When a bank issues a loan to a small business owner or property investor, the borrower should accept the loan understanding that the lending institution wants to be paid back quickly and in full. To help ensure protection of the bank’s loan, the business loan agreement will often contain certain conditions or parameters which must be maintained during the length of the loan. These conditions are also known as a loan covenant.

There a few different types of covenants.

Financial covenants are those which require the borrower or business to maintain certain financial conditions during the length of the loan.

Operating covenants require business to maintain its day-to-day business operations during the loan application.

Collateral covenants may stipulate that the borrower must maintain unencumbered ownership (without a lien attached) of certain properties.

Reporting covenants allow the lender to keep tabs on the happenings of the business through submitted financial reports.

When a loan covenant is broken, the penalty depends on the severity of the contract violation. If it was as simple as failing to submit a financial report or something along those lines, you may get a letter in the mail. When you settle the issue in a timely fashion, the loan agreement will continue business as usual.

However, if it’s a major breach, such as upsetting the debt-to-equity ratio, or taking out a second loan without obtaining your bank’s permission, penalties will be more severe. Your bank could request that you put up some piece of property as more collateral. It can also raise interest rates or demand repayment of the loan more quickly, as well as many other potential penalties.

Being open and honest with your bank is the best bet. The moment you realize you won’t be able to make a payment or that you didn’t send in your quarterly business report on time, contact your bank immediately and explain your situation and how you plan to fix it. By allowing it to languish, your lender may begin to question your integrity.

The best way to avoid any loan covenant default is to consult with an attorney immediately.

For all of your financial issues involving debt relief, contact the Law Office of Joel R. Spivack for a free consultation today. Joel R. Spivack, Esquire, has been a bankruptcy lawyer in New Jersey and Pennsylvania for over 20 years.