The last five years have shown substantial volatility in corporate performance. When I defended my doctoral dissertation in November 2019, I silently wished for a small economic downturn to demonstrate the benefits of the modern legal frameworks for corporate finance restructuring that I was introducing. I certainly did not anticipate a global pandemic, wars in Europe and the Middle East, or, most recently, a global trade war…
I spent the first two decades of my professional life, starting in 1985, at Nordea and its predecessors, primarily arranging market-based financing for leading corporates. At the time, we even developed a methodology for introducing companies to the capital markets. Before launching a transaction—be it a syndicated loan or a bond issuance—we negotiated a detailed covenant policy with the issuer. This policy could also be used in the future financing of group companies. Our thesis was that a well-structured covenant policy was not only beneficial to the company but also important for its relationship banks.
During the following two decades after my banking years, I have primarily worked as a legal advisor in finance law. Having encountered numerous cases involving financial distress, I’ve noticed that the concept of a corporate covenant policy seems to have largely disappeared from corporate memory—at least in many companies.
The covenants could represent one of the most severe risks a company may face.
But why should a company’s board and management pay attention to key covenants? Shouldn’t covenants primarily be the responsibility of corporate lawyers?
In my view, the covenants could represent one of the most severe risks a company may face. In particular performance-related financial covenants deserve board-level attention as they can significantly impact mergers and acquisitions, investments, and more. Other covenants—such as those relating to asset disposals, additional financing, subsidiary indebtedness, or limitation on the use of collateral—should also not be overlooked.
Let me share a real-life example that illustrates this point well. A few years ago, I received a call from the CFO of a major company seeking help with what they described as a ‘small default issue’ involving a subsidiary. The subsidiary had entered into a financing agreement with a governmental lender that included unusually strict covenants—and prepayment was not an option.
This ‘small default issue’ turned out to be serious, triggering a potential cross-default under the group’s financing agreements. Most critically, due to this potential event of default, the company’s main revolving credit facility—on which the board and management relied on as a source for working capital—was at risk. Lenders under the syndicated facility became entitled to withhold further funding, except for rollover loans. It took considerable time to resolve the situation, but fortunately, we succeeded in the end.
Hence, whether you’re serving as a board member, CEO, or CFO, I strongly encourage you to pay close attention to the content and consistency of key covenants across your group’s finance agreements. I am positive your general counsel would appreciate such an approach as well.
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