For borrowers with subsidiaries, intercompany debt – This allows the borrower to use intercompany loans for internal cash management purposes.Trade payables in the ordinary course of business and certain other ordinary course obligations (such as obligations under surety bonds and performance guarantees).The broad prohibition in the debt covenant is typically subject to a number of exceptions including, but not limited to: is subject to mandatory redemption) during the term of the loan. In addition, debt covenants often prohibit the issuance of equity securities that look and act like debt – such as any preferred stock that pays dividends and “matures” (i.e. Indebtedness is typically defined broadly and includes, among other things, any indebtedness for borrowed money as well as any guarantees, capital lease obligations, and obligations with respect to deferred purchase price (including accounts payable and earnouts). In order to address these impacts, the debt covenant prohibits the borrower from incurring additional indebtedness during the term of the loan. Debt Covenantįor lenders, additional debt means, among other things, (1) additional payments of principal and interest that reduce the amount of cash flow available to service the lender’s loan and (2) additional leverage, which potentially dilutes the lender (particularly to the extent it is unsecured or under-secured) in relation to the assets underlying the credit. With respect to bilateral loans to small-cap borrowers, however, lenders often prefer to include only limited exceptions to the negative covenants, opting instead to require the borrower to request a consent or amendment each time they wish to engage in a prohibited activity.īelow is an overview of certain negative covenants commonly found in loan agreements. When these contingencies are built into the loan agreement, they are typically narrowly tailored or otherwise limited (either by dollar amount or by reference to a financial ratio). Other exceptions recognize that, over the course of the term of the loan, the borrower may need to take certain otherwise prohibited actions, such as incurring additional debt or selling assets, in reaction to changing market realities. The majority of the exceptions to negative covenants are designed, in light of the broad nature of the prohibitive provisions, to permit the borrower to continue operating in the ordinary course of business. The scope of these prohibitions and exceptions will depend on the size and type of the relevant loan, the borrower’s creditworthiness and relative negotiating power, whether the loan will be syndicated, and the lender’s risk appetite. Negative covenants, which typically apply to the borrower and each of its consolidated subsidiaries, generally begin with a broad prohibition before enumerating specific exceptions.
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