Covenant

A covenant is a binding condition included in a loan agreement. Financial covenants require the borrower to maintain certain financial metrics (e.g. minimum EBITDA, maximum debt-to-equity ratio, minimum interest cover) throughout the loan term. Operational covenants may restrict the borrower from taking certain actions (e.g. paying dividends above a certain level, making large acquisitions, or changing the business's main activity) without the lender's consent.

If a borrower breaches a covenant, it typically triggers an event of default under the loan agreement, giving the lender the right to demand immediate repayment. Well-advised borrowers negotiate covenant headroom - ensuring the covenant levels are set comfortably below normal operating levels to avoid accidental breach.

Covenants are most common in large structured facilities (£1m+) and commercial property loans. Smaller unsecured business loans typically have fewer or no financial covenants, though they may include negative pledges (prohibiting the borrower from granting other security over their assets).

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