Negative Covenants in Payroll Financing Contracts
Negative covenants are restrictions on certain business activities during the term of the payroll funding contract or bank services. Be sure to read your payroll funding contract closely. Which kind of restrictions are you signing up for?
In one class of negative covenants, the borrower agrees not to
do or take specified actions THE ENTIRE TIME THE AGREEMENT IS IN EFFECT. Note that during the term of the financing contract there could be a period of time where you have no loan balance and absolutely no indebtedness to the payroll funding company–yet the specified actions are still restricted.
In a second type of negative covenant clause, the borrower agrees to not do the restricted activities UNTIL the loan is paid in full. This leaves open the possibility that you can do the restricted activity(ies) during the term of the agreement as long as you do not have a loan balance. Be sure to check if there is a clause in the contract that states a minimum-loan balance requirement.
The third type of negative covenants are rules that you shall not do specified actions at all times WITHOUT PRIOR CONSENT OF THE LENDER. Scenarios will be examined case by case and final decisions are usually in the hands of slow committees and credit groups.
Negative covenants tend to turn up in payroll funding contracts for money-only programs (without payroll or back office services) of bank-owned funding operations. Generally, the lower the rate or payroll funding cost, the higher the propensity there is for negative-covenant restrictions on how you conduct business. With banks, the three types of covenants listed above tend to not be negotiable; the bank makes the final calls.
The following are the main categories of negative covenants and common examples of these restrictions.
The borrower should not engage in any business activities substantially different from those in which the borrower is currently engaged. The borrower cannot cease operations, liquidate, merge, transfer, acquire any interest in, or consolidate with any other entity. The business cannot change its name, move its executive head office, or change the State that it’s legal entity is organized in without proper payroll funding lender-required notifications and approvals. The business cannot transfer any collateral which is included as security for the loan.
The company may not pay any dividends or make distributions of its equity capital (except for certain taxes) . It may not redeem equity interest to those who invested in the business (even by purchasing it or acquiring it). The company may not enter into any transactions with it’s investor equity holders or affiliates of the borrower at any favorable terms; they must be on terms as though the person in the transaction had no relation to the borrower.
The company and/or borrower may not loan, invest in, or advance money to any other person, enterprise or entity. The company and/or borrower may not incur any obligations as a guarantor–may not in any way guarantee loans for anybody else, other than in the ordinary course of business. The borrower may not have any other debt to anyone else except to the payroll funding company /lender/bank, unless the debt is “subordinated”. (Subordinated debt would be a loan to the business from investors, and these investors must agree that if there are any business problems, the bank gets their loan paid off first before the investors are made whole.) There may be a negative covenant restriction that each year, the business may not go into debt any more than X dollars (example $40,000) for the purpose of buying or leasing equipment, or acquiring any capital assets. The last example of a negative covenant is that the borrower may not, during the term of the staffing firm payroll funding agreement, default on the payment of ANY debt to any other person (not just your payroll funding company loan-debt).