All India Management Association (AIMA) 2007 M.B.A Marketing Management Central Banking

d. Loan agreements ranging from banks and their business borrowing customers generally contain covenants which require that the borrower "do certain things1' (affirmative covenants) and "not do others" (negative covenants) during the term of the loan agreement. Covenant requirements can be extensive depending upon the amount and term of the loan and the credit standing of the borrower.
Negative covenants typically address problems affecting fundamental nature of borrowers' businesses (e.g., mergers, acquisitions). Breaching of negative covenants usually constitutes immediate default under most loan agreements. Negative covenants limit managerial flexibility and, consequently, are intensely negotiated. Intrusive negative covenants can lead to allegations that the bank wrongfully interfered with borrower's operations or accelerated circumstances leading to borrower's default - potentially exposing the bank to a legal action. Banks should seek no more "control" than absolutely necessary to maintain its position. Most hazardous provisions for banks are: (i) borrowers to maintain management acceptable to bank; and (ii) provide bank voting control of borrower.
Negative covenants prohibit acts of the borrower that would jeopardize its continued creditworthiness. The lender should keep only as short a restriction as is necessary in the particular instance. Moreover, the breach of many covenants, while creating a default, may also create rights in 3rd parties that may endanger the lender's rights, for which there is no recourse or remedy. Financial covenants prohibit borrowers' key ratios and financial conditions from exceeding specified limits
Affirmative Covenants vs. Representations: While "reps and warranties" convey assumptions underpinning loans, covenants attempt to maintain those assumptions by controlling borrowers' actions. Affirmative covenants serve many purposes, including maintaining borrowers' creditworthiness and preserving borrowers' assets. These covenants require borrowers to maintain corporate existence and property (e.g., licenses, patents, trademarks). It also requires borrowers to comply with all applicable laws and regulations while conducting business. Covenants require borrowers to pay all taxes, assessments, and levies on income or property, maintain property and liability insurance (self-insuring boirowers require exceptions). Financial covenants {e.g., current ratio, working capital) require borrowers to maintain key financial ratio at stipulated levels.
a few of the standard covenants are-maintaining adequate insurance, furnish financial statements quarterly and annually, do not merge with or acquire a different company, not allow other liens on company assets etc. Examples of tailor made covenants are- maintaining a current ratio of not less than 1.5 to 1, maintaining tangible net worth in excess of Rs. Xxxxxxx (varies with the size of company), and a ratio of total liabilities to tangible net worth of no greater than three to one etc

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