Covenant

Covenants are how lenders keep some control over a business they do not own. They fall into two families, and which family a deal carries tells you a great deal about the balance of power when it was negotiated.

A maintenance covenant is tested at regular intervals whether or not the borrower does anything, typically capping net leverage or requiring minimum interest cover. It gives lenders an early trigger to renegotiate when performance deteriorates.

An incurrence covenant is tested only when the borrower takes a specific action, such as raising more debt or paying a dividend. A company that simply performs badly never trips one, which is why covenant lite structures shifted so much control to borrowers and sponsors.

A breach is a default, but rarely the end. Lenders usually price a waiver rather than enforce, because enforcing means owning a business they never wanted in a market where they would be a forced seller.