M&A Vocabulary – Understanding the experts: “Covenants”

Covenants are obligations in the sense of ancillary agreements in a contract. In a company purchase agreement, they become relevant when the transaction takes place in two steps: signing and closing. In the period between the contractual obligation to purchase (signing) and the actual transfer (closing), ownership of and control over the company still remain with the seller. The buyer therefore has a legitimate interest in the company continuing to be run as before.

Covenants can be either positive or negative in nature, depending on whether they consist of obligations to act or to refrain from acting. Common covenants in practice include, for example:

• Proper continuation of ordinary business operations and the definition of actions requiring approval (ordinary-course-of-business clause);
• Rights to information and disclosure;
• Cooperation in connection with financing;
• Participation rights to obtain approvals and consents;
• Confidentiality provisions;
• Provisions on notices and public announcements (press releases).

Covenants also apply after closing. Typical examples include non-compete and non-solicitation clauses to prevent the seller from setting up or financing a competing business.

By agreement, covenants can be converted into post-closing covenants in the event that they could not be fulfilled by closing.

Overall, covenants enable proper performance of the contract and better planning for the period after the company is handed over.

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