Covenant breach
A covenant breach is a failure by a borrower (or other obligor) to comply with a contractual undertaking in a facility agreement or related finance document. Covenants may be financial (ratios, leverage, interest cover) or operational (use of proceeds, insurance, reporting, restrictions on debt or distributions). Depending on the document, breach may be an immediate event of default or may allow a cure period before default crystallises.
How covenant breach is treated on PF and CRE desks
In project finance, covenants form part of the control framework that sits with the security package. AFME describes security and covenant packages that restrict additional indebtedness, dividend payments, activity, and capital expenditure, and that govern permitted payments through a cash waterfall. IFC project-finance material likewise lists financial covenants ensuring prudent and professional project management within a typical security package. Commercial real estate facilities use analogous tests on leverage, debt yield, occupancy, and cash trap triggers.
When a covenant breach occurs, the credit file turns on classification (financial versus information versus negative pledge style undertaking), materiality, and available remedies: waiver, reset, equity cure, cash sweep tightening, drawdown stop, or acceleration. A cross default clause can transmit the breach into other facilities. A material adverse change clause is a separate contractual trigger and is not the same thing as a quantified ratio breach, though both can sit in the events of default schedule.
Mechanics of financial and non-financial breaches
Financial covenants are usually tested on defined dates against audited or management accounts, using agreed definitions. A common project and infrastructure test is DSCR (debt service coverage ratio). A miss against the required ratio is a covenant breach even if interest continues to be paid, because the undertaking is to maintain the ratio, not merely to avoid payment default.
Non-financial covenants cover conduct and information: delivery of reports, maintenance of insurance, negative pledges, change-of-control restrictions, and limits on amendments to material project or lease documents. Failure to deliver information can be as consequential as a ratio miss if it blocks monitoring or drawdown conditions.
Documentation typically specifies notice, grace or cure periods, equity cure mechanics, and the majority or agent thresholds needed for waiver. Until waived or cured, a continuing covenant breach can suspend revolving availability, block distributions, and entitle lenders to enforce security subject to intercreditor rules.
Distinctions
Payment default is failure to pay principal, interest, or fees when due. Covenant breach is failure to meet an undertaking that may not involve a missed payment. Both can be events of default, but cure paths, pricing consequences, and internal watchlist treatment often differ. Desks therefore record the precise clause breached, the test date, and whether default has been declared or merely reserved.