Meaning
Binding agreements dictate the standards by which a board manages company affairs. A corporate governance covenant is a clause in a loan agreement or a shareholders’ agreement that requires the management to follow specific reporting or operational rules. These terms protect investors from reckless management and ensure that the business maintains a high standard of internal oversight.
Management Control
Investors use these clauses to limit the power of the chief executive officer or the majority owner. A corporate governance covenant might require the appointment of independent directors or the creation of an audit committee. These structural requirements ensure that no single person has unchecked authority over the company’s financial resources.
Access to information and the right to attend board meetings are often bundled with these control terms.
Reporting Obligation
The company must provide regular financial statements and meeting minutes to the holders of the debt or equity. Every corporate governance covenant specifies the frequency and the level of detail required in these disclosures. Failure to provide this information on time allows the other party to exercise their rights under the default provisions.
Default Event
Breach of these terms gives the lender the right to accelerate the debt or the investor the right to take a board seat. A corporate governance covenant acts as a tripwire that alerts stakeholders to failing internal controls before the company suffers financial loss. The protection offered by these clauses is a standard feature of venture capital and private equity deals.
