Affirmative covenants are the things a borrower promises to do for as long as the loan is outstanding: deliver financial statements and compliance certificates on time, keep insurance with the lender named on it, pay taxes, maintain the business, its licenses and its collateral, keep proper books, allow inspections, and tell the lender promptly about defaults, lawsuits and other material events. Breaking one is an event of default, usually after a short cure period. The ones that trip most often are the reporting deadlines, particularly year-end statements prepared by an outside accountant working to its own calendar.
- What they are
- Promises to do things: report, insure, pay, maintain, notify
- Opposite of
- Negative covenants, which are promises not to do things
- Common trip-up
- Late year-end financial statements
- If breached
- Event of default, usually after a notice and cure period
- Where to find them
- The "Affirmative Covenants" article of the credit agreement
What affirmative covenants are for
A loan agreement carries three families of promises. Financial covenants set ratios the business must meet. Negative covenants list what the business may not do without consent: take on more debt, grant liens, sell assets, pay distributions. Affirmative covenants list what the business must keep doing.
Their purpose is information and preservation. A lender cannot test a financial covenant it has no statements for, cannot rely on collateral that is uninsured, and cannot protect its position if it learns of a lawsuit or a tax lien months late. Affirmative covenants keep the lender's picture of the business current and keep the assets it lent against intact. They are why a loan can run for years on the strength of an underwriting that happened once.
The standard list
The wording varies from lender to lender, but the list below appears, in some form, in almost every bank, private credit and asset-based agreement.
| Covenant | What it requires | Where companies slip |
|---|---|---|
| Annual financial statements | Year-end statements, at the level of assurance the agreement sets (compiled, reviewed or audited), by a stated deadline | The outside accountant's schedule, especially when the tax return is on extension |
| Interim financial statements | Monthly or quarterly internal statements, within a set period after each month- or quarter-end | Books closed late, or statements sent without a balance sheet |
| Compliance certificate | A signed certificate with each covenant calculation, delivered with the statements | Sent late or not at all even when the numbers pass |
| Borrowing base certificate | On a line, a report of eligible receivables and inventory, monthly or more often | Aging not reconciled to the general ledger |
| Budget or projections | An annual budget before or soon after the start of the fiscal year | Forgotten until the lender asks |
| Tax returns | Copies of business, and sometimes owners', returns once filed | Extensions not communicated |
| Insurance | Property, liability and other cover, with the lender as loss payee and additional insured | Endorsement dropped at renewal or when the broker changes |
| Taxes | Pay taxes, including payroll taxes, when due | A payroll tax shortfall in a tight month becomes a lien |
| Existence and licenses | Keep the company in good standing and maintain permits and licenses | An annual state filing missed after a change of registered agent |
| Books, records and inspection | Keep proper books; allow the lender to inspect and conduct field exams | Records not ready when an exam is scheduled |
| Notices | Tell the lender promptly of defaults, litigation, material contracts lost, environmental issues, key management changes | Assuming the lender does not need to know yet |
| Deposit accounts | Keep operating accounts with the lender, or under a control agreement | Opening a new account elsewhere without a control agreement |
The reporting deadlines that cause most defaults
Affirmative covenants set deadlines measured in days after a period ends. For a company with a controller and a closing calendar, they are routine. For a company whose year-end statements are finished by an outside accountant, they are the most likely covenant to be broken, and the break is usually avoidable.
The pattern is familiar. The agreement requires reviewed year-end statements within a set number of days after year-end. The company's accountant does the tax return first, on extension, and prepares the review later in the year. The deadline passes. The lender sends a notice. Nothing is wrong with the business, but it is now in technical default, and the lender is entitled to charge for the waiver.
The same happens with quarterly compliance certificates. Owners often assume that if the covenants pass, no one needs the certificate. The certificate is the covenant: failing to deliver it is a default in its own right, and a lender that has not received one cannot know the ratios passed.
Agree the reporting calendar with the accountant before agreeing it with the lender. A deadline the accountant cannot meet is a default scheduled in advance.
Practical steps that prevent most of these:
- Before signing, ask the accountant when it can deliver year-end statements at the required level of assurance, and negotiate the deadline to match, with room to spare.
- Ask whether the agreement accepts reviewed rather than audited statements, and accrual-basis internal statements in between.
- Put every reporting date for the life of the loan on one calendar, with the person responsible named.
- Prepare the compliance certificate from the same workbook each quarter, so the calculation matches the agreement's definitions every time.
- If a deadline will be missed, tell the lender before it passes and ask for an extension in writing. Lenders treat an early request very differently from a missed date.
Insurance, taxes and collateral
The next most common problems are the covenants that protect the collateral. Insurance requirements usually specify the types of cover, sometimes minimum limits, and endorsements naming the lender as loss payee on property and additional insured on liability. The endorsement is what lapses: a business switches brokers or carriers to save premium, the new policy is issued without it, and the lender's annual certificate check finds the gap. If the lender requires key person life insurance, the policy must be assigned to it and kept in force.
Taxes matter because unpaid taxes can come ahead of the lender. A federal tax lien can take priority over some of a lender's collateral, and unpaid payroll taxes can also create personal liability for the owners and anyone else responsible for paying them. A company that stretches payroll tax deposits in a tight month has broken an affirmative covenant, and has created a problem every later lender will find in its lien search.
Collateral maintenance covers keeping equipment in working order, keeping inventory where the lender's filings reach it, and, where the lender asked for them, landlord waivers at leased sites. Moving inventory to a new warehouse without telling the lender can leave the collateral outside its lien and its borrowing base.
What happens when one is broken
A breach of an affirmative covenant is an event of default, but most agreements distinguish it from a payment or financial covenant default. Reporting and similar breaches often carry a cure period, which starts either when the breach happens or when the lender gives notice, and runs for a stated number of days. Deliver the statements or reinstate the insurance within that period and the default is cured.
Some affirmative covenants carry no cure period at all, commonly the obligation to give notice of a default or to maintain the company's legal existence. And a breach that is not cured has the full consequences of any default: the lender can stop further advances, charge default interest, and in the end demand repayment. It can also trip a cross-default in the business's other loans and equipment leases, which is how a late set of statements can reach far beyond one lender.
In practice, a lender faced with a late report from a performing borrower usually grants an extension or a waiver, sometimes for a fee. The cost is less the fee than the record: a history of late reporting is one of the things a credit officer notes at renewal, and it weighs on the lender's willingness to be flexible when a real problem comes along.
Negotiating them before closing
Affirmative covenants are less negotiable than financial ones, because most lenders run them from a standard form. The deadlines, the level of assurance for year-end statements, the frequency of interim reporting and field exams, and the materiality thresholds in the notice requirements usually are negotiable, and they are worth the conversation.
The time to raise them is when term sheets are being compared, not after one is signed. A deadline, an assurance level or an exam frequency that differs between two offers is worth weighing alongside the rate. For the documents a lender typically asks for up front, see what lenders need to finance an acquisition and the lender package, which Midas Partners builds in a day once the documents are in.
Common questions
- What is the difference between affirmative and negative covenants?
- Affirmative covenants are things the borrower must do, such as reporting, insuring and paying taxes. Negative covenants are things it must not do without consent, such as taking on more debt, granting liens or paying distributions beyond the agreed baskets.
- Is a late financial statement really a default?
- Yes. Delivery of statements by the deadline is a covenant in its own right. Most agreements allow a cure period, and most lenders will grant an extension if asked before the deadline, but an unremedied late report is an event of default.
- Do asset-based lines have more affirmative covenants than term loans?
- Usually, yes. On top of the standard list, an asset-based line adds borrowing base certificates, receivable and payable agings, inventory reports, field exams and often control of the deposit accounts, because the lender is lending against collateral it has to keep measuring.
- Can affirmative covenants be changed after closing?
- Only by amendment or waiver, which needs the lender's agreement and often a fee. It is far easier to set deadlines and reporting frequency the business can meet at the term sheet stage.
- Which affirmative covenant do companies miss most often?
- Delivery of year-end financial statements at the required level of assurance, because the statements usually depend on an outside accountant whose calendar the lender's deadline was not set around.