A financial ratio test for covenant ( www.practicallaw.com/2-382-3367) compliance that needs to be met at the time specific actions occur (rather than a maintenance test ( www.practicallaw.com/8-382-3604) which needs to be met at regular intervals, such as quarterly or at all times). For example, the borrower may be permitted to incur debt as long as the leverage ratio ( www.practicallaw.com/4-382-3578) is less than 3.0:1.0. The effect is that the lender has no recourse against the borrower until the specific action occurs and the ratio is not met.
Incurrence based covenants are typical for high-yield bonds ( www.practicallaw.com/8-382-3524) . Financial covenants in bank loans traditionally are maintenance tests that need to be maintained at regular intervals (or at all times) so that the lender has recourse against the borrower if its financial condition deteriorates.