Covenants are a part of a written contract and often involve promises or stipulations to do something — or even a promise not to do something in the future. When a breach of covenant occurs, it means one of the parties involved in the contract has violated those promises in some way.

In the case of automobiles, the covenants may be terms or conditions tied to the financing for the vehicle purchase or part of the loan agreement between a lender and you as the borrower.

What is a breach of covenant?

Covenants are promises or stipulations that are part of written contracts, frequently relating to real, tangible property such as a vehicle. If one of the parties involved in the contract fails to live up to some part of those conditions or stipulations, then it is considered a breach of covenant.

In the case of an auto loan — the financing associated with purchasing a vehicle — the loan agreement between the lender and borrower may include requirements surrounding the specific terms of the debt. The covenants are requirements or conditions imposed by the lender and the borrowers must agree to those conditions in order to finalize financing.

Because loans are a contract between a lender and a borrower, any violation of that contract constitutes a breach of covenant and may even result in a lawsuit.

Parts of breaches of covenants

There are various types of covenants including positive and negative covenants and standard and non-standard covenants.

Positive vs. negative covenants

Positive covenants typically include a variety of obligations that a borrower must meet in order to remain in compliance with a contract and for the deal to remain in place.

Negative covenants however, are designed to prevent borrowers from engaging in high-risk actions. These types of covenants typically require borrowers to obtain advance approval for any actions that may be deemed risky.

Standard vs. non-standard covenants

Standard covenants are generally the same for all borrowers. An example of a standard covenant might be that a borrower must make principal payments on a loan and must make those payments by their due date.

By contrast, non-standard covenants are unique to a particular borrower and that borrower’s individual circumstances.

How a breach of covenant affects a borrower

There are a range of consequences for breach of covenant. They could include:

  • Paying financial compensation for violating a covenant
  • Paying a fee or penalty charged by the lender
  • Increased interest rate on your loan
  • Revision of the contractual agreement
  • Termination of the agreement

In some cases, in order to maintain the agreement after a breach of covenant, you may even be required to provide some form of additional collateral.

The bottom line

Covenants are conditions that are part of a contract, particularly debt contracts such as auto loans or financing. When signing onto a contract be sure to review all stipulations and conditions of the agreement carefully so that you fully understand them and can remain in compliance.

When a breach of covenant occurs, you risk having to pay penalties, a higher interest rate or even having the contract terminated altogether.

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