Breach of a bank covenant: acceleration, waiver and renegotiation of the debt

A compliance certificate delivered to the facility agent showing a leverage ratio above the contractual threshold does not automatically trigger immediate repayment of the debt. It does, however, open a short contractual sequence at the end of which the lender holds a unilateral right: to declare early repayment (acceleration), or to charge for its waiver. The bulk of the value for borrower and lender alike is decided between these two outcomes, and reaction time is counted in days, not quarters. This guide describes the mechanics of a covenant breach, the finance director's decision timetable before acceleration (déchéance du terme), the levers for renegotiation (bank waiver, ratio reset, covenant holiday, amend & extend) and the legal exposure of each party, including where the matter moves into the proceedings of Book VI of the French Commercial Code.

What a bank covenant covers and how it is tested

A bank covenant is a contractual undertaking by the borrower, separate from the obligation to repay, the breach of which constitutes an event of default (event of default) giving the lender early exit rights. The standard documentation, in corporate lending as in asset finance, largely follows the standards of the Loan Market Association, whose vocabulary has become established in France, including in contracts governed by French law.

Financial covenants, information covenants, undertakings

The financial covenants are ratios tested on a fixed date, generally quarterly or half-yearly, over a rolling twelve-month period. In corporate finance, the most common are leverage (consolidated net debt divided by EBITDA), cover of financial charges (interest cover ratio) and, depending on the structure, debt service cover (debt service cover ratio) or the equity ratio (gearing). In real estate finance, the usual pairing is loan-to-value and the ICR or DSCR, the first being driven by a periodic valuation of the asset.

This distinction has a major operational consequence. An LTV breach can occur even though rents are coming in normally and debt service is fully covered: it is the valuation, not the letting performance, that has moved. The negotiating case is then not the same as for a leverage breach following a deterioration in EBITDA.

The information covenants require delivery of the annual and interim accounts, the budget and, above all, the compliance certificate (compliance certificate) signed by a manager or the finance director, attesting to the calculation of the ratios. Late delivery is itself an event of default, often subject to a remedy period of a few business days.

The undertakings govern the borrower's conduct: prohibition on creating new security (negative pledge), equal ranking (pari passu), limits on distributions, asset disposals, investments and additional borrowing, change of control clause, material adverse change clause (material adverse change). To these is added the cross-default clause, in its cross-default version (default under other indebtedness alone is enough) or its cross-acceleration version (the other lender must actually have declared the debt due). The wording adopted determines how fast an isolated incident spreads to the whole debt structure.

From covenant breach to acceleration: the contractual chain

A covenant breach produces three successive effects, which must be kept apart because they do not carry the same financial consequences.

The first is immediate and often underestimated: the blocking of drawdowns. As soon as an event of default occurs, repeating the repeated representations becomes impossible and the conditions for drawing on the revolving credit line cease to be met. The borrower loses access to its back-up liquidity at the very moment it needs it. In several structures, this is accompanied by the triggering of a cash trap mechanism (cash trap) or accelerated repayment from excess cash (cash sweep).

The second is the move from potential default (default) to a continuing event of default (event of default), on expiry of any remedy period. Many contracts provide no grace period for financial covenants, unlike payment or information defaults.

The third is the decision to accelerate, which is an option and not automatic. In a syndicated loan, it is taken by the agent on the instruction of the majority of lenders, according to a threshold defined in the contract. Knowing exactly what that threshold is, and what the syndicate looks like at a given moment after participations have been transferred on the secondary market, conditions any negotiating strategy.

Acceleration (déchéance du terme): the regime under French law

Under French law, early repayment takes the form of acceleration (déchéance du terme). It may arise by operation of law or by contract. Article 1305-4 of the French Civil Code provides that the debtor may not claim the benefit of the term if it fails to provide the security promised to the creditor or if it reduces the security that guarantees the obligation. But the main source remains the contractual acceleration clause tied to events of default.

There are two points of caution, for lender and borrower alike.

First, the case law makes the operation of an acceleration clause subject to a prior formal notice that has gone unheeded, unless there is an express and unequivocal stipulation exempting the creditor from that formality. An acceleration notice served without complying with the contractual formalities and this prior requirement exposes the lender to having its act deprived of effect, with the resulting consequences for any enforcement steps taken immediately afterwards.

Second, where the facility is of indefinite duration, Article L. 313-12 of the French Monetary and Financial Code imposes a separate protective regime:

Any facility of indefinite duration, other than an occasional one, that a credit institution (...) grants to a business may be reduced or interrupted only on written notification and on expiry of a notice period set when the facility was granted.

The same text dispenses with notice in the event of seriously reprehensible conduct by the beneficiary or where its situation is beyond recovery. The boundary between serious difficulty and a situation beyond recovery is precisely the one on which disputes over abusive termination of credit crystallise. An authorised overdraft that has not been formalised and is of fixed duration falls under this regime; a documented term loan does not and is governed solely by its contractual mechanics.

The finance director's decision timetable

Managing a covenant breach is decided before the test date, not after the notice of default. Three windows must be treated as decision milestones.

Before the test date. As soon as the closing projection shows that the threshold is likely to be crossed, the question is no longer accounting but strategic. The finance director must settle a position on the cause (cyclical or structural), on the path back within the ratios, and on the lever to be used. This is also the only window in which a corrective action on the scope (a non-strategic disposal, accelerated collection, a trade-off on a capex item) can still affect the calculation.

Between the test date and delivery of the compliance certificate. The contract generally allows several weeks after closing to deliver the certificate. This period is not a reprieve: it is for preparing and, ideally, obtaining the bank waiver before the non-compliance is formally notified. An early, documented request, sent before the certificate is delivered, puts the borrower in the position of a proposer rather than a defaulter.

After the event of default has occurred. The remedy period, where there is one, is short. Beyond it, the lender holds an option that it has no obligation to exercise immediately, and whose mere existence weighs on any later discussion. It is at this stage that the choice of a formal standstill agreement (standstill) arises, under which the lenders refrain from exercising their remedies for a fixed period, in return for enhanced information undertakings.

The equity cure, the first lever to reach for

Many contracts, particularly in acquisition finance under an LBO, give the shareholder a right to remedy the breach by injecting funds (equity cure). The injection, made as capital or as a subordinated shareholder loan, is either added to the EBITDA of the quarter tested or applied to reduce net debt, depending on the wording. This right is circumscribed: a cap per financial year, a maximum number of uses over the life of the loan, a ban on use in consecutive periods, and a time limit for implementation. Checking these limits precisely, and the accounting classification of the contribution, is one of the first reflexes. Some contracts also provide a mechanism for neutralising an isolated breach (mulligan), usable only once.

The collateral effects to anticipate

An unresolved covenant breach produces effects outside the banking sphere, which must be built into the timetable.

• Under IFRS, failure to comply with a covenant at the reporting date leads to the debt being reclassified as a current liability, unless a waiver is obtained before that date; the amendments to IAS 1 applicable to financial years beginning on or after 1 January 2024 clarified how that classification is assessed in light of covenants to be complied with.
• The statutory auditor will examine the going concern position and may start the alert procedure provided for in Article L. 234-1 of the French Commercial Code.
• For a listed issuer, the occurrence of a significant event of default may constitute inside information within the meaning of Article 17 of Regulation (EU) No. 596/2014 (MAR), with an obligation to disclose immediately or a reasoned decision to delay.
• Acceleration, by making the debt immediately due, can tip the business into a state of cessation of payments within the meaning of Article L. 631-1 of the French Commercial Code, triggering the obligation to file within forty-five days under Article L. 631-4, unless a request for conciliation has been made.

The bank waiver: purpose, content and price

A bank waiver is the lender's renunciation of the right to rely on a specified breach. Three forms must be distinguished, of very unequal scope.

A one-off waiver relates to an identified breach, at a given test date. It does not amend the contract for the future and entails no waiver of the lender's rights in respect of future breaches, which waiver letters take care to stipulate expressly. Its purpose is to cure the default, release drawdowns and allow the relationship to continue normally.

A conditional waiver makes the effect of the waiver subject to the performance of new undertakings: delivery of a weekly cash-flow plan, appointment of an independent expert, a ban on distributions, partial early repayment, creation of additional security. It turns the waiver into an instrument by which the lenders retake control of the matter.

An amending agreement (amendment) rewrites the thresholds or the definition of the aggregates for the future. It belongs more to debt renegotiation than to a waiver, and is subject to different majority rules.

The price of a waiver is made up in practice of a fee (waiver fee or amendment fee), a margin increase and sometimes an accelerated amortisation schedule. For the borrower, the cost to compare is not the fee in absolute terms but the total discounted cost set against the alternative: full refinancing on worsened market terms, or dealing with an acceleration.

In a syndicated loan, identifying the required majority is decisive. Amendments affecting principal, interest, maturities, the release of security or the majority rules themselves typically require unanimity or an enhanced majority. A waiver relating to a financial covenant is in principle subject to the simple majority of lenders as defined in the contract. This difference governs the entire strategy for approaching the syndicate, particularly where debt funds have bought participations with an exit strategy different from that of the original banks.

Ratio resets, covenant holidays and restructuring the terms

Where the difficulty is not a one-off, the discussion concerns the very architecture of the financial undertakings. Several levers are combined.

A ratio reset consists in redefining the thresholds for the coming test periods, aligning them with a revised business plan, with a negotiated safety margin (headroom). The usual counterpart is a tightening of other parameters: a ban on distributions, a cap on investments, disposal of identified assets.

A covenant holiday suspends the test of one or more ratios for a fixed number of periods. It is frequently accompanied by a substitute covenant based on minimum cash or available liquidity, so that the lenders keep a warning indicator during the suspension.

An amend & extend lengthens the maturity in exchange for a revision of the pricing and, often, a strengthening of the security package. In real estate finance, this extension is negotiated by reference to the asset's valuation trajectory and its ability to be refinanced at the chosen horizon, which means building the future operating constraints, in particular energy-related ones, into the discussion.

A contribution of new money follows a different logic: it is negotiated against a ranking. Outside proceedings, it takes the form of new security or a structuring as super-senior debt. In a conciliation, Article L. 611-11 of the French Commercial Code reserves a priority to those who provide new cash in the approved agreement, which makes it one of the main arguments for moving to the amicable procedure. The conditions for obtaining this priority and the contributor's actual ranking are set out in our article on the conciliation priority.

Strengthening security deserves particular attention. A security trust (fiducie-sûreté), governed by Articles 2372-1 et seq. of the French Civil Code, gives the creditor greater effectiveness if collective proceedings are later opened. It must, however, be created outside the hardening period (période suspecte), failing which it is exposed to an action for nullity under Articles L. 632-1 et seq. of the French Commercial Code.

Exposure to risk: what each party has at stake

The lender's side

Declaring acceleration is not without risk. Article L. 650-1 of the French Commercial Code lays down a principle that creditors are not liable for the facilities they have granted, subject to three exceptions: fraud, marked interference in the management of the debtor, and disproportionate security taken. Interference is precisely what a lender moves towards when, through conditions attached to a waiver, it imposes management decisions, steers industrial trade-offs or makes continuation of the facility conditional on particular operating choices. The line between legitimate close monitoring and de facto management must be held rigorously in drafting the waiver documentation. On the lender's general immunity and its three exceptions, see our analysis of the liability of the credit provider.

To this are added the risk of abusive termination under Article L. 313-12 of the French Monetary and Financial Code for facilities of indefinite duration, and the procedural risk of an irregular acceleration. A lender that accelerates badly deprives itself of its title, sees its enforcement measures challenged and loses its timing advantage.

The borrower's and manager's side

The borrower first bears the risk of contagion through cross-default: an isolated breach on a secondary line can make the entire financial debt due. It then bears the timing risk, since acceleration can establish cessation of payments overnight.

The manager, for his part, is personally exposed. Article L. 651-2 of the French Commercial Code allows all or part of the shortfall of assets (insuffisance d'actif) to be placed on him where a management fault has contributed to it, it being specified that, in the wording resulting from Law No. 2016-1691 of 9 December 2016 known as Sapin II, mere negligence is excluded. Late filing of the state of cessation of payments, like continuing a loss-making activity once the debt has become due, are among the complaints classically raised. The manager's personal guarantees are the second route of exposure for his personal assets.

Moving into Book VI proceedings: what opening changes

Where negotiation by agreement does not succeed, three tools change the balance of power.

The ad hoc mandate (mandat ad hoc) and conciliation (Articles L. 611-3 et seq. of the French Commercial Code) offer a confidential framework, protected by Article L. 611-15. Their value lies in two mechanisms. Article L. 611-16 deems unwritten any clause that changes the conditions for continuing a contract in progress by reducing the debtor's rights or increasing its obligations solely because an ad hoc agent has been appointed, a conciliation opened or a request made to that end: a default clause triggered merely by applying to the president of the court is neutralised. Article L. 611-7 also allows a debtor who has been served with a formal notice or sued by a creditor to ask the judge for the grace periods of Article 1343-5 of the French Civil Code, up to a limit of two years, while an agreement is being sought.

Safeguard proceedings (sauvegarde) produce more radical effects. Article L. 622-29 provides that the opening judgment does not make debts not yet due payable, any clause to the contrary being deemed unwritten: contractual acceleration is rendered ineffective. To this are added the stay of individual enforcement actions, the prohibition on paying prior debts laid down by Article L. 622-7 and the suspension of proceedings against personal guarantors who are individuals until the judgment adopting the plan.

Since Ordinance No. 2021-1193 of 15 September 2021 transposing Directive (EU) 2019/1023, the formation of classes of affected parties is mandatory above thresholds set by regulation, and the court may impose a plan on a dissenting class under the cross-class cram-down mechanism of Articles L. 626-30 et seq. For a lender, this means that a blocking position negotiated outside proceedings can be bypassed within proceedings, once the conditions for cram-down are met. This prospect must be factored into the assessment of the balance of power from the first waiver discussions. The impact of cross-class cram-down on the creditor's ranking and security is examined in our article on classes of affected parties and the prepack sale.

What to take away and what to do

A covenant breach is not an accounting accident; it is a temporary transfer of negotiating power to the lender. That transfer is reversible, but only for the party that comes to the table with a documented diagnosis, a quantified trajectory and an exact reading of its own documentation: majority thresholds, remedy periods, the limits of the equity cure, the scope of cross-default. On the lender's side, the temptation of immediate acceleration is rarely the best economic option: it exposes the lender to the risk of abusive termination, hastens collective proceedings in which rights will be reconfigured, and often destroys more value than it preserves. The trade-off is between the recovery value in a liquidation scenario and the discounted value of a credible recovery plan.

Our recommendation is practical. Have the whole of the credit documentation reviewed, not just the covenant clause, as soon as the closing projection shows that a breach is likely: the real room for manoeuvre lies in the definitions, the majority rules and the cross-default clauses. Open the discussion with the agent before the compliance certificate is delivered, never after. And decide explicitly, in writing and on a given date, between negotiation by agreement and applying to the president of the court for an ad hoc mandate: if that choice is made late, it will no longer be a choice.

Frequently asked questions

Does a covenant breach automatically make the debt due? No. A ratio breach is an event of default that gives the lender an option to accelerate, not a debt that falls due by operation of law. Acceleration requires a decision by the lender, or by the majority of lenders in a syndicated loan, notified in the contractual form. The case law also requires a prior formal notice that has gone unheeded, unless there is an express and unequivocal stipulation dispensing with that formality. By contrast, the blocking of drawdowns on revolving lines is often immediate.

How long does it take to obtain a bank waiver? There is no statutory period: everything depends on the contractual timetable and the structure of the lending group. The operational aim is to obtain the waiver before the compliance certificate is delivered, that is, within the window between the test date and the delivery deadline set in the contract. In a syndicated loan with many participants, consultation of the lenders by the agent and obtaining the required majority take significant time, which must be anticipated from the closing projection.

What is the difference between a waiver, a covenant holiday and a ratio reset? A waiver is a renunciation of the right to rely on a breach that has already occurred, without amending the contract for the future. A covenant holiday suspends the test of one or more ratios for a fixed number of future periods, generally against a substitute covenant based on minimum cash. A reset durably changes the thresholds by aligning them with a revised business plan. The last two are amendments and may be subject to different majority rules from those applying to a waiver.

Can the bank terminate an authorised overdraft without notice? Article L. 313-12 of the French Monetary and Financial Code requires, for any facility of indefinite duration other than an occasional one granted to a business, written notification and compliance with the notice period set when the facility was granted. Notice is dispensed with in the event of seriously reprehensible conduct by the beneficiary or where its situation is beyond recovery. This regime does not apply to documented term loans, whose early termination is governed solely by the contractual stipulations.

Does opening safeguard proceedings wipe out acceleration? Article L. 622-29 of the French Commercial Code states that the opening judgment does not make debts not yet due payable and deems any clause to the contrary unwritten. If acceleration was validly declared before the judgment, however, the debt has already fallen due on the opening date, with the resulting consequences for establishing cessation of payments. The timing trade-off between the application to open proceedings and the notice of acceleration is therefore decisive.

Is the manager personally liable in the event of a covenant breach? Not because of the breach itself. Exposure arises from the decisions taken afterwards: continuing a loss-making business once the debt is due, filing late for cessation of payments beyond the forty-five-day period in Article L. 631-4 of the French Commercial Code. Article L. 651-2 allows all or part of the shortfall of assets to be placed on the manager where a management fault has contributed to it, mere negligence having been excluded since Law No. 2016-1691 of 9 December 2016. Personal guarantees are the second route of exposure.

Is an LTV breach in real estate finance negotiated like a leverage breach? No. An LTV breach results from a change in valuation and can occur while rental cash flows fully cover debt service. The argument then concerns the appropriateness of the valuation method, the revaluation timetable and the asset's ability to support repayment, not a deterioration in operations. The negotiated remedies also differ: partial early repayment to get back within the ratio, provision of additional security, or substitution of a debt service cover covenant for the value covenant.