Covenants in debt financing agreements are essentially promises made by the borrower to the lender. They can be either affirmative (requiring the borrower to take certain actions) or negative (prohibiting the borrower from taking certain actions). Covenant alignment refers to the process of ensuring that the terms and conditions of a loan, especially the financial and non-financial covenants of the debt agreements, are consistent with the borrower’s financial situation, goals, and risk tolerance. It also ensures that the covenants in multiple debt agreements are consistent and compatible and do not conflict between those agreements. Proper alignment is crucial in multi-tiered financing structures to prevent conflicts between lenders and minimize the risk of unintentional breaches by borrowers.

Key Covenants to Align

• Debt Service Coverage Ratio (DSCR): Align minimum DSCR requirements to ensure cash flow can satisfy the lenders’ obligations.
• Capital Expenditure Limits: Harmonize caps on project spending to avoid triggering default in one agreement while complying with the other.
• Reporting Covenants: aligning the standard, frequency, and content of financial reports.
• Restrictions on Additional Debt: Clearly define permitted indebtedness thresholds to prevent conflicts over future financing. The debt agreements should be aligned on the sources and cap on the amount for additional funding, where additional funding is required by the project to meet its funding goals.

Benefits of Covenant Alignment

1.  Reduced Risk of Cross-Defaults
2. streamlined Monitoring
3. Enhanced Lender Cooperation
4. Avoidance of Conflict

By ensuring covenant alignment, borrowers can easily comply with all covenants and foster a cooperative relationship with lenders while reducing the risk of disputes, paving the way for smoother project execution and financial stability.