DEFINITION of 'Covenant'

A promise in an indenture, or any other formal debt agreement, that certain activities will or will not be carried out. Covenants in finance most often relate to terms in a financial contracting, such as loan documation stating the limits at which the borrower can further lend or other such stipulations. Covenants are put in place by lenders to protect themselves from borrowers defaulting on their obligations due to financial actions detrimental to themselves or the business.


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Covenants are most often represented in terms of financial ratios which must be maintained for businesses which lend, such as a maximum debt-to-asset ratio or other such ratios. Covenants can cover everything from minimum dividend payments to levels that must be maintained in working capital to key employees remaining with the firm. Once a covenant is broken, the lender will typically have the right to call back the obligation from the borrower.

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