Covenants of the company: Overview, definition and example
What are covenants of the company?
Covenants of the company refer to the specific promises or obligations that a company agrees to fulfill as part of a contract. These covenants may be positive (requiring the company to take specific actions) or negative (prohibiting the company from taking certain actions) and are designed to ensure that the company meets certain operational, financial, or legal standards. Covenants can relate to various areas, such as maintaining insurance, complying with laws, or not incurring additional debt without approval.
For example, a company may covenant to maintain a certain level of financial liquidity or refrain from taking on excessive debt.
Why are covenants of the company important?
Covenants of the company are important because they establish the company’s responsibilities and help ensure that it operates in a manner consistent with the expectations of the other parties involved in the agreement. These provisions protect the interests of creditors, investors, or other stakeholders by holding the company accountable for meeting its obligations.
Covenants help mitigate risks, maintain stability, and ensure that the company behaves in a way that supports the long-term goals of the agreement.
Understanding covenants of the company through an example
A loan agreement requires a company to maintain a minimum level of net worth throughout the term of the loan. If the company's net worth drops below this threshold, the loan may be called or the terms renegotiated. This covenant ensures that the company maintains financial health and reduces the risk to the lender.
An example of a covenants of the company clause
Here’s how a covenants of the company clause might appear in a contract:
“The Company covenants and agrees that, during the term of this Agreement, it shall: (1) Maintain at all times a minimum net worth of $5,000,000; (2) Provide the Lender with quarterly financial statements within 30 days of each quarter-end; and (3) Not incur additional indebtedness exceeding $2,000,000 without prior written consent from the Lender.”
Conclusion
Covenants of the company are essential for ensuring that the company upholds specific obligations and operates within agreed-upon parameters. By clearly outlining these covenants, contracts protect the interests of the other parties and help maintain the financial and operational integrity of the company. A well-drafted covenant clause provides accountability and reduces risks for all involved parties.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.