Meaning
Agreement between a buyer and a seller mandates that the target business continues its operations according to its historical practices during the period before closing. The ordinary course covenant prevents the seller from taking unusual actions that could diminish the value of the company or alter its risk profile. It ensures the buyer receives the business in the state they expected when the deal was signed.
Operational Restriction
Management is prohibited from making large capital expenditures or entering into substantial new contracts without permission. Compliance with the ordinary course covenant means the company cannot change its hiring practices or give unusual raises to staff. These rules keep the business stable while the final details of the acquisition are finished.
Financial Preservation
Sellers must maintain inventory levels and continue to collect accounts receivable as they always have. Violation of the ordinary course covenant occurs if the seller tries to accelerate cash inflows or delay payments to vendors to inflate the bank balance. Such actions result in a working capital deficit for the buyer on the first day of ownership and compromise the initial financial projections.
Consent Process
Exceptions to the rule are handled through a formal request and approval system. If a genuine business opportunity arises, the buyer can waive the ordinary course covenant for that specific transaction. This flexibility allows the company to respond to market changes while still protecting the interests of the future owner.
