Loan covenants: what businesses should check before signing
Loan approval does not mean the agreement is safe for your business. Restrictions on new borrowing, dividends, asset sales, account turnover and financial ratios may apply throughout the loan term. A breach can sometimes result in further drawdowns being stopped or a demand for early repayment.
Covenants are the financial ratios, obligations and restrictions imposed on the borrower by the agreement. There is no universal list: the precise formula, test date, data source, headroom, cure period and consequences all matter. Check the entire post-disbursement monitoring mechanism, as well as the rate and repayment schedule.
Covenants explained simply
In business practice, covenants are conditions the borrower undertakes to meet throughout the term of a loan or credit facility. They help the bank monitor whether the company’s financial position has deteriorated or the risk of non-repayment has increased.
Some covenants are numerical, such as a maximum leverage ratio or minimum debt service coverage ratio. Others govern business conduct: submitting reports on time, not taking on new debt without the bank’s consent, maintaining account turnover or not disposing of significant assets.
In its credit documentation requirements, the Bank of Russia specifically identifies documents on compliance with behavioural and financial covenants. It notes that failure to meet conditions may result in a demand for early repayment or indicate adverse trends in the borrower’s business.
Types of covenants found in loan agreements
For practical purposes, conditions can be divided into four groups. Their names may differ, so look for the substance of the obligation rather than the word “covenant” itself.
| Group | What the bank may monitor | What the borrower should check |
|---|---|---|
| Financial | DSCR, debt relative to profit or cash flow, equity, revenue and profitability | Formula, threshold, period, debt components and permitted adjustments |
| Affirmative | Timely reporting, insurance, maintaining licences, paying taxes and using funds for the agreed purpose | Deadlines, evidence required and the responsible employee |
| Negative | New loans and guarantees, dividends, pledging and selling assets, reorganisation and related-party transactions | Limits, ordinary-course exceptions and the consent procedure |
| Information | Litigation, account restrictions, changes of ownership, deteriorating performance and default on other obligations | Which events to report, to whom, by when and in what document |
Where restrictions may be hidden
They are not confined to the “Borrower’s obligations” section. They may appear in individual and general terms, schedules, tariffs, security and surety agreements, the credit committee’s decision, drawdown rules and documents incorporated by reference.
- Check which documents form an integral part of the agreement.
- Check whether the bank can change general terms or tariffs and how the borrower is notified.
- Find provisions on “material breach”, “event of default”, “acceleration” and “suspension of lending”.
- Check cross-contract consequences: whether a problem under one agreement can affect other group loans.
What can happen after a breach
A covenant breach does not always trigger early repayment automatically. The consequences depend on the particular agreement, the nature of the breach and whether the bank has allowed time to remedy it.
Request for explanations
The bank requests a calculation, further documents, a plan to restore the ratio or enhanced monitoring.
Further drawdowns stopped
The undrawn part of a credit facility may become unavailable if the agreement and circumstances provide for this.
Additional security
The bank may propose collateral, a surety, a reduced limit or another change within the contractual mechanism.
Demand for early repayment
If the agreement provides for this consequence, a breach may be grounds for demanding repayment ahead of schedule.
Article 821 of the Civil Code of the Russian Federation separately provides for the lender’s right to refuse to provide all or part of a loan where circumstances clearly indicate a risk that it will not be repaid on time, or where the obligation to use funds for the agreed purpose is breached. Even so, the specific covenant and its consequences must be checked in the agreement: there is no universal automatic sanction for every case.
Checklist: ten questions before signing
| What to check | Question to ask | Why it matters |
|---|---|---|
| Formula | Exactly how is the ratio calculated? | The ratio’s name does not explain the components of its numerator and denominator |
| Scope | Is it calculated for one LLC or the group? | Debt and profit may sit in different companies |
| Data source | Are Russian Accounting Standards, tax or management accounts used? | Different accounting systems produce different figures for the same business |
| Period | A month, a quarter or the last 12 months? | Seasonality can temporarily weaken a ratio |
| Test date | When is compliance measured? | Balance sheet, debt and reporting need to be managed in advance |
| Adjustments | Are one-off expenses and income included? | Without an agreed method, the result may differ from the company’s calculation |
| Headroom | How far is the forecast from the threshold? | Minimal headroom can disappear quickly when revenue or margins fall |
| Cure period | Can the breach be remedied before sanctions apply? | This provides time to explain, repay some debt or obtain consent |
| Consequences | Exactly what can the bank do? | Penalties, stopped drawdowns and early repayment demands involve different risks |
| Consent | How can a waiver or prior consent be obtained? | A verbal understanding does not replace a documented decision |
Illustrative example: compliant today, in breach after borrowing
A company is discussing a RUB 30 million loan. The draft agreement requires “net debt / EBITDA not exceeding 3.0”.
| Measure | Before the new loan | After disbursement |
|---|---|---|
| Net debt | RUB 42 million | RUB 72 million |
| EBITDA for the calculation period | RUB 18 million | RUB 18 million |
| Net debt / EBITDA | 2.33 | 4.00 |
| Contract requirement | Not more than 3.0 | |
Before the transaction, the company meets the threshold, but immediately after drawing the loan it does not. The issue may be that the financial model assumes future EBITDA growth while the agreement tests the actual figure at the next reporting date.
Prepare at least a base-case and a stress-case forecast. The formula and inputs must match the agreement’s methodology, not just the company’s internal model.
This example is illustrative. Banks use different ratios and definitions; EBITDA, net debt and permitted adjustments must be taken from the particular agreement.
How to monitor covenants after disbursement
Create one register of conditions, even if you have several loans with different banks. For each covenant, record the contractual clause, formula, threshold, actual value, headroom, next test date, data source, responsible person and consequences.
Check ratios before disbursement, after the facility is fully drawn and taking existing commitments into account.
Record calculation dates, document submission dates, insurance renewal dates and event notification deadlines.
Do not wait for quarter end: update ratios using management information and monitor headroom.
Check how a new loan, dividend, major purchase or guarantee affects every agreement in the group.
If a ratio is approaching its limit, explain the causes, prepare a recovery forecast and identify matters to agree with the bank.
What to discuss with the bank in advance
- An unambiguous formula and an exhaustive list of adjustments.
- A realistic testing frequency that reflects the business’s seasonality.
- Sufficient headroom between the current ratio and the contractual limit.
- Time to cure a non-critical breach and a notification procedure.
- Ordinary-course exceptions and an agreed materiality threshold.
- A written procedure for obtaining the bank’s prior consent.
When to seek help
A review is particularly useful when financing documents comprise several linked agreements, the business already has loans with other banks, financing is being arranged for a group, or a planned transaction will materially change debt commitments. It is easier to agree formulas and consequences before signing than after the first breach.
Need to assess financing conditions as well as the rate?
NG Finance can help compare debt commitments, cash flow, transaction structure and bank terms before applying or signing. Where needed, have a specialist lawyer carry out a legal review of the agreement.
Request an assessmentFrequently asked questions
Is a covenant a penalty?
No. It is a requirement, ratio or restriction. A penalty may be one consequence of a breach only if the agreement provides for it.
Is there a mandatory covenant list for all banks?
No. The conditions and wording depend on the bank, product, amount, borrower’s financial position, security and transaction structure.
Can the bank stop further drawdowns?
This may be permitted by the agreement and applicable law. Check the grounds, notification procedure and whether the particular breach affects the conditions for further drawings.
What is a financial covenant?
It is a requirement concerning a measurable financial indicator, such as leverage, debt service coverage or equity. Its precise meaning is determined by the contractual formula.
What if a breach is already forecast?
Recalculate the ratio using the contractual methodology, identify the causes, prepare a forecast and discuss documented consent, an amendment or a recovery plan with the bank in advance.
Is the bank manager’s verbal consent sufficient?
No. Material changes and a bank’s waiver of consequences must be documented in accordance with the agreement and the bank’s internal procedures.
Should covenants on other loans be checked?
Yes. New debt, security, guarantees or dividends can affect restrictions in existing agreements, including cross-default provisions.
Who should monitor compliance within the company?
Usually the finance team or owner, together with accounting staff and a lawyer. Appoint one person to maintain the register and calendar and coordinate communication with banks.
Sources and further reading
- Bank of Russia: requirements for submitting loan and security documentation, 15 May 2026
- Bank of Russia Bulletin No. 11 of 13 February 2025: financial covenants in financial difficulty criteria
- Bank of Russia: “Russian Companies’ Credit Line Selection Strategies”, Working Paper No. 158, 2025
- Civil Code of the Russian Federation, Article 421: freedom of contract
- Civil Code of the Russian Federation, Article 821: refusal to provide or receive a loan
This material is for information and is not a legal opinion. The conditions, consequences of a breach and consent procedure are determined by the particular loan agreement and related documents.