Table Of Contents
What Is A Positive Covenant?
A Positive Covenant is a binding clause within an agreement that requires a person or entity to follow, adhere to, and maintain the set standards with respect to making expenditures without their stability being hampered. The main intention of this covenant is to reduce the level of default risk or breach by any of the parties.
Positive covenant enforcement provides a legal obligation to the party. Also, it establishes a bond or commitment to adhere to the contract by the other party. Having legal enforceability makes these covenants open to strict legal actions in case of any kind of breach.
Key Takeaways
- A positive covenant is an agreement between two parties whereby one of them promises to abide by the terms and conditions proposed by the other. It is also known as an affirmative covenant.
- They enable the other party to follow specific ratio standards, maintain operational needs, and comply with legal requirements.
- The affirmative covenant refers to the smooth operation of the terms and conditions. Meanwhile, the negative covenant restricts any operation in the business. It is also called a restrictive covenant.
Positive Covenant Explained
A positive covenant, also called an affirmative covenant, is a promise within an agreement that requires a party to follow specific guidelines to maintain standards. These obligations can take various forms, depending on the usage and context. For example, a lender might add financial obligations as positive covenant enforcement in the agreement.
In business contracts, it usually occurs when one party (receiver) is doubtful of the other party. The seller might ask the buyer to disclose all the documents and papers. Similarly, the latter may ask the same. One must meet specific qualification while executing the contractual terms.
The inclusion of a bond with a positive covenant brings various features with it. It includes the following characteristics:
- Financial contracts may ask the borrower to keep a certain ratio standard. Some include earnings before interest, tax, depreciation, and amortization (EBITDA), the enterprise ratio, the debt-to-equity ratio, and others.
- Parties may need to maintain specific operational needs. For example, an affirmative covenant for a franchise business may require the store to meet cleaning and quality standards.
- Some agreements may include covenants requiring the party to comply with legal requirements.
In Australia, the public positive covenant imposes obligations on the new landowner. They require the landowners to undertake contracts for the council's benefit. Under sections 88D and 88E of the Conveyancing Act 1919, a public positive covenant may imply a condition based on their performance.
Examples
Let us look at some examples of affirmative covenants for a better understanding of the concept:
Example #1
Suppose Shawn owns retail outlets making vegan pizzas all over the United States. He has a secret formula for creating the dough and basil sauce for his recipe. He received an offer to open a franchise in Asia. Although Shawn wished to accept this proposal, he hoped to continue the current business. Also, he wanted to maintain authenticity and taste. Therefore, he put forth a bond with a positive covenant. It defined the following terms:
- The franchise owner will use the original ingredients and the recipe mentioned.
- The team will follow superior cleaning standards.
- The prices of pizzas will remain the same, as suggested by seniors.
The team would take legal action against the staff if they tried to breach them. With the help of this bond, he can not only create a global brand but can also enable others to maintain standards as per the brand.
Example #2
According to a March 2023 news article, the leading kitchen gadget producer, Tupperware Brands, needs help to survive in a competitive market. A month before, the firm had violated affirmative covenants in a credit agreement and still continued to burn cash. Their sales have been declining.
Previous year's taxes and internal control of financial reporting are the reasons the company is facing a delay in filing Form 10-K with the Securities and Exchange Commission (SEC). As a result, the company is looking at its accounting process to create a positive outlook for 2023.
Positive Covenant vs Negative Covenant
Although positive and negative covenants are crucial for a smooth transaction, some differences exist. Let us look at them:
| Basis | Positive Covenant | Negative Covenant |
|---|---|---|
| Meaning | It refers to the terms and conditions needed by the party to be fulfilled in an agreement. | A negative covenant refers to an obligation that the party should not perform. |
| Purpose | Its main objective is to ensure the smooth performance of the contractual terms in a transaction. | To refrain the party from performing any specific action in a transaction. |
| Also known as | Affirmative covenant | Restrictive covenant |
| Normal operations | These covenants cannot disrupt operations. | They can restrict the operations of the business. |
| Action | Here, action is a must, as directed by the party. | The parties don't need to perform. Instead, there are restrictions imposed on them. |
| Additional costs | As this covenant is self-administrative, there are no extra costs. Plus, it is not expensive compared to negative covenants. | In this case, there are additional costs involved. |
| Legal Binding | It is not legally binding and, thus, cannot be forcefully enforced on a party. | Negative covenants are legally binding. |
Frequently Asked Questions
No, it is possible with negative covenants. Affirmative covenants or those deemed to act as a burden (obligation as a covenant) cannot bind successors in title. They cannot enforce it on them in any manner. However, if a covenant is negative, they can efficiently perform it.
As the burden fails to run or comply with land, the affirmative covenants cannot be transferred to successors in English law. It is still impossible, even if the parties maintain a boundary or rooftop.
Running with the land refers to the situation where the rights remain with the land despite who the owner is. However, the affirmative covenants that run with the land do not happen. As a result, the covenant cannot enforce any promise. Thus, transferring ownership is also not possible.
