A covenant breach rarely arrives without warning. In most companies the forecast starts pointing at it a quarter or two before the compliance certificate is due, and a good deal of the outcome is decided in that gap. Owners who use the time to size the problem and work out what they want from the lender tend to get a workable amendment at a sensible cost. Wait for the test date and you are usually negotiating on the lender's timetable instead.
What happens if you breach a loan covenant
Under most credit agreements, failing a financial covenant is an event of default, sometimes after a short cure period. Depending on the document, the lender may then be able to stop further drawings on a revolver, charge default interest or demand repayment. A default under one facility can also trip cross-default clauses in other loans, equipment finance or leases, so a first breach can matter more than its size suggests.
Lenders seldom move straight to calling a loan over a single covenant miss when the business is still paying interest and the owners are engaged. What usually follows is a negotiation. The breach hands the lender bargaining power, and the cost of resolving it depends heavily on how early and how carefully you handle it.
Every agreement is drafted differently, and the definitions carry more weight than the headline ratios. Have your lawyers take you through the covenant definitions, cure rights and default provisions before you speak to the lender. Nothing in this article is legal advice.
Forecasting covenant headroom
Headroom is the distance between where a covenant ratio will stand at the next test date and the level that triggers a breach. Tracking it means running your forecast through the covenant calculations exactly as the agreement defines them, for at least the next four test dates.
Take a hypothetical company whose agreement caps total debt at 4.0 times EBITDA. It has $40 million of debt and trailing EBITDA of $12 million, so leverage sits around 3.3 times and looks comfortable. If trailing EBITDA slips to $10 million, it is at exactly 4.0 times. Two million dollars of lost earnings is the whole cushion, and with two soft quarters in the forecast the breach may be visible today even though the last certificate passed easily.
Covenant EBITDA is a defined term and often differs from the figure in your management accounts, with its own rules on add-backs and acquisitions. Ratios are usually tested on a trailing twelve-month basis, so one bad quarter stays in the number for a year. And leverage is rarely the only test. Fixed charge cover or minimum liquidity can bite first when cash is tight.
Run a downside case alongside the base case. If the downside breaches and the base case only just passes, start preparing now.
Loan covenant waiver, amendment or forbearance
These terms get used loosely. They do different jobs.
A waiver is the lender agreeing not to treat a specific breach as a default. It covers one test date and leaves the covenant where it was. It suits a one-off miss with a clear cause, such as a delayed contract, where the forecast shows you back inside the covenant at the next test.
An amendment changes the agreement going forward. Typically the covenant levels are reset for several quarters while the business recovers, and the lender uses the occasion to adjust other terms. If your forecast shows the breach recurring, a waiver today would only mean another waiver request in three months.
A forbearance agreement is a different animal. The default stands, and the lender agrees not to enforce its rights for a set period while you meet agreed conditions, often frequent reporting and milestones such as a signed refinancing commitment by a certain date. Lenders generally want the default acknowledged in writing. Forbearance buys time and little else, and when the period ends the lender's rights are still there.
What lenders usually ask for
Lenders expect to be paid for the extra risk and the work. The package varies with the lender, the size of the miss and how far they believe the plan, but requests tend to come from a familiar list:
- A waiver or amendment fee, plus the lender's legal costs.
- Higher pricing, sometimes a step-up that ratchets back down as leverage improves.
- Tighter reporting, often monthly financials and a rolling 13-week cash flow forecast.
- Reset covenant levels with less headroom than you would like.
- Limits on dividends, acquisitions or new debt until the ratios recover.
- Additional security or guarantees where the existing package has gaps.
- New money from the owners. Many agreements include an equity cure, which lets shareholders inject cash that counts toward the covenant calculation, usually with limits on how often it can be used. Whether you have one, and how it works, is a question for the document.
Most of these are negotiable. A lender asking for all of them at once is often telling you how it now sees the credit.
Preparing the conversation with your lender
What a credible plan looks like
Your relationship banker has to write up the request and get it through the lender's credit approval. Your plan is the raw material for that write-up, so make it easy to use.
It should explain plainly what went wrong and whether the cause is temporary or structural. It needs a revised forecast with base and downside cases, run through the covenant definitions, with cash shown month by month. Then the specific actions management is taking, with dates, and a clear statement of what you are asking for.
Ask for enough. Set the requested covenant levels against your downside case, with some room to spare. Going back for a second amendment six months later costs far more goodwill than asking for a little extra headroom the first time.
Mistakes that damage the relationship
The most common one is silence. A lender who learns about a breach from a late compliance certificate, or from a calculation stretched with new add-backs, will discount everything else you tell them. Raise it early with your relationship banker, before any formal paperwork, and bring the numbers with you.
Other habits that cost companies later: promising a recovery the forecast does not support, giving different numbers to different lenders in a shared facility, and changing the story between meetings. Exploring a refinancing is legitimate, but your current lender should not hear about it second-hand.
When refinancing out is the better path
Sometimes the cheapest amendment on offer is still the wrong answer. Moving to a new lender deserves serious thought when your current lender has passed the loan to its workout team or signaled that it wants to exit, when the amendment terms would restrict the business so much that recovery gets harder, or when the original structure no longer fits, for instance amortization the cash flow cannot carry.
Private credit funds and specialty lenders often set covenants differently from banks, and some will lend against assets or recurring revenue in ways a bank will not. That flexibility usually costs more, so compare the all-in cost of each route.
Timing is the catch. A refinancing typically takes a few months, and a new lender will look hard at a company already in default. Often the sensible route is a short waiver or forbearance from the current lender to create the window, with the refinancing run in parallel.
Kenward Partners helps companies here, from building the covenant forecast and lender presentation to negotiating the waiver or amendment itself. Where refinancing makes more sense, we run that process with banks, private credit funds and specialty lenders in the U.S., UK, Europe, Canada and Australia. If you can see a breach coming, it is worth a conversation before the next test date.
