Content area
Abstract
The article begins with the provisions themselves - first affirmative covenants and financial covenants, and then restrictive covenants. The discussion explains the drafting pattern by reference to both the legal framework and the financial economics of the agency costs of debt. There emerges a unitary picture of the entire collection of covenants used in practice. The article continues by situating the covenants in transactional context, drawing on empirical studies from financial economics. Incidence varies considerably, from near absence to pervasive coverage, depending not only on the borrowers creditworthiness but on the credit market segment in which the borrowing occurs. Tight and pervasive coverage tends to presuppose relational lending, whether in the bank or private placement market. In the public bond markets, where arms-length contracting prevails, coverage lends to be loose and sporadic. The article then takes up a variant on the theme of constraint by promise, looking at provisions that trigger loan prepayment upon events customarily covered in the full set of covenants, explaining why mandatory pay down sometimes emerges as a superior choice to prohibition by promise.