What it means
The everyday business version is the covenant waiver. Loan agreements contain financial tests, for example a maximum ratio of debt to earnings, and when a borrower fails one the lender can normally demand immediate repayment, so the borrower asks the lender to waive that breach instead.
Waivers appear well beyond banking. A landlord may waive a rent review deadline, a customer may waive a delivery date, a supplier may waive a late payment charge, and an employer may waive a notice requirement, each time giving up an entitlement without asking for the contract itself to be rewritten.
Scope is what makes a waiver safe or dangerous. A properly drafted waiver is limited to one identified breach, one test date and one set of circumstances, and it states expressly that it does not waive any other right or any future breach of the same clause.
The risk of informality is real. If a party repeatedly overlooks the same breach without saying anything, the other side may argue that the right has been given up by conduct, which is why contracts include a clause confirming that failing to enforce a right on one occasion is not a waiver of it.
Waivers are rarely free. Lenders commonly charge a fee, raise the interest margin, tighten the covenant for future periods or require additional information, and the borrower should price the full cost of the waiver rather than treating it as a favour.
In practice
Real-world examples
Example 1
A manufacturer misses its interest cover covenant after a customer's insolvency wipes out a quarter of profit. The bank grants a waiver for that test date only, charges a $30,000 fee and requires monthly rather than quarterly management accounts for the next year.
Example 2
A commercial tenant fails to serve a break notice by the contractual deadline. The landlord, keen to re-let at a higher rent, waives the deadline and allows the tenant to exit three months later than the contract permitted.
Example 3
A software vendor delivers a major release six weeks late. The customer waives its right to service credits in exchange for two years of extended support at no cost, a trade both sides prefer to a dispute.
Think of it
Imagine driving on a motorway with a strict speed limit, and your car engine suddenly loses power, forcing you to crawl slowly in the fast lane. A waiver is like the traffic police officer seeing your hazard lights, understanding your mechanical trouble, and giving you temporary permission to drive slowly without giving you a fine.
Formula
Calculation
Total cost of a waiver = Waiver fee + (Increase in margin x Average drawn balance x Remaining years).
A company breaches a leverage covenant on a $12,000,000 facility and asks its bank for a waiver. The bank charges a waiver fee of 25 basis points on the full facility, which is 0.25% x $12,000,000 = $30,000. It also increases the interest margin by 50 basis points for the remaining 18 months of the loan, and the company expects to have an average drawn balance of $8,000,000 over that period. The extra interest is 0.50% x $8,000,000 = $40,000 a year for 1.5 years, which is $40,000 x 1.5 = $60,000. The total cost of the waiver is $30,000 + $60,000 = $90,000, which the finance director weighs against the alternative of refinancing the facility elsewhere.Case study
Seen in the real world
Talwood Components is an illustrative, fictional engineering business that breached the leverage covenant on its $12,000,000 facility after a large customer entered administration and left $1,900,000 unpaid. The breach was technical rather than a cash problem, but it still gave the bank the right to demand repayment in full.
Talwood approached the bank early with a thirteen-week cash forecast and a recovery plan. The bank waived the breach for that test date only, charged a $30,000 fee, added 50 basis points to the margin for the remaining 18 months and set a tighter covenant for the following two quarters, a total cost of roughly $90,000 on an expected average drawn balance of $8,000,000.
This fictional outcome was far better than the alternative. Refinancing at short notice under a live default would have cost arrangement fees and a materially higher margin, and the board concluded that going to the lender before the covenant certificate was due had been the single most valuable decision in the process.
Watch out
Common mistakes
- Assuming a waiver changes the contract, when it only sets aside a right on one occasion and leaves the original terms fully in force.
- Relying on a verbal or emailed assurance from a relationship manager instead of a signed waiver letter that identifies the exact breach being waived.
- Ignoring repeated minor breaches without written reservation of rights, which can allow the other side to argue the right has been waived by conduct.
Questions
People also ask
What is the difference between a waiver and an amendment?
A waiver excuses one specific failure while leaving the agreement unchanged, whereas an amendment permanently rewrites the clause for all future periods.
Should a borrower expect to pay for a covenant waiver?
Usually yes, in the form of a fee, a higher margin, tighter future covenants or extra reporting, and all of these should be modelled before agreeing.
When is the best time to request a waiver?
As soon as a breach looks likely and before the compliance certificate is due, because lenders respond far better to early notice with a plan than to a surprise.