Special covenants: Overview, definition, and example
What are special covenants?
Special covenants are specific promises or obligations included in a contract that require one or both parties to take (or avoid) certain actions. These covenants help ensure that agreements are upheld and protect the interests of both parties.
For example, a loan agreement might include a special covenant requiring a business to maintain a certain level of cash flow to avoid defaulting on the loan.
Why are special covenants important?
Special covenants provide clarity and legal protection by setting specific conditions that parties must follow. They help reduce risk, prevent disputes, and ensure both sides fulfill their obligations.
For SMBs, special covenants are often used in financing agreements, partnership contracts, and supplier agreements to safeguard business interests. A well-drafted covenant can prevent misunderstandings and provide legal remedies if one party fails to comply.
Understanding special covenants through an example
A small business secures a bank loan to expand operations. The loan agreement includes a special covenant stating that the business must not take on additional debt beyond a certain limit. This ensures the company remains financially stable and reduces the lender’s risk.
In another example, a franchise agreement includes a special covenant requiring the franchisee to follow specific brand guidelines, including signage, uniforms, and marketing materials. If the franchisee fails to comply, the franchisor has the right to terminate the agreement.
An example of a special covenant clause
Here’s how a special covenant clause might appear in a contract:
“The Borrower agrees to maintain a minimum cash balance of [$X] at all times and shall not incur additional debt exceeding [$Y] without prior written consent from the Lender.”
Conclusion
Special covenants are crucial contract provisions that ensure compliance and protect business interests. They help prevent financial and operational risks by setting clear conditions that parties must meet.
For SMBs, including well-defined special covenants in contracts can provide security, reduce uncertainty, and help maintain strong business relationships.
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.