What Is an Affirmative Covenant?

An affirmative covenant is a type of promise or contract that requires a party to adhere to certain terms. For example, an affirmative bond covenant could provide that an issuer maintain adequate levels of insurance or deliver a💦udited financial statements.

Affirmative covenants, which require an issuer to perform certain actions or meet specific benchmarks, may be contrasted with restrictive or 澳洲幸运5官方开奖结果体彩网:negative covenants, which instead disallow the issuer from engaging in 🐓certain actions.

Understanding Affirmative Covenants

A covenant attached to a financial instrument is a promise or 澳洲幸运5官方开奖结果体彩网:indenture imposed on the issuer mandating that certain activities, thresholds, or milestones will or will not be carried out or met. Covenants in finance most often relate to terms in a debt contract, such as a loan document or bond issue stating the limits at which the borrower can further lend. If a covenant is broken, the lender typically has the right to call back the obligation from the borrower and/or face other predefined penalties. In bond agreements, both affirmative and 澳洲幸运5官方开奖结果体彩网:restrictive covenants are used to protect the interests of both issuer and 澳洲幸运5官方开奖结果体彩网:bondholder.

An affirmative or positive covenant is a cla💞use that req🃏uires a borrower to perform specific actions. Examples of affirmative covenants include requirements to maintain adequate levels of insurance, requirements to furnish audited financial statements to the lender, compliance with applicable laws, and maintenance of proper accounting books and credit rating, if applicable. Additional examples of affirmative covenants include obligating the issuer to return the principal of a loan at maturity or maintain its underlying assets or specific collateral, such as real estate or equipment

A violation of an affirmative covenant ordinarily results in outright default. Certain loan contr𒆙acts may contain clauses that provide a borrower with a grace period to remedy the violation. If not corrected, creditors are entitled to announce default and demand immediate repayment of principal and any accrued interest.

Affirmative Covenants and Leveraged Loans

In September 2017, Bloomberg ran an article about the lack of affirmative (or restrictive) covenants in many new offerings. The term “covenant-lite” has been used to describe several new leveraged loans. Without such protections, a firm could potentially rack up a significant amount of debt without regard for performance. The relaxed atmosphere for such terms has created the perception that a loan must be of poor quality if a borrower has to resort to 澳洲幸运5官方开奖结果体彩网:covenants at all. Currently, several lenders do not even require that the issuer meet periodic performaꦛnce goals (also known as maintenance covenants).

While bets of this nature are safer for larger and more established companies with regular cash flows (like 澳洲幸运5官方开奖结果体彩网:blue-chip companies), some investors, for instance, are concerned about loans to 澳洲幸运5官方开奖结果体彩网:middle-market borrowers. These companies have earnings under $50 million, giving them less wiggle room to recover from a costly error and increase their risk of default.

Examples of Affirmative Covenants

In a March 2018 report by Mayer Brown LLP on 澳洲幸运5官方开奖结果体彩网:high yield bonds by German real estate companies, the firm noted that another player, the Luxembourg-based Corestate Capital Holding S.A. (S&P: BB+) joined the group of real estate companies issuing debt. These notes represent a junior portion of a firm’s overall 澳洲幸运5官方开奖结果体彩网:capital structure. Unlike traditional 澳洲幸运5官方开奖结果体彩网:high yield bonds, the notes issued by Corestate Capital would not be callable prior to maturity. At the same time, German law stated that they could not contain a full, traditional high yield covenant package. No limitations💜 were to be placed on Corestate to restrict distributions from its subsidiaries. In addition, there is no affiliate transactions covenant.

Another example involves the case of apparel retailer J.Crew Group, Inc. Faced with declining sales and impatient lenders in 2017, the clothing retailer created an unregistered subsidiary to hold its intellectual property. The new subsidiary was then used as collateral to secure another loan for the company. As a result of J Crew's move, investors in companies began including a covenant known as the J.Crew blocker, which prevented companies from carrying out such moves in the future.