A covenant is a pledge, contract, or arrangement between two parties. The two parties agree that specific actions will be taken or not taken as part of the covenant. Covenants define the terms of various contracts, including restrictions on using your property or business, the social compact upheld by the legal system, and limitations established by religion. 

What is a covenant? 

In the finance industry, covenants are typically associated with clauses in a financial contract that specify the maximum amount a borrower can lend again, as in a bond issue or loan instrument. Religious covenants frequently express the symbiotic relationship that exists between divinity and humans. 

Covenants are enforceable agreements between two or more parties that specify each party’s obligations. They can forbid an event or situation (negative covenant) or encourage behaviour to occur (positive covenant).  

Debt covenants, the most prevalent type in loan agreements, impose financial restrictions on the borrower and lender. Covenants are monetary contracts that, if broken, may result in monetary compensation or other legal action. They are found in numerous fields, including finance, real estate, law, and religion, albeit they are applied in various situations within each industry.

Understanding a covenant 

Covenants are a collection of terms that lenders choose and include in a loan or debt arrangement to control how much the borrower must pay them. Usually, the terms are established depending on the borrower’s ability to handle credit. Sometimes, the lenders are willing to lend money, but there is mistrust between them and the borrower.  

As a kind of security against the amount they loan to another party, a covenant, a lender may be a debt holder, investor, or creditor. Businesses that issue bonds to obtain cash take out large loans from lenders. Consequently, they lose interest payments and need help to repay their loan principal. 

Therefore, to ensure that borrowers pay off their loans on schedule, lenders impose limits on them. Furthermore, the agreement transfers authority from bond issuers to bondholders who purchase the debt securities. The borrower is only granted access to the funds if they accept the terms set out by the lender. 

Types of covenants 

The following are the various types of covenants: 

  • Financial covenants 

Covenants are essential in the financial sphere for fostering confidence between lenders and borrowers. They frequently set the conditions that guarantee borrowers meet their responsibilities, governing bonds and loans. These clauses ensure that lenders and borrowers follow specific financial performance standards by defining financial ratios, including debt-to-asset and interest coverage ratios. Lenders are protected by these covenants, ensuring borrowers maintain a particular standard of financial stability. 

  • Legal covenants 

Legal covenants are duties delineated in statutes or contracts. These covenants, which forbid or require particular behaviours, are included in contracts, laws, and regulations. They are crucial in guaranteeing adherence to legal requirements, establishing limits in commercial transactions, and averting possible conflicts or unfavourable consequences. 

  • Property covenants 

Property covenants, also called deed limitations, regulate how real estate is used and kept up to date. They can restrict anything, including the activities permitted on the site and the colour used to paint a dwelling. By preserving the general attractiveness, property values, and functionality of a neighbourhood or community, these covenants guarantee that people have a stable quality of life. 

Importance of covenant 

In the world of finance, covenants are essential because they are contracts that specify the terms and circumstances that apply to both lenders and borrowers. These clauses are critical for reducing risks and guaranteeing the parties’ financial security.  

Covenants protect lenders’ interests in financial instruments like bonds and loans by restricting the borrower’s ability to do specific actions, like raising debt levels, making capital expenditures, or paying dividends. They offer a systematic framework that supports the preservation of accountability, transparency, and the general soundness of the financial relationship.  

Examples of covenant 

A debt covenant is a usual example of a covenant in the finance industry. A lender may include a covenant in a loan agreement that requires the borrower to keep their debt-to-equity ratio at a certain level.  

A covenant might stipulate, for example, that the borrower’s debt cannot exceed three times their equity. The lender may be able to take remedial action, like requiring early repayment or imposing more limitations, if the borrower violates this covenant by exceeding the predetermined ratio. This kind of covenant establishes restrictions on the borrower’s leverage, which helps control risk and guarantees the parties’ financial stability. 

What are financial covenants? 

The limitations on the borrower’s activity imposed by the terms of a loan contract are known as financial covenants. The lender’s interest in debt contracts is safeguarded by it. Furthermore, it offers protection against the likelihood that the borrower won’t be able to meet his financial commitments

How do restrictions on covenants work?

The restrictions on covenants assist lenders in forbidding borrowers from taking any action that would raise the likelihood of defaults on their part. Nonetheless, the cost of borrowing is less than typical when the borrowers are party to such a debt agreement. Therefore, placing a restriction serves as a financial safety net for lenders and borrowers. 

Are covenants legally binding?

The covenantee is allowed to take necessary measures in case of a violation. If landowners violate these conditions, particularly in the real estate context, the contract becomes strictly legally binding and enforceable by the court. 

What do covenants on a property mean?

Covenants imposed on a property limit its uses or establish requirements for its usage. Think of a home that a homeowner’s association covers. The HOA may restrict the owner’s ability to rent out the house or post it on Airbnb. 

What are the covenants in a contract?

A contract can include any covenant one party desires to impose if the other agrees to comply. Both parties must discuss what they need from the other and decide what should and shouldn’t be in the contract during the contracting phase. As several parties may want to be protected in different ways, the covenants mentioned in one contract may be utterly different from those included in another. 

    Read the Latest Market Journal

    Weekly Updates 26/2/24 – 1/3/24

    Published on Feb 28, 2024 20 

    This weekly update is designed to help you stay informed and relate economic and company...

    All-in-One Guide to Investing in China via ETFs

    Published on Feb 27, 2024 72 

    Start trading on POEMS! Open a free account here! Why China? In the vast landscape...

    Navigating the Post-Inflation Landscape in 2024: Top 10 US Markets Key Events to Look out for

    Published on Feb 23, 2024 112 

    Start trading on POEMS! Open a free account here! In 2023, the United States experienced...

    From Boom to Bust: Lessons from the Barings Bank Collapse

    Published on Feb 23, 2024 36 

    Barings Bank was one of the oldest merchant banks in England with a long history...

    Decoding FX CFD 2.0

    Published on Feb 20, 2024 65 

    This article is aimed at availing information and knowledge essential to intermediate forex traders. It...

    Weekly Updates 19/2/24 – 23/2/24

    Published on Feb 19, 2024 88 

    This weekly update is designed to help you stay informed and relate economic and company...

    Unlock Prosperity with 5 Sure-Fire Financial Instruments!

    Published on Feb 14, 2024 197 

    In Singapore, the concept of guaranteed returns may evoke the spirit of prosperity, reminiscent perhaps...

    Weekly Updates 12/2/24 –16/2/24

    Published on Feb 13, 2024 70 

    This weekly update is designed to help you stay informed and relate economic and company...

    Contact us to Open an Account

    Need Assistance? Share your Details and we’ll get back to you


    This material is provided by Phillip Capital Management (S) Ltd (“PCM”) for general information only and does not constitute a recommendation, an offer to sell, or a solicitation of any offer to invest in any of the exchange-traded fund (“ETF”) or the unit trust (“Products”) mentioned herein. It does not have any regard to your specific investment objectives, financial situation and any of your particular needs. You should read the Prospectus and the accompanying Product Highlights Sheet (“PHS”) for key features, key risks and other important information of the Products and obtain advice from a financial adviser (“FA“) pursuant to a separate engagement before making a commitment to invest in the Products. In the event that you choose not to obtain advice from a FA, you should assess whether the Products are suitable for you before proceeding to invest. A copy of the Prospectus and PHS are available from PCM, any of its Participating Dealers (“PDs“) for the ETF, or any of its authorised distributors for the unit trust managed by PCM.  

    An ETF is not like a typical unit trust as the units of the ETF (the “Units“) are to be listed and traded like any share on the Singapore Exchange Securities Trading Limited (“SGX-ST”). Listing on the SGX-ST does not guarantee a liquid market for the Units which may be traded at prices above or below its NAV or may be suspended or delisted. Investors may buy or sell the Units on SGX-ST when it is listed. Investors cannot create or redeem Units directly with PCM and have no rights to request PCM to redeem or purchase their Units. Creation and redemption of Units are through PDs if investors are clients of the PDs, who have no obligation to agree to create or redeem Units on behalf of any investor and may impose terms and conditions in connection with such creation or redemption orders. Please refer to the Prospectus of the ETF for more details.  

    Investments are subject to investment risks including the possible loss of the principal amount invested. The purchase of a unit in a fund is not the same as placing your money on deposit with a bank or deposit-taking company. There is no guarantee as to the amount of capital invested or return received. The value of the units and the income accruing to the units may fall or rise. Past performance is not necessarily indicative of the future or likely performance of the Products. There can be no assurance that investment objectives will be achieved.  

    Where applicable, fund(s) may invest in financial derivatives and/or participate in securities lending and repurchase transactions for the purpose of hedging and/or efficient portfolio management, subject to the relevant regulatory requirements. PCM reserves the discretion to determine if currency exposure should be hedged actively, passively or not at all, in the best interest of the Products.  

    The regular dividend distributions, out of either income and/or capital, are not guaranteed and subject to PCM’s discretion. Past payout yields and payments do not represent future payout yields and payments. Such dividend distributions will reduce the available capital for reinvestment and may result in an immediate decrease in the net asset value (“NAV”) of the Products. Please refer to <> for more information in relation to the dividend distributions.  

    The information provided herein may be obtained or compiled from public and/or third party sources that PCM has no reason to believe are unreliable. Any opinion or view herein is an expression of belief of the individual author or the indicated source (as applicable) only. PCM makes no representation or warranty that such information is accurate, complete, verified or should be relied upon as such. The information does not constitute, and should not be used as a substitute for tax, legal or investment advice.  

    The information herein are not for any person in any jurisdiction or country where such distribution or availability for use would contravene any applicable law or regulation or would subject PCM to any registration or licensing requirement in such jurisdiction or country. The Products is not offered to U.S. Persons. PhillipCapital Group of Companies, including PCM, their affiliates and/or their officers, directors and/or employees may own or have positions in the Products. Any member of the PhillipCapital Group of Companies may have acted upon or used the information, analyses and opinions herein before they have been published. 

    This advertisement has not been reviewed by the Monetary Authority of Singapore.  


    Phillip Capital Management (S) Ltd (Co. Reg. No. 199905233W)  
    250 North Bridge Road #06-00, Raffles City Tower ,Singapore 179101 
    Tel: (65) 6230 8133 Fax: (65) 65383066