For businesses in need of debt finance, securing a loan often comes with strings attached. At the heart of many facility agreements lies a crucial element meant to safeguard the financier’s funds—the undertaking provisions. These provisions empower lenders with a sense of control while ensuring borrowers maintain financial discipline. Here’s everything you need to know about these provisions and how they can impact your business.
What Are Undertaking Provisions?
Undertaking provisions, often referred to as 'covenants', are promises made by the borrower to the lender. These promises might involve doing (or refraining from doing) something or ensuring certain actions are executed by third parties within the borrower’s control.
The overarching goal? To protect loan monies and reduce risks by controlling the borrower’s assets and business activities. Undertakings can be divided into three distinct categories:
Financial Covenants
Information Undertakings
General Undertakings
Let’s explore these in detail.
Financial Covenants
What Are Financial Covenants?
Financial covenants are commitments tied directly to a borrower’s financial health. They provide the lender with assurance that the borrower will maintain stability and avoid taking undue financial risks while the loan is outstanding. These covenants fall into two main types:
Maintenance Covenants – Ongoing obligations that the borrower must continuously meet (e.g., maintaining a specific leverage ratio).
Incurrence Covenants – Triggered only when the borrower engages in specific actions, such as acquiring new debt.
Forms of Financial Covenants
To give lenders greater visibility and control, financial covenants often involve measurable limits and ratios, such as:
Leverage Ratio – Ensures the borrower’s debt level stays manageable.
Interest Cover Ratio – Helps confirm the borrower’s ability to cover interest payments.
Cashflow Cover Ratio – Ensures sufficient liquidity to meet obligations.
Cashflow-to-Net Debt Service Ratio – Tracks the borrower’s ability to service debt.
Other common limits include:
Minimum Net Worth – Ensures the borrower keeps a healthy equity base.
Capital Expenditure Caps – Prevents excessive, unchecked investments.
Borrowing Limits – Controls how much additional debt the borrower can take.
By meeting these parameters, borrowers reassure lenders of their financial stability and capability.
Information Undertakings
While financial covenants act as safeguards, they are ineffective without up-to-date insights into the borrower’s financial performance. That’s where information undertakings come in—they require the borrower to provide consistent updates.
Key Information Lenders Require:
Year-End Accounts – For a summary of financial health over the year.
Management Accounts – To track operational performance metrics.
Forecasts – Projections of financial performance, including potential risks and opportunities.
Compliance Certificates – Validation that the borrower complies with financial covenants.
These provisions allow lenders to monitor the borrower closely, identifying signs of distress early to mitigate risks.
General Undertakings
General undertakings encompass a broad set of promises made by the borrower, which can be divided into two categories:
Positive Undertakings
These require proactive actions from the borrower, ensuring critical safeguards are in place. Examples include:
Insurance – Borrowers must keep major assets insured, protecting the lender’s security.
Consents, Licenses, and Laws – Borrowers must maintain any required permissions to operate legally and meet their repayment obligations.
Access to Information and Assistance – A lender may request access to premises, books, or records.
Negative Undertakings
Negative undertakings, on the other hand, restrict borrowers from specific actions that could jeopardize financial stability. Key examples include:
Negative Pledge – Bans the borrower from creating security interests on assets, except for the financier.
Pari Passu Ranking – Requires the financier’s claims to rank equally with other unsecured creditors.
Disposals and Acquisitions – Restricts asset disposals beyond normal business activity to prevent liquidity problems.
Lending Restrictions – Ensures borrowers avoid making risky loans that could deplete cash flow.
Shares and Dividends – Limits distribution of profits to shareholders in some cases, preserving the borrower’s financial position.
These clauses work collectively to maintain transparency and mitigate risks.
Why Do Lenders Need Undertaking Provisions?
From a lender’s perspective, undertakings are pivotal for maintaining trust and control. By defining clear expectations, lenders can safeguard assets and ensure that borrowers remain financially disciplined, ultimately protecting their investment.
Meanwhile, for borrowers, honoring undertaking provisions strengthens their relationship with the lender, paving the way for greater flexibility in the future.
Key Considerations for Borrowers
If you're entering a loan agreement, here are essential tips to keep in mind:
Understand the Terms: Know the exact commitments you’re making with each undertaking.
Negotiate Flexibility: Seek carve-outs from prohibitive clauses like the negative pledge to avoid unnecessary operational constraints.
Monitor Compliance: Regularly evaluate your financial and operational performance to meet all provisions.
Maintain Transparency: Keep an open line of communication with your lender to foster trust and increase collaboration.
Final thoughts
Undertaking provisions serve as the backbone of any loan agreement, balancing the lender’s need for security with the borrower’s need for flexibility. For business owners and entrepreneurs, understanding and honoring these provisions is crucial in navigating financial partnerships and building long-term success.
Have questions about your loan agreement? For more insights and personalised advice, reach out to Jamie Tredgold and David Wloszczowski.
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This material is provided for general information only. It should not be relied upon for the provision of or as a substitute for legal or other professional advice.
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