Creditor default

What it means

Creditor default occurs when the creditor fails to accept properly tendered performance or to provide the cooperation needed to fulfil the obligation. Typical examples are a customer who does not collect ordered goods or a client who does not supply an accounting firm with the documents it needs.

While the creditor is in default, the debtor is not in default of performance. The debtor therefore does not have to pay late payment interest or contractual penalties for a delay caused by the creditor. It is the opposite of debtor default, which is far more common in practice.

Creditor default has further consequences. The debtor may claim costs it has incurred, such as storage of goods not collected, and the risk of damage to the goods passes to the creditor. Under certain conditions the debtor may also deposit the subject of performance with a third party.

How it works in practice

To prove creditor default, the debtor should have evidence that performance was properly tendered, such as a written request to collect goods by a set date, or records showing that the client failed to provide documents despite requests. Without such evidence, defending a claim is difficult.

For monetary obligations, where the creditor refuses payment or does not provide an account number, the debtor can deposit the money, for example in notarial escrow or with the court. This discharges the obligation and the debtor avoids late payment interest.

In service contracts it is wise to set out the client's duties of cooperation and the consequences of failing to meet them. An accounting firm can specify deadlines for delivering documents and state that it is not liable for, and will not pay penalties arising from, late filing caused by the client.

What to watch out for

Creditor default does not release the debtor from the duty to perform; it only postpones the consequences of delay. The debtor must remain ready to perform and take reasonable care of the goods, even though the risk of accidental damage no longer lies with it.

For tax and statutory deadlines, such as filing a tax return, a client's delay does not release the person obliged to file from liability to the state. Penalties from the tax authority are paid by the taxpayer; creditor default concerns only the relationship between the contracting parties.