Covenants in Contracts: Promises to Act or Refrain
What Is a Covenant?
In contract law, a covenant is a binding promise to do something (an affirmative covenant) or to refrain from doing something (a negative or restrictive covenant). Unlike representations and warranties, which state that something is true, covenants are forward-looking obligations.
Types of Covenants
Affirmative covenants require action:
- Maintaining insurance coverage throughout the contract term
- Providing quarterly financial statements
- Complying with applicable laws
- Notifying the other party of material changes
Negative (restrictive) covenants prohibit action:
- Non-compete covenants (not working for competitors)
- Non-solicitation covenants (not recruiting the other party's employees or customers)
- Not incurring debt above certain thresholds
- Not selling or encumbering specific assets
Covenants vs. Representations and Warranties
- Representations and warranties confirm that facts are true at a point in time.
- Covenants are ongoing obligations to do or not do something over the contract period.
For example: "The borrower represents that it has no outstanding tax liens" (rep/warranty about the present). "The borrower covenants to pay all taxes when due" (ongoing obligation).
Common Contexts
- Loan agreements. Financial covenants (debt-to-equity ratios, minimum cash balances) protect lenders from borrower risk.
- Real estate. Restrictive covenants limit property use (residential only, no commercial activity).
- Employment agreements. Non-compete and non-solicitation covenants restrict post-employment activities.
- M&A agreements. Pre-closing covenants govern how the target company operates between signing and closing.
What to Watch For
- Overly restrictive negative covenants. In employment, broad non-competes can prevent you from earning a living. In lending, strict financial covenants can trigger default during normal business fluctuations.
- Vague affirmative covenants. Obligations like "use best efforts" or "act reasonably" without clear standards create ambiguity about compliance.
- Remedies for breach. Understand what happens if you breach a covenant — termination, acceleration, waiver, or damages.
When to Consult a Lawyer
Consider consulting an attorney before agreeing to restrictive covenants that limit your business activities, especially non-competes in employment or financial covenants in loan agreements.
This article is for informational purposes only and does not constitute legal advice. Consult a licensed attorney for guidance specific to your situation.