Restrictive covenant (finance)

Definition

A restrictive covenant (or negative covenant) is a loan condition restricting borrower actions — capping additional debt, dividends, asset disposals or acquisitions — to safeguard the lender’s position. It complements financial covenants and a negative pledge.

In plain terms

It is a list of "you may not, without our consent". Breaking one is an event of default even if every payment is on time.

Why it matters for your company

Restrictive covenants can quietly limit your strategic freedom — dividends, growth deals, further finance. Read them before you sign. Creditcorp keeps covenants light on its core term products. See financial covenants.

In practice

Picture a UK limited company operating a term facility with a restrictive covenant preventing further borrowing without consent. Trade picks up and a supplier offers extended credit terms tied to a modest asset-backed loan. On paper this looks sensible, but if the existing facility restricts new debt, the director cannot simply proceed — the lender must be approached first, and consent is not automatic.

In a similar scenario, the same company might want to distribute profits to shareholders. If a dividend restriction sits within the loan agreement, that distribution is blocked until the lender agrees or the loan is repaid, even where the company is otherwise trading comfortably and meeting every scheduled payment.

Common pitfalls

Directors sometimes treat covenants as background paperwork rather than live constraints, only discovering the restriction when a corporate transaction — a new funding round, an asset sale, or a group restructuring — is already underway. Reviewing covenant wording alongside the company's medium-term plans, not just its immediate cash position, avoids this trap.

Another pitfall is assuming a covenant only bites at renewal or review points. In fact, as the page notes, a breach is assessed against the terms as they stand at the time of the action, so timing an intended dividend, disposal or refinancing without checking consent requirements first can trigger an event of default unexpectedly.