“Affirmative Covenants” and “Negative Covenants”?

From reader Zack Miller, of Sacramento, California:

What are your thoughts on organizing credit agreements based on affirmative and negative covenants? (i.e., an article devoted to affirmative covenants and an article devoted to negative covenants). It makes sense to a lawyer, but is it really the best way to organize the various promises in a contract?

Let’s start by considering what MSCD 3.169 says:

Don’t use the phrases affirmative covenant and negative covenant, meaning an obligation to do something and an obligation not to do something. Aside from the archaic quality that covenant adds to those phrases, generally when referring in a contract to obligations imposed by that or any other contract, no purpose is served by distinguishing between an obligation to do something and an obligation not to do something.

In particular, one might be able to address a given issue using either language of obligation or language of prohibition. For example, compare Acme shall remain in good standing with the Delaware Secretary of State with Acme shall not do anything to cause Acme not to be in good standing with the Delaware Secretary of State. So in terms of semantics, separating language of obligation and language of prohibition seems arbitrary.

Beyond that, it’s generally not a good idea to limit a group of provisions according to the category of contract language. For one thing, that approach doesn’t make for an informative heading (Acme’s Obligations). Furthermore, if you’re dealing with anything other than the most rudimentary deal mechanisms, it’s commonplace for a provision ostensibly devoted to obligations to include one or more other categories of contract language, for example language of discretion (Acme may).

So I recommend that instead of grouping provisions according to the category of contract language, you group them according to subject matter and give them a heading that reflects the subject matter. But there are exceptions.

Here’s what MSCD 4.80 and 4.85 says about that:

Custom mostly dictates what sections are included in standard kinds of contract. In commercial contracts, it usually makes sense to have sections address different deal issues. It would be artificial to divide provisions according to the category of contract language—for example, Party A’s statement of facts followed by Party B’s statement of facts and Party A’s obligations followed by Party B’s obligations. But mergers-and-acquisitions contracts are organized that way.

In an acquisition agreement, for example, the body of the contract is generally organized in this sequence: deal terms, statements of fact (traditionally known as representations and warranties; see 3.374), obligations, conditions to closing, termination, indemnification, and miscellaneous provisions.

I have zero lending experience, but I suspect that lending documents are subject to the same sort of structural considerations as acquisition agreements. But they differ from standard acquisition agreements in that they’re also concerned with future operations of the borrower. I suggest that instead of addressing future operations by means of articles entitled Affirmative Covenants and Negative Covenants, you instead use the heading Acme’s Operations, or some such.

But this is largely off the top of my head. Lending people, what do you think?

About the author

Ken Adams is the leading authority on how to say clearly whatever you want to say in a contract. He’s author of A Manual of Style for Contract Drafting, and he offers online and in-person training around the world. He’s also chief content officer of LegalSifter, Inc., a company that combines artificial intelligence and expertise to assist with review of contracts.

2 thoughts on ““Affirmative Covenants” and “Negative Covenants”?”

  1. I’m not a finance person either, but at least from a UK perspective, bank lending documents are driven largely by the precedents of the Loan Market Association. The typical facility agreement has definitions, operative provisions (the facilities, their purpose, utilisation, repayment, interest, etc), then representations of factual matters, financial covenants, undertakings for things a borrower must (or must not) do, and then events of default, all with descriptive subheadings.
    Bank lending documents tend to be very long and unwieldy, but the practitioners using them know what they are doing, and contractual disputes seem to be relatively rare.
    Agreements for intercompany loans tend to be much shorter, and rarely have much in the way of representations, covenants and undertakings.

  2. I agree that the headings may be artificial, and sloppy, but there is benefit in a well-organized agreement. Affirmative covenants are indeed to be used for things that a borrower must actually *do*: providing financial reports is the most common item. An affirmative covenant that is really negative is just poorly drafted, e.g., “Borrower shall obtain consent of Lender before paying any dividend to Borrower’s shareholders” (bad) vs “Borrower shall not pay any dividend to Borrower’s shareholders without consent of Lender” (better).

    Setting out negative covenants, all the things that can’t be done or can’t be done without consent, is again helpful in terms of organization.

    None of my comments have anything to do with the labeling – just the notion that structure, properly executed and respected, saves lawyers from having to re-read the entire contract for every question.


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