Covenant

A covenant is a promise in a loan agreement. Financial covenants are ratios the borrower must maintain, such as a minimum debt service coverage ratio, a maximum debt-to-EBITDA ratio or a minimum working capital or current ratio. Reporting covenants require statements and certificates by set dates. Negative covenants restrict actions such as taking on more debt, paying dividends or selling assets without consent.

Covenants matter because a breach gives the lender rights it did not have the day before, including the right to demand repayment, raise the rate or impose new conditions. Most breaches in BC companies are discovered at the test date, which is too late to do anything about them. The definitions also matter: the EBITDA or the debt in a covenant is calculated the way the agreement says, which is not always the way the management reports show it.

In practice, we read every loan agreement at the start of an engagement, list each covenant with its definition and its test date, calculate the ratios monthly rather than at the test date and show the headroom as a trend in the monthly pack. When the trend turns, the conversation with the lender happens early, with numbers and a plan, which is when lenders are most willing to waive or amend. Your lawyer handles the agreement itself.