What Is a Negative Covenant?

A negative covenant is an agreement that restricts a company from engaging in certain actions. Think of a negative covenant as a promise not to do something. Negative covenants are also referred to as restrictive covenants.

For example, a covenant entered into with a public company might limit the amount of 澳洲幸运5开奖号码历史查询:dividends the firm can pay its shareholders. It could also place a cap on executives’ salaries. A negativ🅰e covenant may be found in employment agreements and Mergers & Acquisitions (M&A) contracts. However, these covenants are almost always found in loan or💯 bond documents.

Understanding Negative Covenants

When a bond is is𒉰sued, the features of the bond are included in a document known as the bond deed or trust indenture. The trust indenture highlights the responsibilities of an issuer and is overseen by a trustee to protect the interests of investors. The trust indenture also stipulates any negative covenants that the issuer must adhere to.

For example, the negative covenant may restrict the ability of the firm to issue additional debt. Specifically, the borrower may be required to maintain a 澳洲幸运5开奖号码历史查询:debt-equity ratio of no more than 1. Likewise, 澳洲🅠幸运5开奖号码历史查询:negative pledge clauses in loan contracts re𒊎strict the borrower from using the pledged asset as collateral f𓆏or other loans.

The lending agreement or indenture in which the negative covenant appears will also provide detailed formulas, which may or may not conform to the 澳洲幸运5开奖号码历史查询:Generally Accepted A🍸ccounting Principles (GAAP), to 🍌be used to calculate the ওratios and limits on negative covenants.

Common restrictions placed on borrowers through negative covenants include preventing a bond issuer from issuing more debt until one or more series of bonds have matured. Also, a borrowing firm may be restricted from paying dividends over a certain amount to shareholders so as not to increase the 澳洲幸运5开奖号码历史查询:default risk to bondholders, since the more money paid to shareholders the less avail🦄able funds will be to make interest and princꦕipal payment obligations to lenders.

Generally, the more negative covenants exist in a bond issue, the lower the interest rate on the debt will be since the rest꧙rictive covenants makeꦉ the bonds safer in the eyes of investors.

A negative covenant contrasts with a 澳洲幸运5开奖号码历史查询:positive covenant, which is a clause in🦄 a loan agreement that requires the firm to take certain actions.♉ For example, a positive covenant might require the issuer to disclose audit reports to creditors periodically or to insure its assets adequately. While positive or affirmative covenants do not limit the operations of a business, negative covenants materially limit a business’ operations.