Covenant Breach Ahead: How Business Owners Can Act Before the Bank Stops the Loan
The quarterly figures are on the table, and one ratio in your loan agreement is heading for its limit. No invoice is overdue and the business is running normally. Even so, the clock has started.
Banks use financial covenants as an early-warning system. For business owners, they can quickly become a trap: if you report a breach only once it has happened, you negotiate from the weakest possible position. See it coming months ahead, and you set the agenda.
This article explains which ratios matter, what Swiss company law requires of the board, and which levers buy you time and room to manoeuvre.
Four ratios that decide your loan
| Ratio | What it measures | Common reference value |
|---|---|---|
| DSCR (Debt Service Coverage Ratio) | Available cash flow relative to interest and amortisation | at least 1.2× to 1.35× |
| ICR (Interest Coverage Ratio) | EBITDA relative to net interest expense | at least 3× to 4× |
| Net Debt / EBITDA | Net debt relative to operating earnings | often a maximum of around 3.5× |
| LTV (Loan-to-Value) | Loan relative to the value of the collateral | often 65% to 75%, depending on the asset |
These are reference values only. Your loan agreement is what counts, including how it defines EBITDA and net debt. Those definitions are often where the first room for negotiation lies.
Check the termination clause as well. Banks can terminate many SME operating loans at short notice anyway. A covenant breach then provides the occasion, and cross-default clauses can pull other financing down with it.
Your negotiating position is strongest while the ratio still holds.
What Swiss company law requires of the board
A covenant breach is first and foremost a breach of contract. But it is often the first visible sign of a development for which the revised Swiss company law has set out clear duties since 2023.
| Stage | Trigger | Duty of the board |
|---|---|---|
| Monitoring Art. 725(1) CO | Ongoing | Continuously monitor solvency |
| Impending insolvency Art. 725(2) CO | The company is at risk of becoming insolvent | Secure solvency; if necessary, initiate restructuring or apply for a debt-restructuring moratorium |
| Capital loss Art. 725a CO | Assets less liabilities cover less than half of the share capital and non-repayable statutory reserves | Take remedial measures; without auditors, have the annual accounts subjected to a limited audit |
| Over-indebtedness Art. 725b CO | Justified concern that liabilities are no longer covered | Have interim accounts audited on going-concern and liquidation values; if over-indebtedness is confirmed, notify the court |
The court need not be notified in only two cases: if creditors subordinate their claims to the extent of the over-indebtedness and also defer interest, or if there is a justified prospect of remedying the over-indebtedness within a reasonable period, and no later than 90 days after the audited interim accounts are available.
In practice, this makes a rolling liquidity plan covering around twelve months essential. It is both a management tool and a liability shield: it shows the bank that the company can be restructured, and it documents that the board acted in time.
Five levers before the loan tips over
1. Go to the bank early, with solid figures
Bring a forecast, a root-cause analysis and an action plan before your file moves to the bank’s problem-loan unit. If you explain the situation yourself, you remain a partner. If you surprise the bank, you become a risk case.
2. Negotiate a waiver or covenant reset
A waiver temporarily suspends the consequences of a breach; a reset redefines the ratios. Banks often ask for fees, higher margins or tighter reporting in return. What matters is what you concede and how much breathing space you actually get.
3. Conclude a standstill agreement
The bank agrees not to terminate or enforce for a defined period, and you commit to a restructuring plan and close reporting. That buys time for an operational turnaround or a refinancing.
4. Use equity cures and subordination
If the loan agreement provides for an equity cure, shareholders can remedy a covenant breach with fresh capital. Subordinating shareholder loans strengthens your position with the bank and can avoid notification of the court. It does not, however, remove the over-indebtedness from the balance sheet.
5. Explore refinancing beyond your main bank
A second bank, private debt or mezzanine capital can break the dependency. A sale-and-leaseback can release capital tied up in operating property, although pledged assets require the bank’s consent. Owners who separate business and property early have more options here, as our article on the OpCo-PropCo model shows.
Case example
The CHF 1 million that makes the difference
Take an industrial company with net debt of CHF 9.8 million and a contractual ceiling of 3.5× EBITDA. EBITDA falls from CHF 4.0 million to CHF 2.6 million, and the ratio rises from 2.45× to 3.77×.
Because the forecast shows this four months ahead, the company goes to the bank with a plan. Shareholders provide CHF 1.0 million to reduce debt, bringing the ratio down to 3.38×. The bank also grants a waiver for two test dates in return for monthly reporting. A sale-and-leaseback is kept ready as a reserve.
The example is simplified, but it shows how little capital can be enough if it comes in time.
Net debt / EBITDA in the practical example
Net debt CHF 9.8m, contractual ceiling 3.5×
FiPAXThe forecast shows the breach four months ahead – enough time to approach the bank with a plan.
Talk to us before the bank talks to you
A covenant breach is rarely the real problem. It becomes dangerous when financing, company law and negotiation are not considered together. Our case study The 60-Day Ultimatum shows how such a situation can become a fresh start.
FiPAX reviews your loan agreement, stress-tests your ratios and negotiates independently of any bank, on an equal footing with your financing partners.
Is one of your ratios heading for its limit? Get in touch – the initial consultation is free of obligation.
Selected legal sources
- Swiss Code of Obligations (CO): Art. 725 (impending insolvency), Art. 725a (capital loss), Art. 725b (over-indebtedness)
This article is for general information only and does not replace advice on individual cases. The ratios mentioned are non-binding reference values.