Covenants are the promises a borrower makes for the life of a loan. They tell the lender what the borrower will do, what it will not do without consent, and what financial condition it will maintain. Done well, they are not traps. They are an early-warning system that brings both sides to the table while there is still time and value to work with.
Our strategy page describes “conservative advance rates and rigorous covenant packages” as part of how we protect principal. This entry explains how covenant packages are built in the market generally; the specific covenants in any Caldrion loan are set loan by loan.
Three kinds of covenant
| Type | What it does | Examples |
|---|---|---|
| Affirmative | Requires the borrower to do things | Deliver financial statements and compliance certificates; maintain insurance; pay taxes; keep the collateral in good repair; allow inspections |
| Negative | Prohibits things without lender consent | Additional debt; additional liens; asset sales; dividends and distributions; mergers; changes of control; affiliate transactions |
| Financial | Requires measurable financial tests to be met | Maximum leverage; minimum interest or debt service coverage; minimum liquidity; minimum net worth; maximum loan-to-value |
Affirmative covenants
Reporting covenants are the most important affirmative covenants because everything else depends on them. A lender cannot test a ratio it cannot see. Typical reporting includes monthly or quarterly financial statements, annual audited or reviewed statements, compliance certificates showing covenant calculations, and collateral-specific reports such as rent rolls, borrowing base certificates or portfolio valuations.
Negative covenants
Negative covenants protect the lender’s position in the capital structure and the collateral pool. A debt basket allows a set amount of other borrowing; a lien basket allows certain other liens; a restricted payments covenant limits how much cash can leave the borrower to its owners. The size of each basket is where much of the negotiation happens.
Financial covenants
Financial covenants turn the underwriting case into a contract. If the loan was sized on the assumption that the business would cover interest comfortably, an interest coverage covenant tests that it still does. The entry Coverage and liquidity tests explains the ratios themselves.
Maintenance versus incurrence
A maintenance covenant is tested regularly, usually quarterly, whether or not the borrower does anything. If leverage rises above the limit because earnings fall, the covenant is breached.
An incurrence covenant is tested only when the borrower takes a specified action, such as borrowing more or paying a dividend. If earnings fall but the borrower takes no such action, there is no breach.
The broadly distributed loan market moved heavily toward “covenant-lite” loans with incurrence tests only. Direct loans, especially to smaller companies and against specific collateral, much more often keep maintenance covenants, because a direct lender that holds the loan needs to know early when something changes.
Setting covenant levels: headroom
A covenant is usually set with headroom, often called cushion, against the borrower’s projections, so that ordinary variance does not trip it. The following is illustrative arithmetic only.
| Quarter | Projected EBITDA (LTM) | Debt | Projected leverage | Covenant (illustrative) | Headroom |
|---|---|---|---|---|---|
| Q1 | $10.0M | $35.0M | 3.50x | 4.50x | EBITDA can fall about 22% before breach |
| Q4 | $11.0M | $33.0M | 3.00x | 4.25x | EBITDA can fall about 29% before breach |
In Q1, the covenant is breached if debt ÷ EBITDA exceeds 4.50x, which with $35.0M of debt happens if EBITDA falls below about $7.8M, roughly 22% below plan. Too little headroom produces technical defaults that waste everyone’s time; too much means the covenant only triggers after the damage is done.
Definitions are the real covenant
A leverage covenant at 4.50x means nothing until EBITDA is defined. Common points of negotiation:
- Add-backs. Which one-time costs, synergies or projected savings may be added back, and whether they are capped.
- Pro forma adjustments. Whether acquired businesses count for a full year.
- Net or gross debt. Whether cash may be netted against debt, and how much.
- Net operating income. For real estate, whether income is measured on actual collections, in-place leases or a forward-looking basis, and which reserves are deducted.
Read the definitions first. A borrower can win the covenant level and lose the covenant through the definition.
Cures, waivers and amendments
- Cure periods. Many defaults, other than non-payment, give the borrower a period, often 10–30 days, to fix the problem after notice.
- Equity cures. Some agreements let the sponsor inject equity that is counted as EBITDA, or used to repay debt, to cure a financial covenant breach. These are usually limited in number and frequency.
- Waivers. The lender agrees not to treat a specific breach as a default, often for a fee and sometimes with tighter terms.
- Amendments. The covenant itself is reset, usually because the original plan has changed in a lasting way.
The entry Defaults, waivers, forbearance and restructuring covers what happens when a breach is not cured.
Covenants by loan type
| Loan type | Common financial and collateral covenants |
|---|---|
| Real estate bridge and construction | Debt service coverage or debt yield tests for extensions; loan-to-value tests; completion and budget covenants; required equity and reserves |
| Asset-based | Borrowing base availability; minimum excess availability; springing fixed charge coverage |
| Corporate term loan | Maximum leverage; minimum interest or fixed charge coverage; capital expenditure limits |
| NAV loan | Maximum loan-to-value against portfolio value; concentration limits; minimum number of assets |
| Lender finance | Pool performance triggers on delinquencies and defaults; eligibility criteria; concentration limits |
| Royalty and contract monetization | Collections versus underwriting case; cash sweep triggers |
A springing covenant applies only when a condition is met, for example a fixed charge coverage test that applies only when availability under a revolver falls below a threshold. Springing covenants are common in asset-based lending because the borrowing base already provides a daily discipline; see The borrowing base explained.
What borrowers should watch
- Model every covenant against a downside case, not only the base case.
- Check the testing dates against seasonality.
- Understand which defaults are cross-defaults to other debt.
- Make sure reporting deadlines are achievable with current systems.
- Raise concerns before signing: a covenant that cannot realistically be met helps no one.
Case studies with covenant detail include Project Anvil and Project Keystone. For the rest of the chapter, see the overview of loan terms and documentation.
This entry is general information as of November 2026, not investment, legal or tax advice, and not an offer of securities.