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Negative and affirmative covenants

Negative covenants prohibit actions. Affirmative covenants require them. Together, they define the operating constraints and reporting obligations you’ll live with throughout the facility life.

Unlike portfolio covenants (which measure collateral) or financial covenants (which measure your balance sheet), negative and affirmative covenants govern behavior. Capital providers use them to ensure you don’t change the business, transfer value to equity holders, or surprise them with material developments.

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Negative covenants

Negative covenants are restrictions on what you can’t do without lender consent. The most impactful ones limit changes to ownership, distributions to equity, and additional debt.

Change of control

Change of control provisions require lender consent before significant ownership transfers.

Typical definition:

"Change of Control" means (i) the acquisition by any Person or group of Persons
of more than 50% of the voting equity interests of the Originator, (ii) any
merger, consolidation, or reorganization in which the Originator is not the
surviving entity, or (iii) a sale of all or substantially all assets...

What triggers change of control:

Event	Usually Triggers	Sometimes Triggers	Usually Does Not Trigger
Majority sale (>50%)	Yes
Full acquisition	Yes
Merger (not surviving)	Yes
Asset sale (substantially all)	Yes
Minority investment (<50%)		Case by case	Yes
Management change		If tied to equity	Usually no
IPO		Depends on structure	Often carved out

Negotiation points:

Issue	Capital Provider Position	What to Push For
Threshold	50% ownership change	Higher threshold (66.7%) or change in control person
Consent standard	Consent required	”Not to be unreasonably withheld” language
Carve-out	None	No consent if facility repaid in full at closing
IPO treatment	Requires consent	Automatic consent for qualifying IPO
Time to respond	No deadline	30-day deemed consent if no response

Change of control provisions rarely kill deals, but they can delay M&A. A buyer conducting diligence will identify the consent requirement and factor the timeline into their offer. Get consent language that’s efficient to execute.

Restricted payments

Restricted payment covenants limit dividends, distributions, and equity redemptions. They prevent value extraction during stress.

Typical structure:

The Originator shall not make any Restricted Payment unless:
(i) no Default or Event of Default exists or would result therefrom,
(ii) after giving pro forma effect thereto, the Originator remains in
compliance with all financial covenants, and
(iii) the aggregate amount of Restricted Payments in any fiscal year
does not exceed [50%] of Net Income for the immediately preceding year...

What counts as restricted payments:

Payment Type	Usually Restricted	Sometimes Restricted	Usually Permitted
Dividends	Yes
Share buybacks	Yes
Distributions to parent	Yes
Subordinated debt payments		Yes
Management fees to affiliates		Yes
Arm’s length compensation			Yes
Tax distributions (pass-through)			Usually carved out

Carve-outs to negotiate:

Carve-out	Purpose	Typical Cap
Tax distributions	Pass-through entities need to distribute for owner taxes	At applicable tax rate
Management fees	Reasonable fees to sponsors or affiliates	$X per year or % of revenue
De minimis distributions	Minor shareholder liquidity	$100K-$500K annually
Dividends if excess liquidity	Allow distributions when overcapitalized	If liquidity exceeds 2x minimum

Additional indebtedness

Debt covenants restrict your ability to incur additional borrowings. They protect the capital provider’s priority position and your ability to service existing obligations.

Typical language:

The Originator shall not incur, create, assume, or permit to exist any
Indebtedness other than (i) the Obligations, (ii) purchase money debt and
capital leases not exceeding $[X] in aggregate, (iii) subordinated debt
expressly subordinated to the Obligations...

Common permitted debt baskets:

Category	Typical Basket	Notes
Trade payables	Ordinary course, no cap	Must be current
Equipment financing	$500K-$2M	For owned equipment only
Capital leases	$1M-$5M	Combined with equipment
Subordinated debt	Uncapped if properly subordinated	Subordination agreement required
Future ABF facilities	Case by case	Non-recourse only
Credit card/working capital	$500K-$1M	Unsecured only

Key negotiation: future ABF facilities

If you’re planning multiple facilities (e.g., different asset classes or geographic markets), negotiate upfront for permission to enter into future non-recourse asset-backed facilities. The carve-out should specify:

• Must be non-recourse to the originator
• Must be secured only by assets not pledged to this facility
• May require notice but not consent

Liens and negative pledges

Lien covenants prevent you from pledging assets that support your ability to perform under the facility.

What capital providers want to prevent:

Asset Category	Why It Matters
Cash and bank accounts	Your liquidity supports operations
Intellectual property	Core to platform and operations
Equity in subsidiaries	Structural subordination risk
Intercompany receivables	Source of parent cash flow
Assets not in the pool	Potential future collateral

Permitted liens to negotiate:

Lien Type	Standard	Rationale
Purchase money	Yes	Doesn’t affect existing assets
Carrier/warehouseman liens	Yes	Arising by operation of law
Tax liens (contested)	Yes	If actively being contested
Judgment liens	Under cap	Usually $250K-$1M
Deposit liens	Yes	Banks require for accounts
Future non-recourse ABF liens	Push for	On unrelated collateral

Fundamental changes

Fundamental change covenants restrict structural modifications to your business.

Typically prohibited:

Change	Requires Consent	Why
Merger or consolidation	Yes	Changes legal entity and credit
Asset sales outside ordinary course	Yes	Depletes enterprise value
Dissolution or liquidation	Yes	Ends the business
Change of business	Yes	You’re no longer what they underwrote
Change of fiscal year	Usually	Affects reporting and testing timing
Amendments to organization docs	Sometimes	Depends on materiality

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Affirmative covenants

Affirmative covenants are things you must do. They fall into reporting requirements, operational standards, and notification obligations.

Reporting covenants

Deliverable	Typical Deadline	Level of Detail
Monthly collateral report	15 business days after month-end	Pool statistics, eligibility, concentrations
Monthly servicer report	15 business days after month-end	Collections, delinquencies, modifications
Quarterly financials	45-60 days after quarter-end	Full financial statements
Annual audited financials	90-120 days after year-end	Audited by acceptable accountant
Compliance certificate	With financials	Officer certification of covenant compliance
Borrowing base certificate	With each advance request	Eligible assets, advance calculation

Common pitfalls:

• Missing a deadline by a day can be a technical default. Build calendar reminders with buffer time.
• The compliance certificate is a legal representation. Verify every number before signing.
• “Acceptable to Lender” for auditors typically means national or regional firm. Confirm upfront.

Operational covenants

Requirement	Typical Standard
Maintain existence	Keep all licenses, qualifications, authorizations
Pay taxes	Timely payment unless contested in good faith
Maintain insurance	As specified in insurance schedule
Maintain books and records	Consistent with past practice and GAAP
Comply with laws	All material laws, including origination licensing
Maintain servicing capability	Personnel, systems, procedures
Preserve collateral	Service per servicing agreement standards

Notification covenants

You must notify the capital provider promptly (typically 3-5 business days) of material events.

Events requiring notification:

Event Category	Examples
Defaults	Any Default or Event of Default, or condition likely to become one
Litigation	Any lawsuit above threshold (typically $250K-$1M)
Regulatory	Any investigation, enforcement action, or license issue
Tax	Any material tax deficiency or audit
Insurance	Any material claim or coverage change
Material adverse change	Any event that materially affects business or ability to perform
Servicer issues	Any servicer default, rating downgrade, or replacement

The “material adverse change” notification is broad and subjective. When in doubt, disclose. It’s better to over-notify than to have the capital provider discover a material event you should have disclosed.

Access and inspection

Capital providers require rights to inspect your business, records, and collateral.

Typical provisions:

Right	Standard Terms
Book and record inspection	Upon reasonable notice, during business hours
Collateral inspection	Annual at minimum, more frequently if issues
System access	Read-only access to servicing system
Management meetings	Quarterly or as reasonably requested
Auditor communication	Right to communicate with your auditors
Third-party reports	Copies of any ratings, audits, or diligence reports

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Negotiating operational covenants

Reporting burden

The reporting burden in ABF facilities can be substantial. Negotiate for:

Issue	Push For
Deadline timing	20 business days instead of 15 for monthly reports
Grace periods	3-5 business day cure for late delivery
Format flexibility	Reasonable format acceptable vs. prescribed templates
Consolidation	Combined reporting for multiple facilities with same lender
Automation	API or system access in lieu of manual reports

Notice thresholds

Negotiate materiality thresholds that make sense for your business:

Item	Typical Threshold	What to Push For
Litigation	$100K-$250K	$500K-$1M for larger originators
Tax matters	Any material	Above $X or contested claims only
Insurance claims	Above deductible	Above $X or material
Regulatory	Any investigation	Formal proceedings only

Negative covenant baskets

Baskets are the permitted exceptions to negative covenants. Negotiate baskets sized for your actual business needs plus growth.

Basket sizing approach:

1. Current usage: What are your current levels of the restricted activity?
2. Growth buffer: Add 50-100% for business growth
3. Specific needs: Identify any planned activities that require capacity
4. Rollover vs. annual: Annual baskets reset; cumulative baskets do not

Example—capital expenditure basket:

Factor	Analysis
Current capex	$1.5M annually
Planned growth	$2.5M next year
Technology upgrade	$1M one-time
Basket to negotiate	$4M annual or $5M cumulative

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Interaction with events of default

Negative and affirmative covenant breaches typically flow to events of default with different severity.

Covenant Type	Typical Treatment
Financial covenants	Default with 30-day cure period
Reporting covenants	Default with 5-10 day cure period
Notification covenants	Default with 5 day cure period (if curable)
Change of control	Immediate Event of Default
Fundamental change	Immediate Event of Default
Restricted payments (while in default)	Immediate Event of Default
Other negative covenants	Default with 30-day cure (if curable)

Some negative covenant breaches are not curable. If you complete a change of control without consent, you can’t undo it. The breach is permanent and the only remedy is negotiating a waiver or paying off the facility.

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Common pitfalls

Missing reporting deadlines. Late delivery of monthly reports or compliance certificates is one of the most common technical defaults. Build a compliance calendar with internal deadlines 5-7 days before contractual deadlines.

Signing certifications without verification. The compliance certificate requires officer certification of covenant compliance. Build a system that generates covenant calculations automatically—don’t rely on manual spreadsheet work under deadline pressure.

Underestimating basket usage. Baskets fill faster than expected. If your permitted debt basket is $2M and you’re at $1.8M, you have no capacity for ordinary course needs. Track basket usage monthly.

Not reading the carve-outs. The negative covenant says you can’t incur debt. But the carve-outs list what you can do. Read the carve-outs carefully—many activities that seem prohibited are actually permitted under specific conditions.

Forgetting about subsidiary restrictions. Covenants often apply to the originator “and its Subsidiaries.” Actions at subsidiary level can breach originator-level covenants. Ensure your subsidiary activities are coordinated with covenant monitoring.

Treating notification as optional. When a potentially notifiable event occurs, the question isn’t whether to notify but when. Delayed notification that the capital provider later discovers creates trust issues. When in doubt, notify promptly.

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Related topics

• Covenants overview — the five covenant categories and how they interact
• Financial covenants — tangible net worth, liquidity, and leverage tests
• Covenant cures and waivers — what happens when covenants are breached
• Servicing covenants — performance standards for the servicer