Debt Covenant

A debt covenant is a condition or restriction placed by a lender on a borrower as part of a loan agreement. These covenants are designed to protect the lender’s interests by limiting the borrower’s actions and ensuring financial discipline.

Types:

  • Positive (Affirmative) Covenants: Require the borrower to perform specific actions (e.g., maintain insurance, timely reporting).

  • Negative Covenants: Restrict certain actions (e.g., limits on additional borrowing, asset sales, or dividend payments).

  • Financial Covenants: Set financial performance thresholds (e.g., maintain a minimum Debt Service Coverage Ratio).

Consequences of Breach:

  • Loan recall or accelerated repayment.

  • Higher interest rates.

  • Negotiated waivers or restructuring.

Example:

A Dubai property developer borrowing AED 20M may face a debt covenant requiring them to maintain a debt-to-equity ratio below 2.0 and a minimum cash reserve of AED 2M.