M&A Vocabulary – Explained by the experts: Covenants

In this ongoing series, a number of different M&A experts from the global offices of Rödl & Partner present an important term from the specialist language of the mergers and acquisitions world, combined with some comments on how it is used. We are not attempting to provide expert legal precision, review linguistic nuances or present an exhaustive definition, but rather to give a basic understanding or refresher of a term and some useful tips from our consultancy practice.

Covenants are collateral agreements in a contract. They become relevant in contracts for the purchase and sale of a business or shares if the relevant contract is executed in two steps: Signing and closing. In the phase between the obligation to purchase (signing) and the actual transfer (closing), the ownership and management regarding the business/company remains with the seller. The buyer therefore has a legitimate interest in a correct management of the business/company.

Covenants can be both positive and negative in nature, depending on whether they consist of obligations to act or to refrain from acting. Covenants that are common in practice include:

• Ordinary-Course-of-Business-Clause;
• Rights of access and information;
• Cooperation in connection with financing;
• Participation rights for obtaining approvals and consents;
• Confidentiality provisions;
• Provisions on communications and public announcements (press releases).

Covenants may be relevant also after closing. Typical examples are non-compete and non-solicitation clauses to prevent the seller from establishing or financing a competing business.

If agreed, covenants can be converted into post-closing covenants if they could not be fulfilled by closing date.

Overall, covenants enable the parties to execute the contract properly and make it easier to plan the transition period after the transfer of business/shares.