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Concept
Default (finance)
Summary
In finance, default is failure to meet the legal obligations (or conditions) of a loan, for example when a home buyer fails to make a mortgage payment, or when a corporation or government fails to pay a bond which has reached maturity. A national or sovereign default is the failure or refusal of a government to repay its national debt.
The biggest private default in history is Lehman Brothers, with over billion in ). The biggest sovereign default is Greece, with billion in ).
The term "default" should be distinguished from the terms "insolvency", illiquidity and "bankruptcy":
Default: Debtors have been passed behind the payment deadline on a debt whose payment was due.
Illiquidity: Debtors have insufficient cash (or other "liquefiable" assets) to pay debts.
Insolvency: A legal term meaning debtors are unable to pay their debts.
Bankruptcy: A legal finding that imposes court supervision over the financial affairs of those who are insolvent or in default.
Default can be of two types: debt services default and technical default. Debt service default occurs when the borrower has not made a scheduled payment of interest or principal. Technical default occurs when an affirmative or a negative covenant is violated.
Affirmative covenants are clauses in debt contracts that require firms to maintain certain levels of capital or financial ratios. The most commonly violated restrictions in affirmative covenants are tangible net worth, working capital/short term liquidity, and debt service coverage.
Negative covenants are clauses in debt contracts that limit or prohibit corporate actions (e.g. sale of assets, payment of dividends) that could impair the position of creditors. Negative covenants may be continuous or incurrence-based. Violations of negative covenants are rare compared to violations of affirmative covenants.
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