Affirmative and Negative Covenants
Affirmative covenants are those things the borrower must affirmatively do during the term of the loan agreement. Most of these requirements are things the borrower would do in any case without being instructed by a lender, such as pay its taxes, comply with laws, and meet its financial obligations. Other covenants are matters that work to conserve the borrower’s cash flow, focus borrower on a specific line of business and generally keep its nose to the grindstone.
Negative covenants are the things the senior lender says that a borrower may not do. Most of these are things the borrower wouldn’t do anyway. The rest are designed to keep the borrower focused on running its business in the ordinary course and repaying the senior lender’s debt.
Here is a list of certain affirmative and negative covenants that are often negotiated in the credit agreement of a private equity transaction:
Affirmative covenants:- Ordinary Course Conduct of Business. Conduct its business in the ordinary course and use its reasonable efforts, in the ordinary course, to preserve its business and the goodwill and the business of its customers, advertisers, suppliers and others having business relations with it.
- Payment of Taxes. Pay and discharge before the same shall become delinquent, all lawful material governmental claims and all material federal and material state, local and foreign income, franchise and other taxes, assessments, charges and levies.
- Maintain Insurance. Maintain insurance with responsible and reputable insurance companies or associations in such amounts and covering such risks that are sufficient, appropriate and prudent in the conduct of the business of the kind conducted by the borrower.
- Access to Information. Let the lender have access to books and records, visit properties of the borrower, meet with management and meet with auditors.
- Books and Records. Keep proper books of record and account, in which full and correct entries shall be made in conformity with GAAP.
- Maintain Condition of Assets. Maintain its properties in good working order and condition and preserve its permits and intellectual property.
- Additional Collateral. Deliver any supplements or amendments to the collateral documents as may be necessary to reflect and fully protect the lender’s security interest in the collateral.
- Deposit Accounts. Where collateral includes cash, deposit all cash in controlled collateral accounts.
- Real Estate. Comply with all obligations under lease agreements, and deliver mortgages on any real estate acquired subsequent to the loan.
- Indebtedness. Borrower will not create, incur, assume or otherwise become or remain directly or indirectly liable with respect to any Indebtedness except for expressly permitted items that are typically subject to caps and refunding limitations.
- Liens. Borrower will not create or suffer to exist, any lien upon or with respect to any of its properties or assets, whether now owned or hereafter acquired, or assign any right to receive income, except for items expressly permitted such as those arising in the ordinary course of business or by operation of law.
- Investments. Borrower will not make any investments in any other party except as specifically permitted or as may be necessary in connection with the borrower’s ordinary course of business.
- Sale of Assets. Borrower will not sell, convey, transfer, lease or otherwise dispose of, any of its assets or any interest therein except as specifically permitted or as may arise in the ordinary course of business (subject to caps and permitted baskets).
- Restricted Payments. Borrower will not pay any dividends on stock or redeem and stock subject to permitted exceptions.
- Prepayment and Cancellation of Debt. Borrower will not prepay or cancel any debt subject to compliance with defined restrictions such as leverage ratios.
- No Mergers. Borrower will not merge with another party or enter into any fundamental transaction that changes the identity of borrower.
- Change in Nature of Business. Borrower will not make any material change in the nature or conduct of its business, except for businesses reasonably related to the business already carried on or ancillary or complementary thereto.
- Modification of Subordinated Debt Documents. Borrower will not change or amend the terms of any subordinated debt if the effect of such amendment is to (i) increase the cash pay portion of the interest rate on such debt, (ii) change the dates upon which payments of principal or interest are due, (iii) change any default or event of default, or change any covenant with respect to such debt in any manner materially adverse to borrower, (iv) change the subordination provisions of such debt, (v) change the redemption or prepayment provisions of such debt or (vi) change or amend any other term if such change or amendment would be materially adverse to borrower.
