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What are Negative Covenants? | Examples of Restrictive Covenant - YouTube
Channel: WallStreetMojo
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hello everyone hi welcome to the channel
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clicking the bell icon today we have a
topic with us is negative covenants and
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some of the restrictions that have in
place well on the negative covenants
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part we'll try and understand first what
exactly what are the negative covenants
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see covenant is basically a restrictive
covenant you know which restricts one
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party from doing certain activities so
negative covenant is hence called as the
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restrictive covenants okay so there is a
formal agreement between the two parties
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some have some legal restrictions are
put on them on each of the party which
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could be limiting the ability to conduct
the business and all the restrictive
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clauses in the agreements are the
negative covin you see the negative
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covenants are used almost in all the
types of the what we call as the
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contracts we have agreements so like you
know it includes employment contracts
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mergers and acquisition bond documents
land use and rent agreements and so on
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and so forth so this can be used as a
part of the agreement or it could be a
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separate agreement as a whole so it
serves a different purpose depending on
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the type of the contract however it is
generally done to prevent a no one
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parties interest over the other party
that's the reason now there are three
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main types of negative covenants okay
we'll try and understand each of them
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the first is the non-compete agreement
see a non corporate a complete agreement
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is mainly written in employment contract
or acquisition contract and during an
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acquisition the new owner once when he
takes over a company and its business
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signs our non-compete agreement such
that you know the old owner of the
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business does not start the same
business again start competing so the
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non-compete agreement is usually for us
period okay for a specific period of
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time and for a specific region so the
new owners of the business usually pay a
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non-compete fees to the original owner
for not entering into the non-compete
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agreements also you know they restrict
the employees from joining the
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competitor or opening the business same
as that of the come so he's employed
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with the with the same this is usually
done to restrict
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employees from being a competitor of the
come after attaining necessary training
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skills experience and such non-compete
agreements in employee contract very
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from you know closely six-month to two
years and so on and so forth then there
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is a thing called non-solicitation
agreement now an on solicitation
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agreement restricts the professional
employees from soliciting the customers
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or the clients from the previous him so
consultants in general you know get to
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know the clients in a very very well and
they may be tempted to start their own
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business and solace at the glands of
their employer or they may join the
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competitor and solace at the client to
the new for such an agreement restricts
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stems to do so thought is called the non
disagreement that is the NDA now a
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nondisclosure agreement
it restricts one party who disclose any
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information to another so the
information may include like their trade
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secrets proprietary info innovations or
any other information which may harm the
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business of the owner of such
information I'll give you some example
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of the same research of the scientists
pharmacists working in laboratories or
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at the research they bound by such
agreements and they work with the new
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product if any which they come across
and in the innovations and the employer
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would like to have a competitive
advantage by innovating that new product
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does you would be you would protect the
flow of the information of the to the
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competitor by signing a nondisclosure
agreement now there is a thing called
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restrictive covenants you know in the
bond indentures now what exactly this is
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see covenants are also found in the bond
indentures such restrictions you know
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covenants are placed safeguard the
interest of the bond investors these are
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used in the bond issues to protect the
investors money and they restrict the
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bond issuers from taking you know what
we call as risky bets or such material
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changes which may impact the investor
know however more the numbers of
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negative covenants
lesser
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is the interest rates on such bond so
the restrictive covenant list may
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include a you know like not altering
accounting practices then there is a
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limit on debt limit on limit of the
dividend payment then there is a limit
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of any contract or a leases of any
amendments there off and there is a
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maintenance of certain you know fin
ratios in particular range of example of
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you if you are like you know the debt
equity ratio when it is less than one
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okay maintaining the current ratio which
is when it is more than one
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okay maintenance of the net profit
margin the gross profit margin in the
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historical range so for negative
covenants the example of the company
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wants to borrow let's say 100 million of
its debt but the loan agreement has the
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restrictions on the payment of the
dividend so the dividend paid to the
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shareholder it cannot over here exceed
1/4 share in 1 year so in bond
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indenture the covenants can be of two
types first is called the operation
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covenants okay operational covenants are
those which can relates to operation of
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the company so they put the restrictions
on the operations of the company which
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can which can be borrower has to be met
with certain disclosure requirements
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that cannot take certain operation or
the line of the business maintain to a
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certain level of insurance second is the
financial covenant no financial
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covenants are like maintenance of the
finances and differential ratio at a
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certain level example you know that
equity ratio is 2:1 that is
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has needs to be minimum working capital
requirement in maintenance of the
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interest coverage ratio okay
no lenders like to have negative
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covenants to bond issues so that you
know the borrower operates at a certain
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level of risk and does it ensures that
lenders money is safe if the borrower
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violates any negative comments it is
considered as a what we call as the
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technical default is called as the
technical default and although the
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borrower might be paying interest and
principal payments but violating
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negative covenants may lower it's what
we call as credit ratings so negative
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covenants in the employment contracts
have a known non-compete and
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non-disclosure agreement in general
sellers are restricted from disclosing
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any sort of information they have during
their employment and to compete with the
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employer the employment employer they
try to secure his interest as he had to
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invest
he had an investor time and money on the
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influenced by giving them initial
training skills and experience that's
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the thing so on the final conclusion
notes negative covenants are the
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restricted covenants which restricts one
party to take the to take some
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operations or work in the financial
prudent way so as to safeguard the
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interest of the other party so this are
these are found in most of the
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agreements the agreements could be
mergers in acquisition the M&A the
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employees contracts bond indentures and
it though it is mentioned in the
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agreement but face it enforcement
problems if negative covenants are added
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or breached it may take a long time to
be settled by the court of law and
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further it would be very costly for both
parties giving given that the damages
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are already but so I hope you have got a
really a fantastic idea about the
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negative covenants the types examples
sources the ratio analysis over here how
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it how it works so that's it for this
particular topic thank you everyone for
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