Affirmative Covenants require the issuer to perform certain actions. The common ones are:
Negative covenants call upon the issuer not to perform certain actions. The main ones are limitations on taking on additional borrowings that would potentially compromise the ability of the issuer to keep its promises to the current bondholders, unless certain tests are met. These tests may include leverage level, liquidity level, etc.
It is in the bondholders’ interest to impose the strictest restrictions on the borrowers, whereas the borrowers would prefer the least restrictive loan agreement. A balance is struck and diligently set out in an indenture. The balance will be a trade-off between interest costs and the restrictions. Failure to adhere to the covenants may be considered a violation or a default situation.
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