What does a covenant in a debt agreement signify?

A covenant in a debt agreement signifies a commitment to certain activities, outlining the actions the borrower agrees to undertake (or refrain from) during the life of the loan. These covenants are meant to protect the interests of the lender by ensuring that the borrower maintains a financial condition that supports their ability to repay the debt. For example, a covenant may require a borrower to maintain specific financial ratios, limit further borrowing, or adhere to operational practices that ensure the stability of the business.

This commitment acts as a set of rules that the borrower agrees to follow, providing the lender with a level of oversight on the borrower's financial health and operational conduct. Non-compliance with these covenants can lead to penalties or immediate calls for repayment, thus reinforcing this commitment as a critical element of the debt agreement.