Financial covenants give lenders a formal moment to engage when performance drifts from plan. A maintenance covenant is a standing test that the borrower must pass each quarter regardless of new actions. An incurrence covenant turns on only when the borrower does something specific, such as taking on new debt or paying a dividend. Getting their scope, definitions, and interactions right decides who has control when the plan slips and how quickly parties reset terms.
Why maintenance covenants drive outcomes
In direct lending, a maintenance leverage covenant is the steering wheel, not the brake. It tells lenders when to step in, negotiate resets, or require fresh equity. The headline tools are broadly consistent across regions. The United States and Europe both rely on leverage and, less often now, coverage. The differences that matter live in the rules under the hood, the accounting adjustments, and the intercreditor framework that determines who holds the waiver lever.
Market context and current direction
Private credit terms loosened into 2021 as capital chased deals. Higher rates and wobblier earnings in 2023-2024 pushed a modest retrenchment. European deals tightened caps on EBITDA add-backs and cures. US credits kept a single leverage covenant but narrowed definitions, limited cash netting, reduced how cures can be used, and added step-downs that bite if rates stay high. The net effect is less synthetic headroom and more discipline when a plan misses.
Baseline mechanics you will actually negotiate
Most facilities test a maximum leverage ratio, usually defined as debt over EBITDA. Variants include first lien, senior secured, or total leverage. Coverage tests still exist but often show up deal-by-deal as rates reset higher. Tests usually occur quarterly, with compliance certificates due 30 to 45 days after quarter end. Monthly maintenance tests are rare in sponsor-backed credits and signal a weaker credit profile.
Placement matters. In US sponsor deals, the test typically sits at the senior or first lien term debt. In Europe, a unitranche often sits beside a super-senior revolving credit facility. The maintenance covenant may spring only to the revolver or apply co-extensively to both. Control then depends on the intercreditor terms, which can shift leverage between bank and fund lenders at the worst time.
US vs Europe: the definitions that decide the day
What the leverage numerator actually includes
US documents commonly test first lien net leverage or senior secured net leverage. A first lien test usually preserves capacity for junior capital without tripping the covenant. Europe more often keys to senior net leverage aligned with super-senior and senior secured layers, with carve-outs for hedging and ancillary lines that keep the math clean for working capital tools.
Cash netting rules that change headroom
Cash netting is where borrowers and lenders quietly negotiate real control. US terms typically allow netting of unrestricted cash up to a cap and exclude trapped or liened balances. Europe tends to net only pledged, restriction-free cash held in specified secured accounts, often within the EEA. This difference matters when liquidity sits in offshore entities, regulated subsidiaries, or tax-inefficient jurisdictions.
EBITDA definitions and add-back discipline
EBITDA definitions moved front and center as higher rates exposed aggressive add-backs. US deals now cap pro forma savings and synergies at roughly 20 to 25 percent of EBITDA, set 18 to 24 month realization windows, and require itemized schedules. Europe often allows broader forward-looking adjustments, longer windows, and good-faith sponsor determinations that can delay the breach. Accounting also complicates comparisons. IFRS 16 lifts reported EBITDA by moving leases below the line. US GAAP under ASC 842 treats leases differently, so US documents often add back operating lease expense to normalize. If the definition does not neutralize accounting differences, headroom is mismeasured.
Headroom design and step-downs
US lenders usually size the covenant at or just above underwritten first lien leverage, with a 0.25x to 0.50x cushion early and step-downs tied to deleveraging. European deals provide similar initial cushions but more often tie step-downs to calendar dates. That subtle shift can force cures during macro slowdowns and raises the value of explicit reset mechanics.
Cure rights that help versus cures that hide problems
Cures are a paid option on time. US sponsors favor EBITDA cures because they can lift leverage-based baskets as well as the test itself, unless blocked. Some documents allow cash paydown cures. Europe permits EBITDA cures but more often requires cash to sit as pledged proceeds or be applied to debt, limits carry-forward, and narrows how cures interact with baskets. Frequency caps matter on both sides of the Atlantic. Two cures in four quarters and four to five life-to-date is common in the US; two in four and three to four life-to-date in Europe. Increasingly, US documents state that cure amounts do not grow builder baskets, and European documents block distributions for a period after a cure.
Timing also shapes outcomes. Cure windows typically run 20 business days after delivery of the compliance certificate. Some US lenders require delivery of that certificate before they credit the cure. European banks can require pre-funding into pledged accounts for revolver tests, which demands extra quarter-end planning.
For a concise overview of current cure drafting trends, see Equity Cure Provisions in Leveraged Finance.
How maintenance tests interact with incurrence capacity
Maintenance headroom often leaks through incurrence baskets. Ratio debt capacity can allow new pari or first lien debt if leverage sits at or below a threshold, sometimes above the maintenance level. That can expand debt capacity precisely when pro forma EBITDA padding is highest. Europe counters by tying ratio debt to senior secured leverage or interest cover and by leaning on no-worse-than tests and strict most favored nation protections for new pari debt. Builder baskets also matter. US available amount mechanics grow with retained excess cash flow and asset sales. Post-2023, cure dollars usually cannot grow the bucket. Europe starts smaller and grows slower. Distribution capacity in both regions now tightens after a cure or near-miss, which keeps cash inside the structure when it is most needed.
Information rights that prevent blind spots
Oversight requires timely data. US lenders increasingly ask for monthly liquidity reports, plan variance bridges, and 13-week cash flows as leverage approaches a defined tripwire, often within 0.5x of the covenant. European unitranche lenders are adopting similar triggers for near-misses. Link missed reporting to an event of default with short grace periods, typically five to ten business days, to prevent prolonged opacity.
Springing covenants and super-senior dynamics in Europe
European revolvers frequently hold the only maintenance covenant. It springs when drawings exceed roughly 35 to 40 percent of commitments. If the unitranche relies on cross-default to that test, the revolver banks hold the waiver lever. US revolvers can also include springing tests, but term lenders more often retain their own maintenance test, preserving control. Where revolvers are asset-based loans, springing tests can shift to availability thresholds. The result is the same. Control lives with whoever owns the springing test, so map it explicitly.
Pricing grids can amplify stress
Leverage-linked ratchets align price with risk, but they also raise the hurdle for cures. In the US, tighter covenants plus ratchets can lift interest costs just as EBITDA falls. Europe uses fewer and narrower steps, and some deals add a penalty tier if a cure was used in the prior quarter. If pricing moves up after a pass-by-cure, the borrower pays more even as operating performance weakens. For market context, review unitranche pricing grids.
Transfers, waivers, and practical control
Decision-making architecture drives amendment speed. US unitranche agreements often centralize decisions with a controlling lender or agent, use majority voting for waivers, and set transfer limits that keep the club cohesive. Europe splits control between revolver banks and the unitranche under intercreditors, stretching timelines and enabling sponsors to shop terms across classes. Clear consent maps and defaulting-lender replacement rights shorten that loop.
Common pitfalls and simple guardrails
- EBITDA add-backs: If projected savings need only a plan, expect 20 to 30 percent EBITDA inflation in year one. Cap at 20 percent, require itemized schedules, and set 18 to 24 month realization windows.
- Cash netting: If offshore cash nets without hard caps, assume leverage is understated by 0.25x to 0.50x in stress. Net only pledged, freely available cash, and cap foreign cash with a fixed dollar amount.
- Equity cures: Carry-forward cures can hide deterioration. Limit cures to the quarter being tested and block cure amounts from growing ratio debt capacity or builder baskets.
- RCF-only testing: If the revolver holds the only maintenance covenant, it gates unitranche remedies. Add a co-extensive unitranche test or hardwire shared control at defined underperformance levels.
- Calendar step-downs: Date-driven step-downs can trigger forced cures in flat quarters. Link step-downs to leverage milestones or new-money resets.
Worked example: headroom and cures
Assume a US unitranche with a 6.0x first lien net leverage covenant stepping to 5.5x in quarter six. At close, first lien debt is 580, unrestricted cash is 30, EBITDA is 100, and net leverage equals 5.50x. A five percent EBITDA miss drops EBITDA to 95 and leverage to 5.79x, still inside 6.0x. If cash netting were capped at 10, leverage becomes 5.99x, right at the limit. At the 5.5x step-down, the same metrics breach. An EBITDA cure of 10 lifts test EBITDA to 105, leverage drops to 5.43x, and the test passes. If the ratchet steps up above 5.0x, interest cost still rises even after the cure. If cures cannot grow builder baskets, distributions remain blocked, which preserves cash but pressures sponsors to inject equity.
Enforcement realities and negotiation timelines
Breaches start negotiations, not accelerations. In the US, lenders typically move within days to weeks to reset covenants, add super-priority tranches or delayed draw term debt, and layer in fees and higher margins. The hazard is underpricing resets if EBITDA remains inflated with add-backs. In Europe, super-senior coordination slows the process and raises the bar for formal enforcement. That nudges parties toward earlier, lighter amendments backed by stronger reporting rights and clearer cure mechanics.
Implementation checklist you can copy
- Definitions: Lock EBITDA adjustments, cap synergies at 20 to 25 percent, set 18 to 24 month windows, require itemized schedules, and normalize lease accounting across IFRS and US GAAP.
- Netting: Limit netting to pledged, restriction-free cash; cap foreign cash; exclude customer deposits and any sums subject to set-off.
- Cures: Cap frequency and block carry-forward; prevent cures from growing ratio debt and builder baskets; permit only one consecutive-quarter cure absent new equity.
- Step-downs: Tie to leverage milestones and include reset mechanics upon agreed new money.
- Springing control: In Europe, avoid revolver-only testing unless intercreditors allocate waiver control to the unitranche at defined underperformance levels or provide co-extensive testing.
- Information: Trigger monthly liquidity, variance bridges, and 13-week cash flows within 0.5x of the covenant; make missed reporting a default with short grace.
- Ratio debt guardrails: Set incurrence tests at or below the maintenance level and require pari collateral and maturity, or robust MFN that baskets cannot sidestep.
Original angle: your quarter-end early-warning dashboard
Three simple practices improve outcomes long before a breach. First, run a covenant math audit 45 days before quarter end that recomputes leverage using zero offshore netting and a 50 percent haircut to pending add-backs. Second, map liquidity topology by entity and currency, then pre-position cash in nettable, pledged accounts three business days before quarter end. Third, activate a cure decision tree that quantifies whether an EBITDA cure or cash paydown is cheaper once pricing ratchets are considered. As a rule of thumb, if the cure increases interest expense more than the cost of a small paydown over two quarters, choose cash.
Alternatives when leverage tests do not fit
Cyclical or project-driven businesses may be better monitored by fixed charge or debt service coverage ratios that track cash generation. High-growth software with negative free cash flow may suit recurring revenue metrics early in the hold. When you adopt non-EBITDA metrics, tighten definitions, shorten reporting deadlines, and add audit rights to prevent metric gaming.
Cross-border and structure-specific nuances
For cross-border deals, secure CFO certification plus third-party validation for larger add-backs and M&A pro formas to preserve credibility. New York or English law both work, but continental share pledge enforcement adds time. Courts versus arbitration changes speed, and English courts under intercreditors often move faster than fragmented local processes. Build replacement rights for non-consenting lenders and ensure each facility can reach voting thresholds without relying on a single institution.
Decision-use checklist for committees
- Add-backs over 25 percent: Assume 0.25x to 0.50x of illusory headroom and haircut covenants accordingly.
- Uncapped offshore netting: Reduce modeled headroom by at least 0.25x in the downside case.
- Revolver-only test in Europe: Require a co-extensive unitranche test or hardwired shared voting at defined stress levels.
- Cures that grow baskets: If cure proceeds can expand ratio debt or distributions, expect faster leakage and negotiate an explicit block.
- Calendar step-downs: Quantify implied deleveraging and require mutual reset rights tied to agreed equity or new money.
What to monitor after closing
- Pro forma vs realized savings: If a quarter slips, treat the remaining add-backs as at risk and revisit headroom immediately.
- Revolver usage: Rising draws toward a springing trigger are an early warning, not background noise.
- Distributions near the line: Repeated use of restricted payment baskets within 0.5x of the maintenance covenant signals misaligned priorities.
- Amendment cadence: More than one amendment before the first step-down is a reset signal that merits re-underwriting liquidity and coverage.
Helpful related reading
For deeper dives on adjacent topics, see these guides on financial covenants, US vs Europe unitranche loans, maintenance covenant norms, delayed draw term loans, and holdco PIK notes.
Conclusion
The structures rhyme across regions: one maintenance leverage covenant, quarterly tests, and familiar ratios. Control shifts with definitions, cure rules, cash netting, intercreditor design, and how incurrence capacity interacts with maintenance headroom. In the US, assume more scope for EBITDA engineering and set caps and validation. In Europe, assume slower enforcement and design covenants that trigger earlier engagement without bank bottlenecks. Treat cures as a paid option whose value declines as operational performance slides. The goal is simple: create a disciplined moment to reset terms while there is still time to protect capital.