The Role of Covenants in Asset-based Financings

Marie J. Lucca

When shipowners shop for a loan, rates and repayment schedules are generally uppermost in their minds. However, covenants in loan and security documents are also an area of keen interest and concern. Although most covenants are standard, there have been several recent and significant changes to the covenants sections of loan agreements and ship mortgages.

Covenants are the shipowner’s undertakings to minimize risks during the period of the commitment and for the duration of the loan. Violation of a covenant gives the lender the right to refuse to make additional advances or, after giving notice and the passage of the applicable grace period, creates an event of default which permits the lender to call for the repayment of the loan and cancel the commitment.

Both affirmative and negative covenants permit the lender to influence the future conduct of the shipowner – and sometimes its subsidiaries or affiliates – in a manner which will reduce the risk that the loan will go into default. They do this by setting minimum standards for the shipowner in the areas of loan repayment and security, corporate structure and finances, liens, insurance, vessel maintenance and trading.

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