Quick answer
A covenant breach happens when a business misses a financial test or undertaking in its loan agreement — such as interest cover, debt service cover, gearing or reporting deadlines. It usually gives the lender rights, not an automatic demand. The best response is early: tell the bank before it finds out, explain the cause, propose a cure, and have a refinance option ready in case the waiver terms are unacceptable.
Key points
- A breach gives the lender options; it doesn't automatically mean repayment is demanded.
- Raise it with the bank first, with an explanation and a cure plan.
- Waivers often come with fees, repricing, tighter reporting or new security.
- Know your alternatives before the waiver conversation, not after it.
- Common tests
- ICR, DSCR, gearing, reporting
- Usual response
- Waiver, reset or reprice
- Fallback
- Refinance
- Timing
- Act early
What counts as a covenant breach?
Covenants are promises in your facility agreement. Some are financial tests measured at set dates; others are undertakings about how you’ll behave. A breach is any failure to meet one.
| Covenant type | Typical measure | Common trigger for a miss |
|---|---|---|
| Interest cover (ICR) | EBIT or EBITDA ÷ interest | Earnings dip, pricing rise |
| Debt service cover (DSCR) | Cash earnings ÷ principal + interest | Earnings dip, new debt, shorter term |
| Gearing / leverage | Debt ÷ EBITDA, or debt ÷ equity | Acquisition, losses, dividends |
| Loan-to-value (LVR) | Debt ÷ security value | Revaluation down |
| Reporting | Accounts within set days of year-end | Late accountant, disputes |
| Negative pledge | No other security without consent | Equipment finance, second mortgage |
The definitions matter more than the labels. Your facility letter will define “EBITDA”, “debt” and “interest” in its own way — often differently from your management accounts. The guide to debt service and interest cover explains the common adjustments.
Before the breach: what should you do?
The best covenant conversations happen before the test date.
- Model the next two test dates. Use management accounts and a realistic forecast, with the bank’s definitions. The debt service cover calculator gives a quick first read.
- Identify the cause. A one-off (a lost contract now replaced), a timing issue (a large payment falling just before the test), or structural (margins permanently lower).
- Prepare the cure. Cost actions, a debt reduction from an asset sale, an equity injection, or a restructure of repayments.
- Talk to the bank first. A banker who hears about a likely breach from you, with a plan, is in a very different position from one who discovers it in late accounts.
- Line up an alternative. Knowing you could refinance changes the tone of a waiver negotiation. Ask a specialist what a refinance might look like before you need it.
After the breach: what usually happens?
Most banks start by seeking to understand the cause. Common outcomes:
- Waiver, sometimes with a fee.
- Reset of covenant levels to fit the business’s new shape.
- Repricing to reflect higher perceived risk.
- Tighter reporting — monthly management accounts, cash-flow forecasts.
- Extra security or guarantees. See when the bank wants more security.
- Debt reduction requirement within a set time.
- Transfer to a specialist area within the bank, sometimes called a credit management or business support team.
None of those is necessarily fatal. But if the conditions would cripple the business — for example, a debt reduction it can’t fund — refinancing becomes the real alternative.
What protections exist for smaller businesses?
The 2025 Banking Code of Practice took effect on 28 February 2025. For standard-form small business loan contracts, it provides that banks won’t include an event of default based on unspecified material adverse changes, and it allows financial indicator covenants for particular loan types, such as property development and specialised lending. Whether the Code applies depends on your business’s size and the bank’s subscription; the ABA publishes the Code.
Separately, ASIC’s unfair contract terms guidance covers small business contracts — broadly, businesses with fewer than 100 employees or turnover under $10 million — and for financial products, contracts with an upfront price of up to $5 million.
These frameworks matter, but they’re not a strategy. The practical protection is an early, well-prepared conversation and a credible alternative.
Illustrative covenant cure
Illustrative only; no real business. A $15 million turnover manufacturer’s DSCR covenant is set at a level it’s comfortably met for years. A major customer shifts volume offshore, earnings fall, and the next test will be missed. The finance manager models the shortfall six weeks ahead, briefs the bank with a plan to replace the lost volume and sell a surplus property, and presents a refinance proposal from a property-backed lender as a fallback. The bank grants a waiver with monthly reporting for two quarters and resets the covenant for the following year.
When refinancing is the better answer
- The waiver conditions are unaffordable or unrealistic.
- The bank wants to exit the relationship regardless. See when the bank won’t renew.
- Covenants will keep biting because the business has permanently changed.
- A property-backed structure would remove cash-flow covenants that don’t suit the model.
Our page on refinancing business debt walks through the process.
Covenant breach checklist
- Recalculate the test using the facility letter’s exact definitions
- Identify whether the cause is one-off, timing or structural
- Prepare a short note: cause, cure, timeline and forecast
- Contact the relationship manager before the test date or reporting deadline
- Request a waiver or reset in writing; keep a record of the response
- Understand any conditions attached — fees, pricing, reporting, security
- Check cross-default clauses in other facilities, including equipment finance
- Map a refinance alternative in parallel, with indicative timing
After the waiver: rebuilding headroom
A waiver fixes one test date, not the next one. Once it’s granted, update the forecast with the bank’s definitions, track the ratio monthly, and report early if it drifts again. Two consecutive quarters comfortably inside the covenant rebuild more credibility than any explanation, and put you in a stronger position to ask for a reset at the following review.
Facing covenant pressure?
If a test date is approaching or has passed, the sooner we see the numbers, the more room you have. Bring the covenant definitions, the latest management accounts and a view of the security available.
There’s no credit check at the enquiry stage. Your details won’t be broadcast to a pool of lenders; a specialist reviews them and explains your options candidly. Please be accurate about existing debt and the covenant position — it lets us tell you straight away whether a refinance is realistic. Get a covenant-pressure review.
Frequently asked questions
Does a covenant breach mean the bank will call in the loan?
Not automatically. A breach usually gives the lender rights under the agreement, which it may or may not exercise. Most banks first seek to understand the cause, then consider a waiver, reset or repricing. The risk rises if the breach is concealed, repeated or accompanied by other problems.
What is a covenant waiver?
A waiver is the lender's agreement not to exercise its rights for a particular breach. It's often conditional — a fee, higher pricing, extra reporting, additional security or a plan to reduce debt.
Can a covenant be reset rather than waived?
Yes. If the business has changed permanently, a reset of the covenant levels to reflect the new shape may be more useful than a one-off waiver. Banks will expect a credible forecast to support it.
Does the Banking Code limit covenants for small business loans?
The 2025 Banking Code of Practice, effective 28 February 2025, restricts some default triggers in standard-form small business loans, including a default based on unspecified material adverse change. It allows financial indicator covenants for certain loan types such as property development. Check the Code and your own facility letter.
Can we refinance while in breach?
Often, yes, though options narrow. Property-backed lenders focus more on security and exit, so a breach with a bank covenant is not necessarily a barrier to refinancing elsewhere.