Friday, April 17, 2009

Breach of Debt Covenant

While a Company withdrawn loans from bankers, a debt covenant condition will be stated on the term loan facility letter require the Company to maintain /meet certain financial position. For instance, the debt covenant might require the Company to maintain current ratio of at least 1, or maintain net worth ( i.e. net asset) of certain amounts.

If the Company does not meet the debt covenant requirement, the bank is contractually entitled to call back the loans immediately. To illustrate, if Company XYZ fail to meet debt covenant requirement of maintaining current ratio of 1, bank is entitled to call back the loans amount immediately.

However, in practise, the Company will negotiate with its bankers to extend the period of review ( ie. extend the timeline for the Company, in order for the Company to improve its financial positoin).

For auditing purpose, the Company must require a waiver letter from the bank as an evidence that the bank will not call back the loan immediately. If not the non-current portion of term loan has to be classified as term loan if waiver letter was not obtained after the Company has breached its debt covenant.

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