Loan covenants are restrictions that lenders (creditors, debt holders, investors) put on lending agreements to limit the actions of the borrower (debtor). In other words, loan covenants are agreements between a company and its lenders that the company will operate within certain rules set by the lenders. They are also called banking covenants or financial covenants. In this article, breach of loan covenant, we take a look at what happens if the loan covenant is violated.
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For a free initial discussion on how we can help you deal with the legal implications of breaching a loan covenant, get in touch with us today. We will review your situation and discuss the process involved in a clear and approachable manner. Early expert legal assistance can help you avoid making mistakes, saving you money and also avoiding the stress of dealing with these issues on your own. Simply call us on 0345 901 0445 or complete our online enquiry form and a member of the team will get back to you.
What is the purpose of a loan covenant?
Loan covenants are not used to place additional burdens on the borrower. Instead, they are used to align the interests of the principal and agent, as well as address problems between the management (borrower) and debt holders (lenders).
There are implications for both parties. A loan covenant will likely reduce the cost of borrowing which will be of benefit to the borrower. Debt restrictions protect the lender by prohibiting certain actions by the borrowers. Loan covenants restrict borrowers from taking actions that can result in a significant adverse impact or increased risk for the lender.
The different types of covenants.
Covenants can be classified into two types. Positive ones describe what a business must do, such as reach agreed financial thresholds and provide financial statements. Negative ones state what a borrower cannot do, such as sell certain assets or borrow more money. Without such agreements, lenders would feel less secure and consequently insist upon a higher return on their investment.
What are the consequences of breaching a loan covenant?
The breach of a covenant can have an impact on a debtor’s liquidity and solvency. If the covenant gives the lender the right to request the immediate payment of the loan, the debt involved becomes a current liability for the debtor, potentially altering their financial health.
When a loan covenant is breached, depending on the severity, the lender can do several things:
- Demand penalty payment
- Increase the predetermined interest rate
- Increase the amount of collateral
- Demand full immediate repayment of the loan
- Terminate the debt agreement
- Repossession of an asset
If you find yourself in the position whereby you might breach your loan covenant, you should consider contacting your lender early and cooperate. Prepare a detailed and realistic plan, supported by numbers, showing how you will get back to compliance. Although it could be considered that informing your lender immediately and having a detailed plan ready in advance are slightly contradictory, this is largely a good place to start. In many cases, it may lead to a positive outcome such as having the loan term extended, getting a payment holiday or recognising the breach as technical
The problem is that the lender is under no obligation to adopt such a helpful approach. It is a possibility that the bank will seize assets or charge financial penalties.
Your lender can choose from a number of different approaches and you won’t really know what to expect until you have discussed the situation with them. Consequently, having expert legal advice is crucial. We can help you deal with the breach and accompany you to lender meetings. We can advise upon the preparation of information and present it to the lender in the most convincing or least concerning light. We can also advise upon the options and incentives a lender might have at each point in the process.
How we can help
We have a proven track-record of advising upon breaches of loan covenants. We will guide you through the process and ensure all checks are carried out swiftly and efficiently and we firmly believe that with the right solicitors by your side, the entire process will seem more manageable and far less daunting.
How to Contact our Corporate Solicitors
It is important for you to be well informed about the issues and obstacles you are facing. However, expert legal support is crucial in terms of reducing risk, saving you money and ensuring you achieve a positive outcome.
To speak to our Corporate solicitors today, simply call us on 0345 901 0445, or allow a member of the team to get back to you by filling in our online enquiry form. We are well known across the country and can assist wherever you are based. We also have offices based in Cheshire and London.
Disclaimer: This article provides general information only and does not constitute legal advice on any individual circumstances.
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