contract like bonds, loans, mortgages and promissory notes.
Failure to meet obligations as they fall due for payment.
A default can be generally defined as a failure of a debtor to make timely payments of principal and interest.
Thus, when one is in default, a person or a company is said to default on a loan or other official financial obligation. Default also occurs when a debtor fails to sufficiently meet any timely provisions of a bond, mortgage, lease, or futures contract. Before extending credit, banks, lenders, as well as debt and equity issuing entities take into consideration default risk, i.e. a possibility that a company or an individual will not honour a debt commitment. Some borrowers with higher-than-average default risk must pay a compensatory default premium. Default premium would constitute a higher bond yield offered by a company with scanty financial tenets. Default premium is also frequently paid by individuals with poor credit, typically in a form of above-market interest rates.
One of the major reasons for the occurrence of default as discussed earlier is the failure of the borrower to pay back the money. It can be referred as breach of debt contract, according to which certain amount of money was to be paid after a scheduled period of time. Apart from this, there can be several other reasons also like borrower may fail to sustain insurance, the borrower sells good against which mortgage loan is obtained or can transfer ownership to any other person.
Talking about default we can distinguish it into two basic types namely debt services default and technical default. Debt services default is a condition that can occur when a borrower is unable to pay the scheduled sum of money with interest or even principal amount. State of technical default arises due to violation of an affirmative or a negative contract.
An affirmative covenant is known as a clause in any debt contract, according to which any firm borrowing money has to sustain definite levels of capital or fiscal ratios. Most vulnerable restrictions that are violated in any affirmative covenant include restrictions imposed on operational capital, short term liquidity and debt service coverage all of real net value. Clauses in debt contract that imposes a limitation on corporate actions are termed as negative covenants. Negative covenants are enforced on sales of assets and payment of dividends.
This section explains legal proceedings that can be done in order to get rid of any default organization. Actions initiated by the court in case debtor is unable to pay the debt. There are certain clauses that are to be satisfied first before initiation of any kind of legal actions on the defaulter.
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This glossary post was last updated: 23rd December 2018.