Negative covenants: Overview, definition and example
What are negative covenants?
Negative covenants are contractual promises that restrict one party from engaging in certain activities or actions without the other party’s consent. These clauses are designed to protect the interests of one party by preventing behaviors that could harm the agreement or its intended outcomes.
For example, a negative covenant in a loan agreement might prohibit the borrower from taking on additional debt without the lender’s approval to ensure the borrower’s financial stability.
Why are negative covenants important?
Negative covenants are important because they safeguard the rights and interests of one party by setting clear boundaries for the other’s actions. These provisions help maintain trust, minimize risk, and ensure the agreement’s objectives are met.
In business contexts, negative covenants are commonly used in loan agreements, partnership agreements, and mergers to prevent activities that could jeopardize financial performance, ownership rights, or operational stability.
Understanding negative covenants through an example
A business takes out a loan from a bank. The loan agreement includes a negative covenant prohibiting the business from selling key assets without the bank’s prior approval. This ensures the borrower maintains sufficient resources to repay the loan, protecting the lender’s interests.
An example of a negative covenant clause
Here’s how a negative covenant might appear in a contract:
“The Borrower agrees not to incur additional indebtedness, sell or transfer any material assets, or enter into any agreements that could materially affect the Borrower’s financial position without the prior written consent of the Lender.”
Conclusion
Negative covenants are crucial for defining boundaries in contracts, helping to protect the interests of one party while ensuring the other complies with agreed restrictions. By clearly outlining prohibited actions, these clauses reduce risks, foster trust, and support the successful fulfillment of the agreement’s objectives. Including well-drafted negative covenants is a key element of effective contract management.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.