Loan Covenant

A loan covenant is a condition attached to a loan agreement that must be maintained throughout the loan term. Affirmative covenants require specific actions (providing accounts, maintaining insurance, filing statutory documents). Negative covenants restrict actions (taking on additional debt without consent, disposing of key assets, changing the nature of the business).

Financial covenants set numeric thresholds that must be maintained. Common examples include a minimum interest coverage ratio (EBIT/interest must exceed 2.0x), a maximum leverage ratio (net debt/EBITDA must be below 4x), or a minimum tangible net worth. Covenant compliance is typically assessed annually against the year-end accounts or quarterly against management accounts.

Covenant breach does not automatically mean a lender will demand immediate repayment, but it gives them that right. Lenders often prefer to negotiate a waiver or amendment rather than enforce, particularly if the borrower has been transparent. Proactive communication with lenders when a covenant breach is anticipated is strongly advisable.

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