from definition it says that affirmative covenant means it requires certain action while negative covenant means it prohibits something, but then how to judge this one “prohibit excess dividend payment to ensure current ratio > 1”? to me, the “prohibit” piece and “ensure” piece both show up….. my head spins…
affirmative vs. negative covenant
- Thread starter pkuguorui
- Start date
imo, that’s a negative covenant.
Affirmative covenants involve an action. In regards to maintaining ratios, paying down debt to keep debt to EBITDA in line with ratios when being acquired.
A negative covenants are more like long term policies, so a prohibition on excess dividend payments is a negative covenant.
Affirmative covenants involve an action. In regards to maintaining ratios, paying down debt to keep debt to EBITDA in line with ratios when being acquired.
A negative covenants are more like long term policies, so a prohibition on excess dividend payments is a negative covenant.
Actually i would say that this is an affirmative covenent as you must keep the ratio above certain level. Negative would be for eg. if you cannot issue another secured debt or use an asset as a collateral or must not pay more than some amount in dividents. But aggreeing to do sth (keep the ratio, make timely payents etc) is affirmative covenant.
We need some more minds here
We need some more minds here
Well, it’s a good question:
From the book on page 248, I think it approaches this sort of issue (maintaining a ratio) from both sides:
From an affirmative covenant perspectave: “Covenants might also require a company to redeem debt in the event of the company being acquired or to keep the ratio of debt to EBITDA below some prescribed amount.”
From a negative covenant perspective: “The limitations might include a cap on the amount of cash that can be paid out to shareholders relative to earnings, or perhaps on the amount of additional secured debt that can be issued”
In my view pkugs example is more similar to the cap, whereas the affirmative type covenant example is saying they need to redeem debt (an action) to maintain EBITDA.
I agree, we need a third opinion.
From the book on page 248, I think it approaches this sort of issue (maintaining a ratio) from both sides:
From an affirmative covenant perspectave: “Covenants might also require a company to redeem debt in the event of the company being acquired or to keep the ratio of debt to EBITDA below some prescribed amount.”
From a negative covenant perspective: “The limitations might include a cap on the amount of cash that can be paid out to shareholders relative to earnings, or perhaps on the amount of additional secured debt that can be issued”
In my view pkugs example is more similar to the cap, whereas the affirmative type covenant example is saying they need to redeem debt (an action) to maintain EBITDA.
I agree, we need a third opinion.
It’s a negative covenant. Think about it this way. A company can be in compliance with a negative covenant simply by operating as usual and not taking any action that will violate the covenant. In order to comply with an affirmative covenant, a company must take a specific action to comply. The best example of an affirmative covenant is providing financial statements. The company must actively provide financial statements to the bank providing credit in order to be in compliance.
In this case, the company is not allowed to make excess dividend payments. The company can comply with this covenant simply be operating as normal and not making any dividend payments in excess of those allowed by the covenant.
In this case, the company is not allowed to make excess dividend payments. The company can comply with this covenant simply be operating as normal and not making any dividend payments in excess of those allowed by the covenant.
As a follow up, where did this question come from? Usually covenants restricting dividend payments would not be worded like that. Typically, it might be structured such that a dividend could not be paid if the current ratio is less than one, but it is impossible for a dividend policy to ensure that the current ratio is greater than one, given that dividends cannot be negative.
For instance, what if no dividends are paid and the current ratio is still less than one? In this case, there is no possible dividend policy that could ensure a current ratio greater than one.
For instance, what if no dividends are paid and the current ratio is still less than one? In this case, there is no possible dividend policy that could ensure a current ratio greater than one.