Debt Covenant Definition
Debt covenants are lending agreements that include restrictions on actions by the borrower or require permission of the lender to act. Debt covenants can be used for both public and private debt agreements.
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Common Debt Covenant Terms
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Both private and public debt covenants require annual or quarterly financial audits. For large loans or loans made to those with high debt loads, a debt covenant can prohibit the borrower from taking on any new debt while the current debt covenant is in effect.
Private Debt Covenants
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Private debt covenants are agreements between private individuals. Debt covenants can prevent borrowers from selling specific assets. For example, a debt covenant can prevent someone from selling a farm until the mortgage on it is paid off.
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Public Debt Covenants
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Public debt covenants place restrictions on public companies borrowing money. They can limit managers' pay. Public debt covenants can specify the type of accounting methods or auditors to be used by the borrower.
Penalties for Breaking Debt Covenants
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Debt covenants can include interest rate increases or loss of collateral if payments are not made in time or in full. Debt covenants can include a call feature. If the borrower violates the terms of the debt covenant, the lender can demand payment in full.
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References
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