What Is a Restrictive Covenant?
A restrictive covenant is a condition that restricts, limits, prohibits, or prevents the actions of someone named in an enforceable agreement. In bond obligations, restrictive covenants limit the amount issuers can pay in dividends to investors. Restrictive covenants are common in real estate deeds and leases, where they restrict how owners and tenants can use a property.
It's important to differentiate between the two main types of covenants: negative and positive. Negative covenants are actions you can't take, while positive covenants are actions you must take. For example, a negative covenant in real estate could prevent you from raising chickens on your property. On the other hand, a positive covenant could require you to mow your lawn.
- Restrictive covenants are clauses that prevent, prohibit, restrict, or limit the actions of a person or entity named in a contract.
- Restrictive covenants are common in real estate transactions and apply to everything from the colors you can paint your house to how many tenants can live in a building.
- In bond obligations, restrictive covenants aim to minimize default risk by limiting the amount issuers pay in investor dividends.
- Restrictive covenants are enforceable, meaning they can lead to fines and even legal action if they aren't followed.
- Restrictive covenants were previously used to keep communities racially segregated, a practice that's now illegal.
Understanding Restrictive Covenants
As the name implies, a restrictive covenant is an agreement that restricts one of the parties in a contract from taking specific actions. For example, a restrictive covenant may limit how much public companies pay their shareholders in dividends. It may also place a cap on executive salaries. Failure to abide by restrictive covenants can result in fines and other penalties, including legal action.
Restrictive covenants are commonly used to prevent a bond issuer from issuing more debt until one or more series of bonds mature. The issuer may also be restricted from paying dividends above a certain amount to shareholders to minimize bondholders' default risk. That's because if more money is paid to shareholders, less is available to meet payment obligations to lenders.
The more negative covenants a bond issue has, the lower the interest rate will be on the debt because restrictive covenants make the bonds safer in the eyes of investors.
Restrictive covenants are also found in:
- Employment contracts (e.g., non-compete, non-disclosure, and non-solicitation agreements)
- Mergers and acquisitions (M&A) contracts
- Loan documents
- Real estate agreements
Restrictive Covenants in Real Estate
Restrictive covenants are common in real estate. They mandate owners and tenants to avoid or take specific actions intended to preserve the value and enjoyment of the adjoining land. Restrictive covenants are established in a deed or a separately recorded document called a declaration of restrictive covenants. Homeowner associations (HOAs) stipulate covenants, conditions, and restrictions (CC&Rs) to safeguard property values in the community. Covenants are generally considered valid only if reasonable and of benefit to all the property owners within the community.
A Declaration of Covenants, Conditions, and Restrictions (CC&Rs) is a legal document that outlines the rules for a planned community. If you buy a home in a planned community, you generally must become a member of the homeowner association and follow the CC&Rs.
Restrictive covenants can cover things such as:
- Minimum setback lines
- Minimum home size (square footage)
- Number of bedrooms
- Building height, width, and placement on the property
- Architectural guidelines (e.g., construction materials, styles, and colors)
- Fence height and type
- Property use (e.g., business and rental use)
- Types of animals allowed on the property (e.g., no livestock)
- Flagpole height and flag size
- Signage (e.g., for sale or political signs)
- Maintenance (e.g., lawn mowing, tree trimming)
- Swimming pools
- The number and type of vehicles allowed on the property
- The number of people who can occupy the property
In general, covenants are unenforceable if they violate homeowners' rights, violate federal or state laws, or are applied inconsistently or arbitrarily.
If you're considering entering an agreement that has restrictive covenants, be sure you understand what you're getting into before signing on the dotted line.
History of Restrictive Housing Covenants
Historically, restrictive covenants were used in real estate deals to influence the demographics of many communities in the U.S. The restrictions kept certain populations out of specific neighborhoods, encouraging racial, ethnic, and cultural segregation.
It wasn't uncommon for real estate contracts to bar Black and Jewish Americans from buying properties. For example, covenants were used between the 1920s and 1940s in Washington State to keep underrepresented groups out of some Seattle-area neighborhoods. Black, Jewish, and Asian Americans were forced to look for housing elsewhere by forming their own segregated communities.
The Goodwin Company attached racially restrictive covenants to property it sold in Washington State from 1924 to 1938. The Goodwin property deeds stated that property could not be sold “to any person not of the White race; nor shall any person not of the White race be permitted to occupy any portion of said lot or lots or of any building thereon, except a domestic servant actually employed by a White occupant of such building.”
In 1948, the U.S. Supreme Court ruled that these racially charged provisions were unconstitutional under the country's equal protection laws after hearing the case of Shelley v. Kraemer. The ruling came after Missouri's top court blocked the Shelleys, a Black family, from taking possession of the home they bought in 1945 in St. Louis. The Kraemers, a White family who lived nearby, sued to prevent the Shelleys from moving into the neighborhood, citing a restrictive covenant prohibiting people of color from occupying the property.
Mortgage lending discrimination is illegal. If you think you've been discriminated against based on race, religion, sex, marital status, use of public assistance, national origin, disability, or age, you can file a complaint with the Consumer Financial Protection Bureau or the U.S. Department of Housing and Urban Development (HUD).
Despite the ruling, racial deed restrictions remain on the books in nearly every state in the U.S. While the covenants are no longer enforceable, the offensive language still exists.
What Is the Fair Housing Act?
The Fair Housing Act is a federal law that protects people from discrimination when they rent or buy a home, get a mortgage, seek housing assistance, or partake in other housing-related activities. The Act prohibits discrimination in housing based on race, color, national origin, religion, sex (including gender, gender identity, sexual orientation, and sexual harassment), familial status, and disability. The Fair Housing Act is also known as Title VIII of the Civil Rights Act of 1968.
Who Enforces Restrictive Covenants?
If you live in a planned community, the homeowners association (HOA) and the individual lot owners have the right to enforce covenants. However, violations can become unenforceable through laches—the loss of a right through undue delay or failure to assert it. For example, say you build a fence that violates the restrictive covenants. If the HOA doesn't try to enforce it until several years later, they could lose their rights to enforce through laches—meaning, you get to keep your fence.
What Is a Restrictive Covenant Agreement in Real Estate?
A restrictive covenant in real estate mandates owners and tenants to avoid or take specific actions to preserve the value and enjoyment of the adjoining land. For example, restrictive covenants can prevent owners and tenants from making certain renovations, having pets, parking RVs in the driveway, or raising livestock. Covenants that pass from owner to owner are said to "run with the land."