Covenant Breach and What Follows

What this topic is

A covenant is a promise inside a loan agreement. Break one and you have created an event of default: a contractual trigger that hands the lender a set of rights, from doing nothing at all to demanding the entire loan back and taking the collateral.

Why it matters

Most businesses that fail do not fail on a missed payment. They fail on a ratio, months earlier, and then mishandle the ninety days that follow. Those ninety days are where the outcome is actually decided, and they are almost entirely about information, credibility and sequence.

Who should learn it

Owners and CFOs carrying bank debt, anyone who has signed a compliance certificate, and advisers who get the call after the certificate has already gone out.

What you will understand

• The difference between covenants tested every quarter and those tested only when you act
• The exact sequence of lender responses, from reservation of rights to foreclosure
• How an equity cure works and why it is cheaper than paying debt down
• What you should do in the weeks before the test, not after

Prerequisites

• Forbearance Agreements
• Cramdown and the Cramdown Interest Rate

Common misconception

"We breached a covenant, so the bank is going to call the loan." Almost never on the first breach. Calling a loan converts a performing asset into a workout, a legal budget and a probable loss, and lenders avoid that when the business is still viable. What they do instead is convert the breach into leverage: fees, a higher rate, tighter reporting, new collateral, sometimes a guarantee. The real risk is not that the bank acts immediately. It is that the borrower spends the breach's only asset, credibility, before the negotiation starts.