Bank Covenants: Make Sure You Know What You Are Getting Into

I’m sure you have all heard or seen by now, the lending world has changed. As many of our business clients meet with their lenders we thought it was a good time to remind them that their loan documents most likely contain numerous covenants which, more than ever, are being closely monitored and are not being waived by the banks.

While most clients regularly monitor and comply with the regular reporting requirements and formula based covenants that have been imposed by their bank, such as Cash Flow Coverage or Minimum Net Worth, many forget that almost all loan documents contain a great number of additional affirmative and negative covenants with which a borrower must comply. Most recently, lenders are taking a hard line with these covenants and are taking action when these covenants are breached or willfully ignored by their borrower.

For example most loan agreements provide that, without the bank’s prior written consent, a borrower may not make any acquisition, incur any additional indebtedness, permit any further liens against its assets, sell any of its assets, prepay any indebtedness or sell or repurchase any of its corporate stock. Additionally, most borrowers are required to provide their bank, upon the filing of any lawsuit against the borrower, with copies of all tax returns and to notify the bank of any material change in its business operations. These are just some of the fairly standard covenants in a loan agreement.

Bank covenants should be reviewed by your attorney and accountant prior to signing any loan agreement. Further, before engaging in any material transaction or upon the occurrence of any major event impacting your business, make sure you are not required to obtain consent from or notify your lender. We’ve heard many times from our banking friends, that they do not like surprises. Make sure you keep your bank in the loop. Failure to do so could be a costly mistake. For questions about bank covenants and other loan documents, contact Jeff Knoll, or your Stark & Knoll attorney, at 330-376-3300.