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Covenant Stripping

"Short-term need creates long-term vulnerability"

Negotiating the removal or weakening of protective covenants in loan agreements, often in exchange for short-term concessions.

How It Works

  1. 1

    Company needs covenant relief or new financing

  2. 2

    Lenders demand removal of protective covenants in exchange

  3. 3

    Stripped covenants may include: debt limits, dividend restrictions, asset sales

  4. 4

    Company gains short-term flexibility

  5. 5

    Long-term, company vulnerable to value extraction

Key Mechanics

Maintenance covenants require ongoing compliance

Incurrence covenants only tested when action is taken

Loose covenants allow 'J. Crew' style asset transfers

Liability management exercises exploit weak documentation

Regulatory Context

Private contract matter. Credit rating agencies assess covenant quality. Bond indenture trustees may have limited enforcement role.