Bond Covenants in India: The Fine Print That Actually Protects Your Money

According to the RBI data, companies raised INR 9.9 lakh crore in FY25, marking a record 28% growth from the previous financial year¹. However, despite this increased investor affinity towards fixed-income generating bond assets, investors often lack the understanding of bond covenants and their importance.

Bond covenants set contractual clauses that ascertain the responsibilities and impose restrictions on bond insurers, thereby providing bondholder protection, safeguard of principal and interest, among other benefits.

This blog breaks down bond covenants' meaning, types, working methodology and more to promote informed investing.

What Are Bond Covenants?

The word Covenant means an agreement or pledge. Therefore, bond covenants are clauses in the bond agreement that set requirements for an issuer to fulfil or prohibit them from undertaking certain activities. These legally binding clauses ensure that the credit risk is controlled and that investors do not lose out on the principal that they extended as debt to the issuer or the interest accrued.

For instance, a bond covenant of ABC insurer specifies that the insurer must maintain an insurance policy for its key assets. Moreover, another covenant specifies that the issuer cannot merge or restructure the company without consent.

In short, government or corporate bond covenants are like terms and conditions that the issuer must fulfil, in exchange for credit to ensure that investors stay protected. These covenants offer various key benefits to issuers and investors.

Benefit Of Bond Covenants

The bond covenants are useful and necessary not only for investors but also for the issuers. Discussed below are the benefits of protective covenants for both parties.

Benefit to Issuers

1. The bond covenants indicate the financial discipline of issuers and assure prospective investors of a controlled risk profile. 
2. Optimal covenants can help attract debt at a lower cost and better investor reception, thus increasing investment opportunities. 
3. Moreover, bond issuer obligations provide guardrails that avoid risky financial decisions and future defaults, which can result in a diminished risk rating and litigation.

Benefit to Investors 

1. Strong covenants help ensure high recovery rates and avoid defaults. 
2. Covenants can be used to set regular filing needs of financial and statutory reports. This increases transparency and promotes informed investing.
3. Moreover, covenants can prevent the sale of assets, payment of dividends, etc., in uncertain periods. Thus, it prevents erosion of bond debt repayment capacity.

Now, there are various categories of bond covenants, each fulfilling a specific requirement.

Types Of Bond Covenants

The meaning of bond covenants cannot be fully understood without exploring the meaning of these types. Discussed below are the different types of bond covenants.

1. Affirmative Bond Covenants

Covenants that specify the steps an issuer must take to ensure financial health, transparency and security are called positive bond covenants or affirmative covenants. These clauses refer to the actions that the issuer is supposed to commit.

For instance, ABC Limited issued 6% corporate bonds along with positive covenants stipulating that they submit audited financial statements quarterly, pay taxes and interest on time, provide clarity to bondholders on ongoing insurance, etc.

2. Negative Bond Covenants

Covenants that prohibit the issuers from undertaking actions that can hurt investor interests are called negative bond covenants. While positive or affirmative covenants specify the actions to do, negative covenants specify the actions not to do.

For example, the 6% bonds issued by ABC Limited carried covenants that prevented mergers or acquisitions without the bondholder's permission, restricted the sale of major assets beyond the operational activity of the business, etc.

3. Financial Covenants

Covenants that set caps on financial metrics and provide for periodic review to ensure that the metrics are within the specified limits are called financial covenants. It can include a debt-to-equity ratio covenant, an interest coverage ratio covenant, etc.

For instance, A covenant for the 6% bonds stipulated that ABC Limited keep its quarterly interest coverage ratio above 3.0x. 

This ensures that the company maintains optimal financial health so that the investment of bondholders stays protected. 

4. Event-Based Covenants

Certain provisions specify that if a particular incident occurs, then the investor is eligible for certain benefits or remedial measures. For instance, in case of asset sale, risk rating downgrade, change of control, etc., bondholders can get premium offers or repayment. This is called event-based covenants. Such covenants are triggered after the occurrence of an event and protect investor interest.

Now, let us explore how these restrictive bond covenants impact the risk-return expectation of investors.

Recent Covenant Breaches In India 

Bond covenants are designed to protect investors. However, there have been several instances in India where issuers failed to comply with these obligations. These cases highlight why investors should review bond covenants before investing rather than relying only on promised returns. 

1. GMR Goa International Airport Ltd.

The company reported a breach of its Net Debt-toEBITDA covenant. A financial covenant that requires it to maintain leverage within agreed limits. However, the breach was subsequently waived by debenture holders, allowing the company to continue under the existing bond terms. 

2. Akara Capital Advisors Pvt. Ltd.

Akara Capital disclosed a breach of the Portfolio at Risk (PAR 90+) covenant, which capped the proportion of loans overdue by more than 90 days. After the breach was identified, the company obtained the necessary approvals from debenture holders to waive the covenant violation. 

3. Parsvnath Landmark Developers Pvt. Ltd.

The company reported breaches related to the security cover requirement and delay in providing mandatory information to the debenture trustee. These disclosures demonstrated the importance of monitoring both financial and reporting covenants throughout the life of a bond. 

These covenant breach examples in India show that a covenant breach does not always lead to immediate payment defaults. In many cases, issuers can seek waivers or take corrective action. However, such breaches often act as early warning signals that investors should monitor closely. 

Credit Ratings vs Bond Covenants 

Credit ratings and bond covenants both can help you evaluate risk before investing. They both serve very different purposes. 

How Bond Covenants Impact Investor Risk And Returns

A legally binding contract exists between bond issuers and bondholders, called a bond indenture. The bond indenture carries several covenants that ensure the safety of investments made by bondholders. The bond indenture covenants stipulate guardrails by either directly prohibiting certain actions, ensuring some requirements are met and by setting caps that can act as signals if not met.

Between the bond issuer and bondholder, there exists a bond trustee. They are financial institutions that act as intermediaries and represent the interests of bondholders. They monitor and ensure compliance with covenants. If the bond covenants are breached, then bondholders are eligible for the following remedies via the trustees.

• Default triggers like immediate repayment, higher rate of interest, etc.
• Seizure of collateral in case of secured bonds.
• Penalties can also be imposed.
• Depending on the nature of the covenant breach, courts can also intervene.

The table below shows some common covenants and what they restrict.

However, corporate bonds often rely more on high-yield bond covenants.

What Happens After A Covenant Breach? 

A covenant breach does not always mean the issuer has defaulted on interest or principal payment. Instead, it indicates one or more contractual obligations under the bond indenture have been violated. If the bond covenants are breached, then bondholders are eligible for the following remedies via the trustees.

• Default triggers include immediate repayment, a higher rate of interest, etc.
• Seizure of collateral in case of secured bonds.
• Penalties can also be imposed.
• Depending on the nature of the covenant breach, courts can also intervene.
• Negotiation between bondholders and the issuers to rectify the breach before it escalates into a payment default.

Bond Covenants In Corporate Bonds Vs Government Bonds

Government bonds carry a sovereign guarantee, which is absent in the case of corporate bonds. Moreover, in the case of high-yield bonds, the degree of risk is higher than that of providing lower returns. Therefore, it is important to analyse covenants before investing to ensure security.

Along with covenants, it is important to choose optimal bond platforms. For instance, Grip Invest is registered with SEBI as an Online Bond Platform Provider (OBPP).

Grip offers a range of corporate bonds that can offer up to 12.5% yield to maturity.

Visit Grip Invest today!

Conclusion

Bond covenants are one of the most important yet often overlooked aspects of bond investing. They act as a legal safeguard that helps protect investors by placing financial and operational restrictions on issuers throughout the bond tenure. Factors such as credit rating, coupon rates and yield to maturity are important. 

However, understanding a bond’s covenants provides a clear picture of protection available if the issuer’s financial health weakens. Reviewing both the bond indenture and covenant terms can help investors make more informed fixed-income investment decisions. If you are looking to invest in corporate bonds, then always evaluate the issuer's credit profile, covenant structure and overall risk before making any investment decision. 

FAQs On Bond Covenants

References:

1. Economic times, accessed from: https://economictimes.indiatimes.com/markets/bonds/corporate-bonds-in-india-from-institutional-stronghold-to-broader-participation/articleshow/122808987.cms

Author: Grip Invest Editorial Team The Grip Invest Editorial Team is a group of Chartered Accountants, MBA (Finance) graduates, and Qualified Research Analysts dedicated to helping you invest smarter. We dive deep into India's fixed income landscape to deliver content that is accurate, up-to-date, and easy to understand. Whether you're exploring bonds, fixed deposits, or other fixed income opportunities, our guides cut through the noise and give you the clarity to make better financial decisions.

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