Suspension of covenants: Overview, definition, and example
What is suspension of covenants?
Suspension of covenants refers to the temporary suspension or postponement of specific terms or obligations (called covenants) in a contract or agreement. Covenants are promises or commitments made by a party in a contract, often related to actions the party must take or avoid. In some cases, circumstances may arise that prevent a party from meeting these obligations, and the suspension of covenants allows the party some relief by temporarily halting or modifying the covenant requirements. This suspension is typically agreed upon by all parties involved and is often used in situations like financial hardship, force majeure events, or other unforeseen circumstances.
In simpler terms, suspension of covenants means that certain rules or obligations in a contract are temporarily paused or put on hold.
Why is suspension of covenants important?
Suspension of covenants is important because it provides flexibility in contracts and allows businesses to manage unforeseen difficulties without immediately triggering penalties or breaches of the agreement. It can be especially helpful when events or circumstances outside of the party’s control (such as economic downturns or natural disasters) make it temporarily impossible to meet contractual obligations. This provision helps maintain business relationships and prevents the need for drastic measures, such as litigation or termination of the contract, during difficult times.
For SMB owners, understanding the suspension of covenants can be crucial when entering into long-term agreements, as it offers a mechanism to deal with temporary disruptions or challenges.
Understanding suspension of covenants through an example
Imagine your company has a loan agreement with a bank, which includes a covenant requiring you to maintain a minimum level of cash flow each month. Due to an unexpected decline in sales, your business is unable to meet the cash flow requirement for a few months. Instead of immediately triggering a default under the loan, the bank agrees to temporarily suspend the cash flow covenant, giving you additional time to recover. The suspension is agreed to for six months, during which you won’t be penalized for not meeting the requirement.
In this example, the suspension of covenants helps avoid immediate financial penalties and gives your business some breathing room to address the issue.
Example of a suspension of covenants clause
Here’s an example of what a suspension of covenants clause might look like in a contract:
“In the event of unforeseen circumstances, including but not limited to natural disasters or economic downturns, the Borrower may request a temporary suspension of the financial covenants outlined in Section 4.1. Such suspension shall be granted at the Lender’s discretion, for a period not to exceed [X] months, provided that the Borrower can demonstrate good faith efforts to comply with the terms of the Agreement.”
Conclusion
Suspension of covenants is a useful provision that provides flexibility in contracts, allowing parties to temporarily pause or modify their obligations during challenging or unforeseen circumstances. For SMB owners, understanding how suspension of covenants works can help manage risks and maintain business relationships when facing temporary setbacks. By including clear terms for suspension in agreements, businesses can safeguard against potential defaults and maintain smoother operations during difficult times.
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.