Covenants

Updated 12 Mar 2026Content was accurate at the time of publication

A covenant is a promise, obligation or restriction recorded in a contract or on title that binds one or more parties. Whether you are negotiating a loan, drafting a lease, buying property or managing compliance, understanding covenants—their scope, enforceability and remedies for breach—is essential.

What is a covenant?

Covenants take two main forms in everyday practice:

Contractual covenants are promises written into a commercial agreement or loan document. For example, a borrower might covenant to maintain a minimum interest coverage ratio or not to sell key assets without lender consent.

Land covenants are burdens or positive obligations attached to land under the Torrens register or by deed. These restrict or require certain land uses—for instance, a covenant might prohibit buildings above two storeys or require the owner to maintain a shared driveway.

Covenants operate as enforceable obligations where the language is clear, the parties are identifiable, and the covenant has appropriate formality. For land, this commonly means registration on title. In commercial practice, lenders use covenants to protect credit quality, while owners and councils use restrictive covenants to preserve neighbourhood standards.

How covenants work in contracts

In a contract, a covenant is simply a clause promising to do or not to do something. Covenants are typically located in the "Representations and Warranties" and "Covenants" sections of financing or security deeds, and in schedules and annexures that set reporting obligations and financial tests.

Affirmative (positive) covenants require action: maintain insurance, prepare audited accounts, or make tax payments. These obligations are ongoing unless otherwise specified.

Negative (restrictive) covenants prohibit actions: do not incur additional debt, do not sell key assets, or do not enter into related-party transactions. These protect the lender's security or the borrower's business interests.

Covenants can be continuous—ongoing obligations that must be satisfied throughout the loan term—or snapshot, tested at specific dates such as quarter-end or year-end.

A covenant breach can be an event of default that triggers remedies in the loan documents, such as acceleration, enforcement of security or termination rights. Contracts often include waiver and cure mechanics: a lender may permit a remedial period, require notice and opportunity to cure, or accept a formal waiver.

Where assets are leased or financed, covenants might intersect with leases and with charges registered against those assets.

Main types of covenants

Below are the common covenant categories you will see in commercial and property settings:

Financial covenants

Purpose: Protect lender repayment capacity.

Examples: minimum interest cover ratio, maximum leverage (debt/EBITDA), minimum net tangible assets.

Short example: "The Borrower shall maintain a Net Debt / EBITDA ratio not greater than 3.0x."

Negative (restrictive) covenants

Purpose: Limit actions that could harm the lender or the value of an asset.

Examples: restrictions on additional indebtedness, disposal of major assets, changes to business model.

Short example: "The Company must not create or permit any encumbrance over its plant and equipment without Lender consent."

Positive (affirmative) covenants

Purpose: Ensure ongoing action to preserve value or compliance.

Examples: maintenance of property, insurance, regulatory compliance, delivery of financial statements.

Short example: "The Borrower shall deliver audited accounts within 120 days of year end."

Restrictive covenants on land

Purpose: Control land use or development standards under title or deed.

Examples: building height limits, no commercial use of residential lots, obligations to repair shared infrastructure.

Short example: "No building shall be erected above two storeys on Lot 12."

Non-compete and confidentiality covenants

Purpose: Protect trade secrets and business goodwill.

Examples: former director barred from competing within a region for a set period.

Short example: "For 12 months after termination, the Executive shall not carry on a competing business in the Territory."

Operational covenants

Purpose: Require routine actions such as tax filings or workplace safety procedures.

Examples: permit renewals, environmental compliance programs.

Enforceability and legal requirements

Enforceability depends on form, certainty and statutory framework:

Contractual formalities. A covenant in a contract must be clear, supported by consideration (for new covenants) and signed by the parties as required by statute where relevant.

Certainty. Courts require precise language. Vague terms such as "reasonable efforts" are enforceable only if they can be objectively applied.

Restraint of trade and public policy. Non-compete covenants are scrutinised for reasonableness in scope, duration and geography. Excessive restraints risk being void as an unreasonable restraint of trade.

Privity and assignment. Covenants bind parties who agreed to them. For third-party beneficiaries, express assignment or annexation is necessary.

Land covenants and registration. Under the Torrens registration system, burdens affecting title must be registered or noted on the folio to be binding on future owners. State registry procedures set out the mechanics for registration, variation or discharge. Review title encumbrances and search the register during due diligence.

Statutory limits and relief. Courts may sever unenforceable parts, and statutory regimes allow application for modification or discharge of covenants where they are obsolete or unduly burdensome.

When interpreting covenants, courts balance the parties' intentions with public policy and fairness. If a lender seeks enforcement, they commonly rely on clear drafting, notice evidence and contemporaneous commercial records.

Remedies and consequences of breach

Remedies depend on clause drafting and whether the remedy is equitable or contractual:

Injunctions. A common remedy for restrictive covenants (land or contractual) to prevent ongoing or threatened breaches.

Damages. Compensatory damages for losses caused by breach; quantification can be straightforward (lost revenue) or complex (reputational loss).

Specific performance. Rare but available where damages are inadequate, such as with unique property obligations.

Acceleration and enforcement. In loan contexts, breach of a financial covenant often gives the lender a right to accelerate repayment, enforce securities and appoint receivers.

Forfeiture or termination. Contracts may permit termination rights or automatic acceleration on specified events of default.

Waiver and cure. Parties commonly include cure periods, notice requirements and waiver clauses allowing lenders to grant limited relief without triggering default mechanics.

Lender remedies are often documented in a master security deed. For borrowers, this means anticipating practical consequences such as frozen credit facilities or demand for immediate repayment. If dispute arises, courts will consider whether the breach was material and whether equitable relief is appropriate.

Financial covenants in loan agreements

Financial covenants are central to credit risk controls. Common metrics include:

Gearing / Leverage. Net Debt / EBITDA maximum ratio, setting a ceiling on how much debt the borrower can carry relative to earnings.

Interest coverage. EBITDA / Net interest expense, minimum threshold. This protects the lender's capacity to receive principal and interest payments.

Minimum liquidity / cash balances. Ensures the borrower maintains sufficient working capital.

Net tangible asset (NTA) floors. Protects lender equity and security value.

Best-practice monitoring

Specify the testing period and test dates (quarterly or annually). Define calculation methodology precisely, including pro forma adjustments, normalisations and accounting standards. Require covenant compliance certificates signed by directors and accompanied by supporting schedules and reconciliations. Include reporting cadence: management accounts monthly, audited accounts annually. Build materiality thresholds and de minimis carve-outs to avoid triggering defaults on trivial variances. Provide waiver and cure mechanics with a clear process for seeking lender consent and agreed cure periods (typically 30–90 days) before automatic default.

Practical monitoring checklist

Monthly management accounts due within 15 days. Covenant certificates within 30 days of test date. Supporting bank statements and reconciliations attached. Director sign-off and statement of no material adverse change.

If you are a borrower, consider liquidity buffers and stress-testing covenant outcomes under downside scenarios. Lenders offering facilities such as https://emumoney.com.au/business/business-loans or https://emumoney.com.au/business/asset-finance will typically set financial covenants tailored to the sector and asset class.

Restrictive covenants on land

A restrictive covenant on title can limit development and use. Key practical points for buyers and owners:

Title search. Always obtain a full title search and review encumbrances to identify restrictive covenants and easements.

Nature of burden. Determine whether the covenant is negative (restrictive) or positive (requires action) and whether it benefits identifiable land or parties.

Registration and notice. A covenant not properly recorded may not bind transferees; check the state registry and plan annotations.

Modification and discharge. Registries permit procedures to modify or discharge covenants where circumstances have changed. Courts can also vary covenants if they are obsolete or unfairly hamper reasonable land use.

Building approvals and planning. A covenant may operate alongside planning controls; compliance with one does not guarantee compliance with the other.

Due diligence. Engage conveyancers and check local planning instruments. For guidance on registry practice, consult your state titles office and research cases on AustLII.

When purchasing, include warranties and indemnities about title burdens and consider a contractual option for removal or compensation if a covenant materially affects value. For transactional issues arising from leases and land use, seek professional legal advice.

Drafting and negotiating covenants

Checklist for clear, enforceable covenants:

Be specific. Define terms (e.g., "EBITDA" calculated in accordance with IFRS), dates and test points.

Set measurable standards. Avoid open-ended phrases like "best endeavours" without definition.

Limit scope. Restrict obligations to what is commercially necessary in terms of geography, duration and parties affected.

Include carve-outs. Permitted dispositions, change-of-control exceptions, permitted indebtedness baskets and other exceptions should be clearly listed.

Materiality and cure. Include materiality thresholds, notice and cure periods to avoid hair-trigger defaults.

Sunset clauses. Set expiry or step-downs for covenants that are time-limited.

Allocation of costs. Clarify who pays for compliance, monitoring and remedies.

Interaction with security. Ensure covenants align with registered securities and mortgages.

Red flags to negotiate

Vagueness in calculation mechanics. Unlimited cross-default clauses that could trigger widespread defaults. Penalty-style remedies or automatic forfeiture without cure periods. Over-broad non-compete provisions lacking geographic or temporal limits. Covenants that require illegal or impractical conduct.

Negotiation trade-off: borrowers generally seek flexibility; lenders require predictability. Draft with realistic operational metrics and sensible disclosure obligations.

Example clauses

Below are three illustrative clauses. These are examples only and should be reviewed by lawyers before use.

1. Negative covenant — restrictive use

Plain language: "You must not sell or lease the main factory without the lender's written consent."

Legal form: "The Borrower covenants and agrees that it will not, without the prior written consent of the Lender (such consent not to be unreasonably withheld or delayed), dispose of, lease, or otherwise transfer any Material Asset comprising the Manufacturing Facility."

2. Affirmative covenant — maintenance and reporting

Plain language: "You will maintain insurance and send copies of policies to the lender each year."

Legal form: "The Borrower shall at all times maintain insurance on the Secured Assets against fire, theft and such other risks as are customary for assets of that type and shall deliver to the Lender, within 14 days of renewal, evidence of such insurance in form and quantum satisfactory to the Lender."

3. Financial covenant — minimum interest cover

Plain language: "You must keep interest cover at least 2.5x each quarter."

Legal form: "The Borrower covenants that, at the end of each Financial Quarter, the Interest Coverage Ratio shall not be less than 2.5:1, calculated as EBITDA for the preceding 12 months divided by Net Interest Expense for the same period, in accordance with the definitions set out in Schedule A."

When to get legal advice

Seek legal review when:

You are negotiating complex debt facilities or security over multiple asset classes. A covenant affects land title or requires registration. A covenant may restrain trade, limit director actions, or shift governance. There is a potential event of default, enforcement action or receiver appointment. You need to modify, discharge or challenge a restrictive covenant on title.

A lawyer can draft precise calculation mechanics, advise on enforceability risks and represent you in negotiations or court applications.

FAQ

Can covenants be changed?

Yes—by agreement of the parties, by registration amendment or variation under the titles registry, or by court order where justified. For registered land covenants, follow your state registry's process for discharge or variation.

Are non-compete covenants enforceable?

They are enforceable if reasonable in scope, duration and geographic reach and necessary to protect legitimate business interests. Overbroad restraints risk being void.

What happens if I unknowingly breach a covenant?

Consequences depend on the contract: you may trigger an event of default, but many agreements allow notice and cure periods. Prompt disclosure to the counterparty and seeking a waiver can mitigate escalation.

Do land covenants bind future owners?

Properly registered restrictive covenants can bind successors in title. Always check the register and plan annotations during conveyancing.

How are financial covenants calculated?

Precisely as drafted—disputes often arise from ambiguous definitions. Ensure EBITDA, Net Debt and adjustments are defined in the loan documents to avoid interpretation issues.

Can a lender accelerate a loan for covenant breach?

If the covenant breach is an event of default under the loan agreement, acceleration and enforcement are typical remedies. Whether acceleration is proportionate can be a matter for negotiation or court consideration.

Who enforces a restrictive covenant on land?

The party entitled to the benefit (often a neighbouring owner) or sometimes a covenant holder. Local councils may also have enforcement powers if specified.

Is registration required for security over leased assets?

Security interests often require registration (such as on PPSR); check the applicable security and lease type.

Key takeaways

Covenants are binding promises in contracts or on property title that protect lenders, secure compliance and preserve land use standards. Understanding whether a covenant is contractual or land-based, affirmative or negative, and how it is enforced in your jurisdiction is essential for negotiating loans, buying property and managing compliance. Always obtain a full title search for land purchases, define financial metrics with precision, and seek legal advice before signing complex agreements or challenging a restrictive covenant.