You've breached a covenant, or you're about to. What happens next.

Recognition

The numbers won't pass the next test

It usually shows up in the management accounts before anyone says it aloud. Leverage has crept above the ratio in the agreement, interest cover has dropped under it, or a minimum net worth or EBITDA figure won't be met at the next measurement date. Sometimes it has already happened and the covenant certificate is due in a fortnight. Either way, the question is the same: what can the lender do now, and what should you do first?

What a breach actually is

A contract term, not a legal event

No statute sets what happens when a financial covenant fails. The facility agreement does. In most agreements a failed financial covenant is an event of default, sometimes immediately and sometimes after a short remedy period, and an event of default typically lets the lender do some or all of the following:

• Accelerate. Declare the loan, or part of it, due now rather than on the agreed schedule.
• Stop lending. Cancel undrawn commitments and refuse further drawings, which is often the part that hurts first on a revolving or overdraft facility.
• Charge more. Default interest or a higher margin while the default continues, if the agreement provides for it.
• Move towards the security. Under the debenture, a default can make the security enforceable, and in some debentures it is also a trigger for a floating charge to crystallise. A lender holding a qualifying floating charge has its own route to appointing an administrator.

Before the test date

What to read in your own agreement, in this order

• The definitions. Covenants are tested on the agreement's own definition of EBITDA, debt or net worth, not the figure in your statutory accounts. Add-backs, exceptional items and lease treatment can move the result, and sometimes a projected breach isn't one.
• The test dates and the certificate deadline. The breach happens on the measurement date; the lender usually learns of it from the certificate. The gap between the two is your window.
• Cure and remedy rights. Some agreements let shareholders inject funds to cure a financial covenant breach, or give a period to remedy it. Many smaller facilities have neither. Know which yours is.
• Notification duties. Many agreements require you to notify a default, or a potential default, once you know. Staying quiet can itself be a separate breach.

Not every default is financial. A company that falls behind on its Companies House filings, including the new director identity verification, can run into the agreement's non-financial undertakings instead: see Companies House identity verification and your lender.

The usual outcome

Waiver, reset, and what they cost

Most lenders would rather keep a viable borrower than enforce against it, so the common outcome is a waiver of the specific breach or an amendment that resets the covenant levels. Neither is free. Expect some mix of a waiver or amendment fee, a higher margin, closer reporting (monthly management accounts and cash flow forecasts rather than quarterly), tighter terms elsewhere in the agreement, and, where the lender is more worried, the account moving to its business support or restructuring team. None of those figures is standard; they are negotiated case by case.

What decides how that negotiation goes is mostly what the lender is shown: a clear reason for the miss, a forecast that shows when the numbers recover, and evidence the business is still generating cash. The facility review pack checklist covers the same material a lender asks for at an annual review, and it is most of what a waiver request needs too.

If the existing lender won't play

When refinancing is realistic, and when it isn't

• A one-off or technical breach in a sound business. A lender that tests something else can be the answer. An asset-based facility lends against debtors, stock and plant rather than being sized mainly on a profit multiple, which can suit a business whose earnings dipped but whose assets and trading did not.
• A breach caused by the facility itself. Covenants set for a business that has since changed shape (a growth spurt, an acquisition, a new contract mix) can be a facility mismatch rather than a credit problem.
• A breach that reflects a business that can't service its debt. Refinancing only moves the problem to a new lender, and a new lender will usually see that. This is where the question changes.

Any refinance has to repay and release the existing security, so its cost belongs in the comparison from the start. The facility switch cost estimator adds up exit, break, legal and release costs from your own agreements.

When it stops being a finance question

If the company may not be able to pay its debts

A covenant breach on its own says nothing about solvency. But if the breach is a symptom of a company that can't meet its debts as they fall due, the directors' position changes. The duty to promote the company's success has effect subject to any rule requiring directors to consider or act in the interests of creditors (Companies Act 2006, section 172(3)). Wrongful trading under section 214 of the Insolvency Act 1986 turns on when a director knew or ought to have concluded there was no reasonable prospect of avoiding insolvent liquidation or insolvent administration, and the defence is having taken every step with a view to minimising the potential loss to creditors from that point.

Adding new secured debt at that stage is not a neutral act, and it is not something we will help arrange. The right first call is a licensed insolvency practitioner; the Insolvency Service's find an insolvency practitioner search on GOV.UK lists them. What happens to the lender's security in that case is covered on charges and insolvency.

Decision helper

Limits of this page

Covenant terms, default rights, remedy periods and cure rights vary between agreements and lenders, and what a lender does with a breach depends on its view of the business. This page describes the common pattern, not your agreement. Established Finance is an introducer, not a lender, and this is information rather than legal or insolvency advice.