4. Covenants and undertakings

4. Covenants and undertakings

Covenants and undertakings clauses set out actions that the borrower is required to take or refrain from taking in the future. The difference between representations and warranties and covenants and undertakings is that the former is a declaration of the present status while the latter is a promise as to future conduct. Undertakings can be broadly categorised as being “positive”, i.e. something the borrower is required to do, or “negative”, i.e. something the borrower is prohibited from doing.

The following are some aspects commonly covered by covenants and undertakings:

Financial condition and provision of information

Some loan agreements may contain covenants relating to the financial condition of the borrower, particularly in the case of corporate borrowers. For example, corporate borrowers may be required to covenant to maintain a minimum consolidated tangible net worth. 

It is common to require borrowers to provide the up-to-date financial statements of the borrowers and other security providers from time to time, and also other information and documents, such as details of any litigation against the borrower or other security providers and further information regarding the financial condition, business and operations of the borrower’s group members which may be requested by the lender. 

This allows the lender to assess the condition and operations of the borrower, whether the representations made by the borrower are accurate and whether covenants have been breached. 

Negative pledge

A borrower gives a negative pledge when the borrower undertakes not to create or permit to subsist security over assets of the borrower, subject to carve-outs to be agreed. Such negative pledge aims at protecting the lender from allowing the borrower to have other creditors having priority over relevant assets of the borrower by virtue of being a secured creditor. 

Pari passu ranking

Loan agreements may provide that the obligations of the borrower under the loan agreement owed to the lender shall rank pari passu, in other words, equal, with all other unsecured and unsubordinated liabilities of the borrower. The purpose of such undertaking is also to ensure that the lender’s claim against the borrower would be at least on equal priority with other unsecured creditors.

Restrictions on disposal

A borrower may often be bound by an undertaking not to enter into any transaction to sell, lease, transfer or dispose of its assets, unless such disposal falls within the scope of agreed exceptions. For example, where the assets are disposed of in the ordinary course of trade of the borrower, involves an exchange for other assets comparable or superior as to type, value and quality, or the market value or consideration receivable for the assets do not exceed an agreed threshold. This covenant seeks to maintain the amount of assets of the borrower, in case there is any default and the creditors’ debts are to be paid out of those assets. 

Merger

In the case of a corporate borrower, a loan agreement may prevent borrowers from undergoing corporate restructuring, including entering into an amalgamation, demerger, merger or corporate reconstruction. The rationale is to ensure the borrower does not merge with other entities of lower credit worth.

Change of business

A change of business clause disallows a corporate borrower from making a substantial change to the general nature and scope of its business, as this may impact the credit assessment of the borrower. Note that a disposal of substantial assets of the borrower may constitute a change of business as well. 

Incurring financial indebtedness

Loan agreements may prohibit the borrower from incurring or allowing any financial indebtedness to be outstanding. This means the borrower may not make any additional borrowings, other than any borrowings that may be expressly permitted under the loan agreement.