Role of Debt Covenants

Affirmative Covenants: These are the borrower promises to bond holders, for example, the borrower may be required to maintain a minimum of certain ratios, such as minimum interest coverage ratios, or minimum cash flow levels. The borrower also promises the timely payment of principal and interest.

Negative Covenants: These covenants constrain borrowers form certain activities. They are also called restrictive covenants as they restrict borrower activity. Common restrictive covenants include various limitations on the company’s ability to incur additional debt. Bondholders may want to include limits on the absolute dollar amount of debt that may be outstanding. The bondholders may also want to put a restriction on sale of assets that are pledged as collateral.