Definition
A covenant is a promise a borrower makes in a loan contract that must be kept for the life of the loan. Common covenants include providing annual financial statements, maintaining insurance, keeping certain financial ratios, not granting other security without consent and notifying the lender of major changes. Breaching a covenant can be an event of default even if every repayment is made.
Covenants are the ongoing rules of a loan. Repayments are only part of the deal.
Common examples
- Providing financial statements or tax returns within a set time after year end.
- Keeping assets insured with the lender’s interest noted.
- Maintaining minimum financial ratios.
- Not taking on other debt or security without consent.
- Notifying the lender of changes in directors or ownership.
Why they matter
A covenant breach can be an event of default. That can trigger default interest or give the lender rights to review or demand repayment.
Managing them
List every covenant when you sign, diarise reporting dates and check financial covenants before year-end results are final. If a breach is likely, talk to the lender early. Our guide to reading a loan contract explains more. For finance with terms that suit your business, make one enquiry.
Common questions
What is a financial covenant?
A covenant requiring the business to meet a financial measure, such as a minimum interest cover or maximum loan-to-value ratio, usually tested at set times.
What happens if I breach a covenant?
The lender may treat it as a default, but many will discuss a waiver or adjustment if contacted early with an explanation.
Sources and further reading