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A debt covenant is a legally binding agreement between a borrower and a lender, setting specific operational rules and restrictions to protect the lender's interests and ensure the borrower's financial stability. These covenants can be positive (affirmative), requiring the borrower to fulfill certain obligations; negative (restrictive), preventing high-risk actions without approval; and financial, involving the maintenance of specified credit ratios and operational metrics.
Negotiating debt covenants is essential for aligning the interests of borrowers and lenders. Effective negotiation strategies include:
Violating a debt covenant can trigger penalties such as increased interest rates or demands for immediate loan repayment. Lenders might waive a violation under certain conditions, allowing the borrower to avoid stringent penalties while addressing financial or operational challenges. Such waivers can offer temporary relief but may also lead to adjustments in the lender’s risk assessment.
Compliance with debt covenants is crucial for maintaining a stable and mutually beneficial financial relationship between borrowers and lenders. Key benefits include:
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