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Between Financial Discipline and Grey Areas
In corporate financing, contractual clauses — often called covenants — play a role that is discreet but essential. They structure the relationship between lender and borrower, protect each party’s interests, and create a framework for financial discipline. Yet people often forget what they really imply: constraints, risks of unintentional trigger events, but also a way to avoid misunderstandings in times of stress.
Let’s dive into the architecture of these clauses, highlighting what many people (wrongly) assume, what they actually guarantee, and how they shape the life of a financed company.
1. Negative covenants: what the company undertakes not to do
A negative covenant is designed to prevent the borrower from taking certain actions without the lender’s consent.
In principle:
It prohibits decisions that could deteriorate the company’s solvency or value.
In practice (the real nuance):
Many companies believe they retain broad autonomy and that these clauses only apply to “extreme” decisions.
Common mistake: some wordings are so broad that a simple leasing contract or an intra-group loan can amount to a breach.
Common examples:
- prohibition on incurring additional debt;
- prohibition on creating additional pledges or mortgages;
- prohibition on selling a strategic asset without consent;
- prohibition on granting loans to third parties.
What a prudent lender monitors:
Negative covenants protect against risk dilution.
But if they are too strict, they can become counterproductive and hinder growth.
2. Positive covenants: what the company undertakes to do
These clauses require the borrower to comply with certain proactive behaviours.
Typical objectives:
- providing financial statements on time;
- maintaining adequate insurance;
- complying with financial ratios (liquidity, leverage, EBITDA/interest, DSCR).
A misconception to correct:
A positive covenant is not just an administrative formality.
Some of them, such as compliance with financial ratios, can trigger an event of default even if the company is profitable but going through an atypical quarter.
Why lenders insist on these clauses:
They allow early detection of risks, well before a payment default.
They are the banking equivalent of warning lights in a cockpit.
3. The pari passu clause: equality… but not absolute fairness
The pari passu clause ensures that the relevant debt will rank equally with other existing unsecured debt.
What companies believe:
“Pari passu = all creditors are treated identically.”
Not exactly.
In reality:
- it protects against undisclosed contractual subordination;
- it does not protect against secured creditors (mortgages, pledges);
- it does not require simultaneous payment, but non-discriminatory treatment.
In structured finance:
It must be coupled with a negative pledge.
Otherwise, the borrower can grant security to a new lender → that new lender becomes de facto senior.
4. Dividend stopper: discipline or rigidity?
This clause prohibits or limits the distribution of dividends as long as the debt has not been repaid or the covenants have not been met.
Economic logic:
It prevents cash from being paid out that should primarily be used to service the debt.
Legitimate counter-argument:
In international groups, this clause can complicate cash pooling or dividend upstreaming to a holding company, even when the business is in excellent health.
What a lender is looking for here:
Cash-flow stability.
But too much rigidity can hinder strategic development.
5. Global assignment of receivables: the lender’s ultimate weapon
Very common in Swiss, German or Austrian contracts, this clause transfers to the lender all or part of the trade receivables (global assignment).
Useful effect:
- secures the debt against a liquid asset;
- reduces the lender’s risk;
- can justify a lower interest rate.
But beware:
It can become an operational brake:
- the company must inform its debtors if the assignment is enforced;
- it partially loses control over its cash flow;
- it can alarm business partners in times of crisis.
Critical analysis:
This is a powerful clause, but it needs to be handled with precision.
A borrower often overestimates their comfort with such an assignment… until the first cash-flow tension.
6. Material Adverse Change (MAC) clause
Even if it was not initially requested, this is one of the most feared clauses.
It allows the lender to suspend the credit line if a significant event adversely affects the company.
Fundamental issue:
The MAC is often subjective, creating an asymmetry of power.
In negotiation:
It should be framed with:
- quantitative thresholds,
- objective criteria,
- exclusions (e.g. general macroeconomic turmoil).
7. Why these clauses must be read as a system, not in isolation
A good credit agreement is based on a balance:
- too few clauses = the lender takes excessive risk → higher rate or refusal;
- too many clauses = the borrower is in constant breach → legal instability.
The real strength of a well-negotiated financing is to have covenants that are:
- relevant,
- measurable,
- proportionate,
- aligned with operational reality.
This is precisely where a player like PrestaFlex creates value: turning a potentially conflictual relationship into a clear, stable and intelligent pact between the company and its financiers.
Conclusion: clauses are not obstacles, but rational safeguards
Properly understood, negotiated and calibrated, they become:
- tools for transparency,
- protection mechanisms,
- signals of mutual trust.
Misunderstood, they turn into legal landmines.
In an increasingly demanding financial landscape – IFRS covenants, liquidity ratios, prudential requirements, rise of alternative financing – mastering these clauses is no longer a bonus: it is a strategic necessity.
An article by Munur Aslan, Managing Director at PrestaFlex
See also our articles Corporate financing Zurich and Corporate financing Geneva for a broader perspective.
Between Financial Discipline and Grey Areas
In corporate financing, contractual clauses — often called covenants — play a role that is discreet but essential. They structure the relationship between lender and borrower, protect each party’s interests, and create a framework for financial discipline. Yet people often forget what they really imply: constraints, risks of unintentional trigger events, but also a way to avoid misunderstandings in times of stress.
Let’s dive into the architecture of these clauses, highlighting what many people (wrongly) assume, what they actually guarantee, and how they shape the life of a financed company.
1. Negative covenants: what the company undertakes not to do
A negative covenant is designed to prevent the borrower from taking certain actions without the lender’s consent.
In principle:
It prohibits decisions that could deteriorate the company’s solvency or value.
In practice (the real nuance):
Many companies believe they retain broad autonomy and that these clauses only apply to “extreme” decisions.
Common mistake: some wordings are so broad that a simple leasing contract or an intra-group loan can amount to a breach.
Common examples:
- prohibition on incurring additional debt;
- prohibition on creating additional pledges or mortgages;
- prohibition on selling a strategic asset without consent;
- prohibition on granting loans to third parties.
What a prudent lender monitors:
Negative covenants protect against risk dilution.
But if they are too strict, they can become counterproductive and hinder growth.
2. Positive covenants: what the company undertakes to do
These clauses require the borrower to comply with certain proactive behaviours.
Typical objectives:
- providing financial statements on time;
- maintaining adequate insurance;
- complying with financial ratios (liquidity, leverage, EBITDA/interest, DSCR).
A misconception to correct:
A positive covenant is not just an administrative formality.
Some of them, such as compliance with financial ratios, can trigger an event of default even if the company is profitable but going through an atypical quarter.
Why lenders insist on these clauses:
They allow early detection of risks, well before a payment default.
They are the banking equivalent of warning lights in a cockpit.
3. The pari passu clause: equality… but not absolute fairness
The pari passu clause ensures that the relevant debt will rank equally with other existing unsecured debt.
What companies believe:
“Pari passu = all creditors are treated identically.”
Not exactly.
In reality:
- it protects against undisclosed contractual subordination;
- it does not protect against secured creditors (mortgages, pledges);
- it does not require simultaneous payment, but non-discriminatory treatment.
In structured finance:
It must be coupled with a negative pledge.
Otherwise, the borrower can grant security to a new lender → that new lender becomes de facto senior.
4. Dividend stopper: discipline or rigidity?
This clause prohibits or limits the distribution of dividends as long as the debt has not been repaid or the covenants have not been met.
Economic logic:
It prevents cash from being paid out that should primarily be used to service the debt.
Legitimate counter-argument:
In international groups, this clause can complicate cash pooling or dividend upstreaming to a holding company, even when the business is in excellent health.
What a lender is looking for here:
Cash-flow stability.
But too much rigidity can hinder strategic development.
5. Global assignment of receivables: the lender’s ultimate weapon
Very common in Swiss, German or Austrian contracts, this clause transfers to the lender all or part of the trade receivables (global assignment).
Useful effect:
- secures the debt against a liquid asset;
- reduces the lender’s risk;
- can justify a lower interest rate.
But beware:
It can become an operational brake:
- the company must inform its debtors if the assignment is enforced;
- it partially loses control over its cash flow;
- it can alarm business partners in times of crisis.
Critical analysis:
This is a powerful clause, but it needs to be handled with precision.
A borrower often overestimates their comfort with such an assignment… until the first cash-flow tension.
6. Material Adverse Change (MAC) clause
Even if it was not initially requested, this is one of the most feared clauses.
It allows the lender to suspend the credit line if a significant event adversely affects the company.
Fundamental issue:
The MAC is often subjective, creating an asymmetry of power.
In negotiation:
It should be framed with:
- quantitative thresholds,
- objective criteria,
- exclusions (e.g. general macroeconomic turmoil).
7. Why these clauses must be read as a system, not in isolation
A good credit agreement is based on a balance:
- too few clauses = the lender takes excessive risk → higher rate or refusal;
- too many clauses = the borrower is in constant breach → legal instability.
The real strength of a well-negotiated financing is to have covenants that are:
- relevant,
- measurable,
- proportionate,
- aligned with operational reality.
This is precisely where a player like PrestaFlex creates value: turning a potentially conflictual relationship into a clear, stable and intelligent pact between the company and its financiers.
Conclusion: clauses are not obstacles, but rational safeguards
Properly understood, negotiated and calibrated, they become:
- tools for transparency,
- protection mechanisms,
- signals of mutual trust.
Misunderstood, they turn into legal landmines.
In an increasingly demanding financial landscape – IFRS covenants, liquidity ratios, prudential requirements, rise of alternative financing – mastering these clauses is no longer a bonus: it is a strategic necessity.
An article by Munur Aslan, Managing Director at PrestaFlex
See also our articles Corporate financing Zurich and Corporate financing Geneva for a broader perspective.
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