Posted in Finance, Accounting and Economics Terms, Total Reads: 35
Definition: Negative Covenant
Negative Covenant in a layman’s term are the things that you cannot do while signing an agreement. For Example, if you are working with a company which is highly technology oriented and its comparative advantage its technology. If that technology is disclosed to a competitor firm than your company will no longer have that advantage and there’s a possibility that it might shut down.
So, in a such a case, in order to protect your firm, you would include Negative Covenant in the Employment contract while hiring employees. Thus Negative covenant will refrain them to work with a competitive firm, disclose any confidential information or starting their own firm based on the same technology. This covenant should have considerable duration and not for the entire lifetime of an employee. Hence, it is also termed as “Restrictive Covenant”.
In terms of Finance, Negative covenant are generally used in bond. Thus, sometimes also called as bond covenant. While purchasing a bond, the bondholder agrees on various activities which he / she cannot perform. They are in the best interests of bondholders and are written in the agreement while issuing a bond. The types of negative covenants while issuing a bond can be,
• Limiting and controlling the dividends paid by the firms
• Prohibiting firms to issue additional debt.
Also, more number of negative covenants are written while issuing a bond in order to make the bond safer from an investors perspective, because as the number of negative covenants increase the rate of interest on the debt decreases, which makes the bond, a safer investment.