Oscar recently applied for a new business loan. The lender intends to include certain loan covenants in the agreement. Oscar has concerns that his company will not be able to comply.
Oscar’s concerns are valid since lenders are very serious about loan covenants. Basically, loan covenants are requirements and/or restrictions that a lender imposes as part of a business loan agreement.
There are several types of loan covenants. Affirmative covenants are requirements that a business must fulfill, such as submitting periodic financial statements to the lender. Negative covenants are restrictions designed to limit a business from taking certain actions without first obtaining the lender’s approval, such as making management changes. And financial covenants require a business to maintain various financial ratios related to items such as working capital.
Oscar’s lender will periodically review his financial statements, tax filings, and other reports to check for compliance with the covenants. His lender may even conduct occasional on-site field audits to verify that he has the assets serving as collateral for his loan.
If the lender finds that Oscar is noncompliant with respect to the loan covenants, the lender could accelerate the maturity of the loan and/or enforce default provisions allowing for such things as an increase in the interest rate, seizure of collateral, or imposition of monetary penalties. Oscar may have an opportunity to “fix” the problem before his lender takes action against him — or he may not.
A careful review of any covenants included in your business loan agreements can help you evaluate whether your company will be able to comply.
Client Profile is based on a hypothetical situation. The solutions we discuss may or may not be appropriate for you.
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