A covenant breach is when your company no longer meets a financial condition in its loan agreement. The conditions are set out as financial covenants—typically a series of key ratios that must be kept within certain limits. When you exceed a limit, the bank gains contractual rights to change terms, demand additional security, or in the worst case call the loan.
What do covenants typically cover?
The most common financial covenants in loan agreements are:
- Gearing limit: Total debt must not exceed a certain multiple of EBITDA (e.g. 3.5× or 4.0×).
- Interest cover: Operating profit must cover interest expense by a certain factor (e.g. 3.0×).
- Minimum equity: Solvency or equity must be kept above a minimum threshold.
- Debt service coverage: Liquidity must cover principal and interest payments.
Why is a breach so serious?
When you breach a covenant, it gives the bank a range of contractual rights. Even if the company is still paying principal and interest on time, the bank now has grounds to change the terms. That can mean higher interest, demand for additional security, restrictions on dividends, or in the worst case termination of the entire loan.
The key point: A covenant breach is rarely a sign that the company cannot pay. It is a sign that the contractual balance has tipped. The bank goes from being a passive lender to being an active decision-maker.
What is the difference between technical and actual breach?
A technical breach means that a ratio limit has been exceeded, even though the company is still meeting its payment obligations. An actual breach (or payment default) means failure to pay principal or interest.
In practice, most covenant breaches are technical—and these are what Covenant Horizon helps you anticipate.
Why is it important to see it coming?
A covenant breach rarely comes as a surprise. The numbers show it months in advance. But if you only see it when it happens, your room for maneuver is gone. If you see it well in advance, you have time to negotiate, seek a waiver, adjust the capital structure, or bring in new investors.
That runway is what separates reactive crisis management from proactive negotiation.