What happens if a short can't be covered?

Buying and shorting on margin requires 50% margin.

If you short 100 shares at $100 the you have:

$10,000 Market Value

$ 5,000 Equity

$15,000 Credit

Margin is Equity/Market Value = 50%

The Minimum Margin Maintenance Requirement for NASDAQ and NYSE stocks is 25% though brokers can require more (leveraged ETFs require more margin). The MMMR is Credit/1.25 = $12,000. At $120 per share, you'll have 25% margin ($3,000/$12,000):

$12,000 Market Value

$ 3,000 Equity

$15,000 Credit

In the old days, if you modestly breached the MMMR, brokers would give you a warning and up to 3 days to meet the margin call. These days, the computers at online brokers monitor the margin level closely and they tend to close violations out, often with poor fills. Some might give you the opportunity to transfer other in house assets into your margin account to meet the margin call.

If your position sky rockets and blows through the remaining 25% of margin with no opportunity to close (for example, a buy out offer), your position will be closed ASAP by the broker. The lender of the shares does not take the hit. The broker does and will chase you legally.

Normally you handle that with a "stop-loss" order that buys the stock (closes out your short) if it rises to a certain price. You're asking what happens if you don't, or can't, and it rises quickly.

They will automatically force you to buy to cover it. If that disadvantages you, they really don't care.

They will use your brokerage account's assets. Starting with cash positions obviously, but they will cheerfully sell any asset without considering the tax impact. Stocks held long obviously, shorts that are in the money, anything positive.

As for negative assets (like other shorts), as they strip assets, you have less assets to cover the broker's risk on those... so they may force their sale also. This can become a cascade.

If cashing you out isn't enough, they'll loan you the money, and you must pay it. But this means the broker really screwed up, got fantastically unlucky, or is very, very confident you have outside assets to cover it.

Then you pay, or a) you won't be doing any trading there, and b) after the mark hits your credit report, you won't be doing any trading anywhere else, either.

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What if it's rising slowly? Then the broker may contact you to ask you to put more assets in the account (or voluntarily close out the short). This is called a "margin call".

You agree to certain terms when you initiate a short position. If, by some sort of magic, the transaction goes off the rails beyond the safeguards imposed by your broker you would simply be in breach of contract and get sued.

Courts exist to sort these situations out.

These fantastical situations where no shares exist to cover or whatever might seem like interesting thought expirments but ultimately if you agree to something, then can't make good on your end of the agreement, you get sued and the courts work it out.