covenant violation
A breach of a loan agreement's covenants, which can trigger events of default allowing lenders to demand immediate repayment even if payments are current.
Example
“The company's debt-to-EBITDA rising to 5x constituted a covenant violation, giving lenders the right to accelerate repayment.”
Memory Tip
COVENANT VIOLATION = you broke a loan condition. Lender can technically call the loan immediately.
Why It Matters
Understanding covenant violations is critical for borrowers because breaching loan covenants can have severe consequences beyond simply missing a payment. A lender can declare your entire loan immediately due if you violate covenants, potentially forcing you into financial distress or bankruptcy even when you have been making regular payments on time.
Common Misconception
Many borrowers mistakenly believe that covenant violations only occur when they miss a payment or fall behind on their loan obligations. In reality, covenants often include non-payment conditions such as maintaining a minimum credit score, keeping debt below a certain level, or maintaining employment, and violating any of these can trigger default.
In Practice
A small business owner borrows 500,000 dollars with a covenant requiring they maintain a debt-to-income ratio below 40 percent. Six months later, they take on additional debt and their ratio climbs to 42 percent, technically violating the covenant. Even though they have made all loan payments on time, the lender can now demand immediate repayment of the entire remaining 450,000 dollar balance plus penalties.
Etymology
COVENANT (loan condition) VIOLATION (breach). The VIOLATION (breaking) of a COVENANT.
Common Misspellings
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See Also
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