Covenants are promises that borrowers make to lenders as part of their loan agreements.
Two common covenants are “keep-well clauses” and “hard financial measures.”
- A keep-well clause describes what a company will or will not do while the loan is still outstanding (for example, agree not to sell any part of the company, not to incur additional debt, or to keep the same management team in place for the duration of the loan).
- Hard financial measures are measures the borrower is expected to meet (for example, to maintain a debt-to-equity ratio of 1:1 or less, or a current ratio of 2:1 or better).
Covenants typically include a timeline and a list of supporting documents required to show the borrower has met the conditions of the loan.
More about covenants
Covenants are reviewed at least once a year and may be adjusted should conditions change. When a borrower breaks a covenant, the loan may technically be in default because its terms are not being met.