Incurrence Covenant
Definition
An incurrence covenant is tested only when the borrower takes a specific action — such as incurring new debt, paying a dividend, making an investment, or selling assets. If the company cannot pass the test (e.g., pro forma leverage below a ceiling or a fixed charge coverage ratio above a floor, often 2.0x in high-yield indentures), it simply cannot take that action; there is no default from passive deterioration.
Incurrence covenants are the standard protection in high-yield bond indentures and covenant-lite term loans. A typical debt covenant allows unlimited ratio debt (subject to the test) plus negotiated baskets (a "free and clear" amount, a credit facilities basket, general baskets) that permit debt even when the ratio test fails.
The contrast with maintenance covenants is the key concept: incurrence tests constrain behavior, while maintenance tests continuously monitor credit health and trip early when performance deteriorates.
Why interviewers ask
"Maintenance versus incurrence covenants" is a staple leveraged finance and credit interview question. Interviewers want the one-line distinction — tested on action versus tested on a schedule — plus which instruments carry which.
Related terms
Interviews don't test definitions — they test recall under pressure.
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