What Is a Negative Covenant?

A negative covenant restricts engagement in certain activities as part of a contractual agreement. It can be attached to a debt, an employment contract, or a sale, among other things. These clauses must be clearly defined and reasonable in order to be fair to their subjects, and can be subject to negotiation before an agreement is finalized. Contracts can also have positive covenants, mandating that people perform a certain activity to maintain their end of the deal.

In the case of employment contracts, companies may have employees sign no-compete clauses. These can include mandates that they not consult with the competition while employed with a company, and that for a set period of time after leaving employment, they cannot start a competing business or provide expertise to another company in the industry. This is designed to protect employers from the risk that an employee’s expertise will be used against them. Non-disclosure agreements are also a form of negative covenant, mandating that employees not discuss compensation terms or other sensitive matters.

Debt instruments can come with similar clauses. Lenders may mandate that people not sell or transfer assets used as collateral without permission. They can also state that borrowers may not take out another lien on the same asset. Corporate loans may come with a negative covenant indicating that companies cannot increase executive compensation beyond a certain point while paying off the debt, ensuring that the lender is repaid in a timely fashion and the company doesn’t overreach itself.

Sales contracts for business and real estate may have attached covenants. A common example is a negative covenant restricting the construction of buildings that might obstruct a neighbor’s view. People buying real estate may be able to use this clause to their advantage by arguing that it decreases the overall value of the property. Because they can’t use it as freely as a similar piece of real estate, they may ask for a discount on the price to compensate for the negative covenant.

It is advisable to read and understand negative covenants, and to consider whether the restriction is reasonable. Once a contract is signed it is difficult to cancel or change the agreement, unless the other party fails to perform or the contract is legally invalid. Courts tend to fall on the side of enforcing contracts where possible, and may not uphold a request to cancel or modify a negative covenant that someone feels is unfairly restrictive.