What Is a Covenant? Definition, Meaning, Types, and Examples (2024)

What Is a Covenant?

In its broadest sense, a covenant is a promise, agreement, or contract between two parties. As part of the covenant, the two parties agree that certain activities will or will not be carried out.

Covenants in finance most often relate to terms in a financial contract, such as a loan document or bond issue stating the limits at which the borrower can further lend. Covenants in religion often convey the binding relationship between a deity and humanity.

What Is a Covenant? Definition, Meaning, Types, and Examples (1)

Key Takeaways

  • Covenants are agreements between multiple parties that create a legally binding agreement on how each party is to perform.
  • Covenants can either promote activity to occur (positive covenant) or disallow an event or condition (negative covenant).
  • Debt covenants are most common, as they place financial covenants on the borrower and lender as part of the loan agreement.
  • Covenants are legally binding clauses, and if breached will trigger compensatory or other legal action.
  • Many sectors like finance, real estate, law, and religion have covenants, though it is used in many different contexts across each group.

Understanding Covenants

Regarding business, covenants are most often represented in terms of financial ratios that must be maintained, such as a maximum debt-to-asset ratio or other such ratios. Covenants can cover everything from minimum dividend payments to levels that must be maintained in working capital to key employees remaining with the firm.

Once a covenant is broken, the lender typically has the right to call back the obligation from the borrower or take measures to reduce the lender's risk. Generally, there are two types of primary covenants included in agreements: affirmative covenants and negative covenants. In addition, a third type of covenant—financial covenants—is sometimes separated into its own category.

Affirmative Covenants

An affirmative or positive covenant is a clause in a loan contract that requires a borrower to perform specific actions. Examples of affirmative covenants include requirements to maintain adequate levels of insurance, requirements to furnish audited financial statements to the lender, compliance with applicable laws, and maintenance of proper accounting books and credit rating, if applicable.

A violation of an affirmative covenant ordinarily results in outright default. Certain loan contracts may contain clauses that provide a borrower with a grace period to remedy the violation. If not corrected, creditors are entitled to announce default and demand immediate repayment of principal and any accrued interest.

Negative Covenants

Negative covenants are put in place to make borrowers refrain from certain actions that could result in the deterioration of their credit standing and ability to repay existing debt. The most common forms of negative covenants restrict or forbid something from happening. Common examples include restricting a company from issuing dividends to its shareholders, restricting management fees from being paid to related parties, or restricting the amount of debt a business can carry.

A negative covenant can be circumnavigated with specific overriding approval of the covenant issuer. For example, imagine a company that wants to embark on a merger but is not allowed to due to a negative covenant. Should the opposite party in the covenant agree to release the restriction, the company can proceed. This may also be the case during the acquisition of real estate, capital investments, or disposition of assets.

Numerical or Financial Covenants

Lastly, a covenant can be tied to a specific numerical metric. This metric is often financial and may be a single number or calculation to derive a certain ratio for value. A financial covenant is often monitored closely over time as it is the most likely covenant to suddenly change.

The argument could be made that a financial covenant is actually a positive or negative covenant. For example, imagine a company being required to maintain a certain financial ratio above a certain calculated amount. Since this is imposing a requirement, it could technically be classified as a positive covenant. However, some view positive or negative covenants as a single outcome. Meanwhile, financial covenants evaluate operating performance to ensure the overall health of the entity.

In business, financial covenants are often separated into maintenance covenants or incurrence covenants. Maintenance covenants often stipulate operating performance that can not be breached. An example is the interest coverage ratio to ensure a company has sufficient earnings to cover interest assessments. Incurrence covenants occur when a company takes action that impacts financial performance. For example, a company must maintain its debt-to-equity ratio above 0.40; should it wish to raise more debt, it must ensure it satisfies the incurrence covenant.

In finance, covenants are often put in place by lenders to protect themselves from borrowers defaulting on their obligations due to financial actions detrimental to themselves or the business.

Types of Covenants

Different industries and sectors have different types of covenants. In general, it's pretty common to see both positive and negative covenants across different industries.

Debt Covenants

Debt covenants have been the example used most within this article. A debt covenant arises when an entity works with a financial institution to take out a loan. To secure the loan, the entity must agree to meet certain criteria, not perform certain activities, and maintain good financial standing.

Debt covenants can also impact the lender. For instance, imagine a company secures a line of credit and hopes to use this line over the next several years. It is in the company's best interest to partner with a bank that maintains good financial standing and manages operational risk. Therefore, the borrower may impose covenants on the lender as part of the agreement to ensure the borrower will have long-term capabilities of securing financing.

Property Covenants

A property covenant is an agreement between multiple parties that stipulates how real property or real estate will or will not be used. These types of covenants may restrict the landowner or require specific action to be taken. For example, homeowner association (HOA) covenants often require property to have trees trimmed to a certain height or outline how parking spaces are to be utilized.

Some property covenants will "run with the land" or exist in perpetuity regardless of who the owner is. For example, a property covenant may restrict the type or quantity of livestock allowed on a property. Should this covenant be transferrable to any new owner in the future, the covenant is tied to the land.

Covenants have been historically used to discriminate against race, religion, or sexual orientation. For example, more than 500 of these historical covenants were discovered applying to 20,000 properties in King County, Washington. Supreme Court rulings and state law now make these discriminatory covenants illegal.

Law Covenants

While covenants are legal agreements by their nature, covenants are also simply part of the legal system. Law is a form of covenant, as law covenants are often negative covenants that restrict an individual or company from performing certain actions. The law may explain the outcome of what will happen should the covenant (law) be broken. Any common law intended to prevent criminal activity is an example of a law covenant.

Religious Covenants

Covenants are often found in religion, as a deity often makes promises or agreements to the people of the world or requires something of humankind. Although the types of religious covenants specifically within the Bible are discussed below, covenants are a common part of Christianity, Islam, Hinduism, and Buddhism.

There are two types of covenants in the Bible. First, conditional covenants are promises from God that certain outcomes will occur. However, for God to fulfill his part of the covenant, humanity must do its part first. Second, the Bible includes unconditional covenants, which are promises from God that he will fulfill an oath with his divine power without any associated conditions.

Covenant Violations

A covenant violation—often called a breach of covenant—is a failure to uphold the agreed-upon terms of a covenant. Whether a party failed to execute a positive covenant, performed a task it shouldn't have as outlined by a negative covenant, or wasn't able to maintain certain operational metrics, the contract has been broken.

Debt Covenant Violations

A bond violation is a breach of the terms of the covenants of a bond. Bond covenants are designed to protect the interests of both parties, where the inclusion of the covenant is in thebond's indenture, which is thebinding agreement, contract, or document between two or more parties.

When an issuer violates a bond covenant, it is considered to be intechnical default. A common penalty for violating a bondcovenantis the downgrading of a bond's rating, which could make it less attractive to investors and increase the issuer's borrowing costs. For example, Moody's, one of the major credit rating agencies in the United States, rates a bond's covenant quality on a scale of 1 to 5, with five being the worst. This means that a bond with a covenant rating of five is an indication that covenants are being violated consistently.

Lenders will often allow for remedy on violated covenants. For financial covenants, after a company has breached its covenant, it must often:

  1. Obtain proficient financial metrics that comply with the covenant
  2. Sustain those metrics over an agree-upon timeframe

Other Violations

In general, a party may have legal recourse to seek compensation for damages should a different party have breached a covenant. For property, failure to comply with association rules or covenants may result in fines or liens. Though an HOA cannot force a homeowner to sell their home, other types of property covenants may call for liquidation or transfer of ownership.

Failure to comply with law covenants results in fines, penalties, fees, or more serious legal punishment. When you park your car on the side of the street, you are subject to the covenant that stipulates you pay for that space during a specific time. Should you fail to comply, you are subject to a parking ticket. Any court proceeding or case is an example of a failed covenant.

Lastly, different religions uphold different consequences for not adhering to specific teachings. The Quran states that should someone stray from believing in Islamic teachings, Allah will never forgive them nor will He guide them "to the right way."

Example of Bond or Debt Covenants

As part of its 2021 annual report, Amazon.com Inc. publicly disclosed its note payable obligation. Because of the potential importance and restriction of covenants, it chose to publicly state that the notes were not subject to any covenants.

Conversely, Apple Inc. also report notes payable, though there are terms and conditions as part of their debt obligation. The following excerpt from its 2021 annual report outlines exceptions the limitations on additional interest on the notes:

"The Company will, subject to the exceptions and limitations set forth below, pay as additional interest on the Notes such additional amounts (“Additional Amounts”) as are necessary in order that the net payment by the Company or the paying agent of the Company...will not be less than the amount provided in the Notes to be then due and payable."

Apple further discusses covenants restricting consolidation or merger activity. Their covenant states they may perform these activities as long as:

  • "We are the continuing entity, or the resulting, surviving or transferee person (the “Successor”) is a person (if such person is not a corporation, then the Successor will include a corporate co-issuer of the debt securities) organized and existing under the laws of the United States of America, any state thereof or the District of Columbia and the Successor (if not us) will expressly assume, by supplemental indenture, all of our obligations under the debt securities and the applicable Indenture and, for each security that by its terms provides for conversion, provide for the right to convert such security in accordance with its terms
  • "Immediately after giving effect to such transaction, no default or event of default under the applicable Indenture has occurred and is continuing
  • "In the case of the 2013 Indenture, the trustee receives from us an officers’ certificate and an opinion of counsel that the transaction and such supplemental indenture, as the case may be, complies with the applicable provisions of the 2013 Indenture."

What Are Examples of Covenants?

Covenants may be related to finances, property, law, or religion. In business, a loan covenant may disallow a company from acquiring another company or may require a certain amount of cash on hand. A property covenant may require the grass to be cut a specific number of times per year. A religious covenant may be a promise from God to never send a destructive flood like the one Noah experienced again.

What Do Covenants on a Property Mean?

Covenants on a property restrict how a property can be used or set the precedence of how it must be used. Consider a house under the provision of a homeowner's association. The HOA may restrict the owner from renting out the property or listing the property on Airbnb.

What Is an Example of Covenants in Real Estate?

Real estate covenants used to restrict who could legally purchase or occupy real property. For example, consider covenants in King County, Seattle, that used to enforce restrictions based on race, national origin, or ethnic background.

Today, real estate covenants are more related to the actual operation and maintenance of a home. Some covenants require certain action to be taken (e.g., owners of a home must trim their trees) while others restrict action (e.g., owners of a home are not allowed to build a fence).

What Are the Covenants in a Contract?

A contract can outline any covenant one party wishes to require as long as the other party agrees to its compliance. As part of the contracting stage, the two parties must communicate their requirements and negotiate what to include and exclude in a contract. The covenants listed from one contract to another may be entirely different, as different parties may wish to be protected in different ways.

What Is the Lord's Covenant?

According to the Bible, the Lord has made several covenants. At the highest level, God has promised to humanity that he will one day return to Earth and grant everlasting life. The Bible also outlines several other covenants where God has made a promise to mankind that may or may not require action on humanity's part.

The Bottom Line

Covenants create the parameters of many contracts, whether it's the social contract enforced by a system of laws, the boundaries created by a religion, or limits on how to use your business or property. Read and understand any affirmative or negative covenants before entering into an agreement.

What Is a Covenant? Definition, Meaning, Types, and Examples (2024)

FAQs

What Is a Covenant? Definition, Meaning, Types, and Examples? ›

A covenant is a promise in any formal debt agreement, that certain activities will or will not be carried out or that certain thresholds will be met. Covenants in finance most often relate to terms in a financial contract, such as a loan document or bond issue stating the limits at which the borrower can further lend.

What is the meaning of covenant and examples? ›

a part of a formal written agreement in which it is stated what must or must not be done, or in which someone promises to do or pay something: The lease contains a covenant that no animals can be kept on the property. Any loss of rent may be claimed as damages for breach of covenant (= failure to do as promised).

What would be an example of a covenant? ›

Examples of Covenants include the Marriage Covenant, which involves promises of fidelity and commitment; the Land Covenant, which involves promises of protection and preservation; the Blood Covenant, which involves promises of loyalty and brotherhood; the Religious Covenant, which involves promises of faithfulness and ...

What are the three types of covenants? ›

Generally, there are two types of primary covenants included in agreements: affirmative covenants and negative covenants. In addition, a third type of covenant—financial covenants—is sometimes separated into its own category.

What is a covenant in the Bible simple? ›

A covenant in the ancient world was similar to what we in the modern world would call a contract, treaty, or a will. Each covenant established the basis of a relationship, conditions for that relationship, promises and conditions of the relationship and consequences if those conditions were unmet.

What is the covenant given by God? ›

Within the gospel, a covenant means a sacred agreement or mutual promise between God and a person or a group of people.

How does God make a covenant with us? ›

A covenant is a two-way promise, the conditions of which are set by God. When we enter into a covenant with God, we promise to keep those conditions. He promises us certain blessings in return. A covenant is a two-way promise.

How many covenants did God make? ›

Specifically, the Bible speaks of seven different covenants from Genesis to Revelation: Adamic, Noahic, Abrahamic, Mosaic, Davidic, New, and Everlasting Covenants. With each covenant are four elements— promises, terms, blood, and a seal.

How to enter into a covenant with God? ›

A proper “covenant relationship” with God requires five major experiences: 1) Faith, faith in Jehovah God and Jesus Christ. 2) Repentance of sins. 3) Confession of sins. 4) Baptism and 5) Obedience, effective operation of all of these means genuine conversion.

What is the spiritual meaning of the covenant? ›

A covenant is a sacred agreement between God and His children. God sets specific conditions, and He promises to bless us as we obey these conditions. Making and keeping covenants qualifies us to receive the blessings God has promised. When we choose not to keep covenants, we cannot receive the blessings.

What is a modern day covenant? ›

Marriage…is probably our best modern-day example of a covenant. Remember our definition? Covenant = A chosen relationship in which two parties make binding promises to each other.

What is the most important covenant in the Bible? ›

Within the context of the Bible, covenants are agreements between God and humanity. The most important biblical covenant is the Mosaic Covenant, which was established between the Israelites and God, outlining a multitude of laws to be followed.

What is the power of covenant with God? ›

The source is God. Our access to that power is through our covenants with Him. A covenant is an agreement between God and man, an accord whose terms are set by God. In these divine agreements, God binds Himself to sustain, sanctify, and exalt us in return for our commitment to serve Him and keep His commandments."

What is the true meaning of covenant? ›

covenant. Literally, a contract . In the Bible (see also Bible ), an agreement between God and his people, in which God makes promises to his people and, usually, requires certain conduct from them. In the Old Testament , God made agreements with Noah , Abraham , and Moses .

What is a covenant in your own words? ›

A covenant is an agreement between two people, or companies, or even countries. It is formal, solemn, sometimes even sacred. There are some places where you'll hear covenant get used. It's a little old fashioned and formal, but marriage is often referred to as a covenant.

What does God say about covenant? ›

A covenant is defined as “an unbreakable agreement between two parties that have joined together as one to support, provide, protect and defend each other.” Psalm 105:8 (KJV) says, “He hath remembered His covenant for ever, the word which He commanded to a thousand generations.”

What is an example of a covenant in everyday life? ›

For example: I will always pay my tithing. I will never smoke. Find some way to serve every day. Pray to recognize the people you can serve.

What is God's covenant to us today? ›

The New Covenant provides not just the better promises of eternal life, but the spiritual help that is absolutely necessary in order to fulfill our part of the agreement. It is ludicrous to believe we could ever earn forgiveness or eternal life! But still God desires and requires our loyal obedience for our own good.

What is an example of a personal covenant with God? ›

In the strength of divine grace, I engage to live in a holy and habitual reliance upon God for all things pertaining to life and godliness, giving diligent attention to the means of grace as ordained by God for my good, promising to wait upon him in secret prayer morning and evening, to attend family, social and public ...

Top Articles
Latest Posts
Recommended Articles
Article information

Author: Catherine Tremblay

Last Updated:

Views: 5239

Rating: 4.7 / 5 (47 voted)

Reviews: 86% of readers found this page helpful

Author information

Name: Catherine Tremblay

Birthday: 1999-09-23

Address: Suite 461 73643 Sherril Loaf, Dickinsonland, AZ 47941-2379

Phone: +2678139151039

Job: International Administration Supervisor

Hobby: Dowsing, Snowboarding, Rowing, Beekeeping, Calligraphy, Shooting, Air sports

Introduction: My name is Catherine Tremblay, I am a precious, perfect, tasty, enthusiastic, inexpensive, vast, kind person who loves writing and wants to share my knowledge and understanding with you.