Divestopedia Explains Negative Covenant
There is a time lag between signing an acquisition agreement and closing due to time-consuming procedures such as obtaining consents and approvals. During the intervening time period, both the buyer and seller have certain obligations toward each other. Even after closing, they agree to do or not to do certain things for a specified period of time. These pre- and post- closing agreements between the buyer and the seller are called covenants, and they are extensively negotiated by the parties involved. Negative covenants are also called restrictive covenants.
The greater the number of negative covenants in a bond issue, the lower the interest rate is on the debt because restrictive covenants make bonds safer in the eyes of investors. Negative covenants protect the purchaser and prevent the seller from taking actions prior to closing that materially alter the firm that the purchaser expects to buy on closing. These include:
- Not changing accounting methods or practices
- Not incurring a liability in excess of a certain amount
- Not paying a dividend or other distributions to stockholders
- Not releasing or waiving rights
- Not amending or terminating contracts or leases
These can also include non-solicitation of offers, non-solicitation of employees, non-competition, etc., which restrict the seller from engaging in activities that would compete with the purchaser after closing for a specific time period or geographic area. The purchaser is similarly restricted from making confidential information related to the seller’s business public.