Cross-Default & Cross Collateralization. What’s the Difference?
It is fairly common for a commercial real estate owner to have several properties mortgaged to a particular lender. They’ve identified a lender who is responsive to their needs. They have developed a good working relationship, and the lender has been a consistent and predictable source of financing.
This type of arrangement benefits the borrower of course, but also has benefits for the lender. They have an experienced borrower who is likely to continue to provide lending opportunities. However, should there be an issue with repayment on one particular loan, the lender may well be concerned with the remaining loans provided that borrower.
What’s the Difference?
In such a circumstance lenders often employ cross-default and cross-collateralization language in their loan documentation. But what is the difference?
Lenders regularly grant two or more loans to a borrower. A cross-default clause allows a lender to treat default under one loan, as default under the other. Consequently they can take enforcement action under either or both loans.
Cross-collateralization on the other hand, is language that speaks to the security offered for the loan. If there is cross-collateralization in place, a lender could look to the other mortgaged property to secure the indebtedness on the initial property. To properly secure themselves, the lender would look to have the loan documentation for each property reference that the property is security for both loans. Consequently each loan document would reference the total amount of indebtedness.
Your Lender wears a belt and suspenders!
As a borrower, you may want your lender to treat each loan as a stand alone obligation. Your lender, on the other hand, will always be looking to reduce risk wherever possible. Cross-collateralization provides them with both a belt, and suspenders! Understand that your lender may be able to utilize the proceeds of the sale of one property to reduce your indebtedness on another property.
A good review of the this topic is found in a recent article by Kym Stasiuk of Blaney McMurtry LLP, entitled Secured Real Estate Financing: just Because Your Are Cross-Defaulted, Does Not Mean You Are Cross-Collateralized.