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What are protective covenants? Explain with some examples.

Question:

What are protective covenants? Explain with some examples.

Covenants:

Covenant is an agreement or promise between two parties which bind them legally to carry out activities according to terms or to restrict from performing certain activities. The legal agreement is formed to protect the rights of the lender.

Answer and Explanation:

Protective Covenant: Protective covenants are terms of an agreement that defines the actions the borrower should undertake during the period of loan so as to protect the interest of the lender.

Examples of protective covenants are:

1. A protective covenant can be used to protect rights while using residential property. The restriction might be put from conducting any business activity on the property like using it for running office or business from the residential property.

2. A protective covenant can be used by putting a limitation on corporate salaries and dividends. It helps in determining the part of the profit that can be shared with stakeholders and what part will be retained. It protects rights of the lender as interest is paid out of profit, and if more salaries and dividends are declared, than it would default in interest payment.


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Long-Term Debt & the Indenture Agreement

from Finance 101: Principles of Finance

Chapter 7 / Lesson 2
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