Mistakes, Problems and Official Sources
Covenant breach or loan default: what a Canadian lender can do and what you can do first
What happens when a Canadian business breaches a loan covenant or misses payments: waivers, forbearance, demand and the 10-day BIA notice, receivership, and proposals.
A covenant breach, such as a debt service coverage ratio below the level in your loan agreement, is a default even if every payment has been made, and it gives the lender rights it did not have before: to charge a waiver fee, raise the rate, ask for more security or, in the end, demand repayment. In practice most Canadian lenders first look for a waiver or amendment, then a forbearance agreement, before enforcing. If a lender does enforce against substantially all the assets of an insolvent business, the Bankruptcy and Insolvency Act requires it to send a notice of intention to enforce security and wait 10 days. The more time and information you give the lender, the more options you keep.
This guide is part of business loan mistakes to avoid. It is general information; get legal advice and, where debts are unmanageable, speak to a Licensed Insolvency Trustee.
Types of default
| Default | Example | How serious |
|---|---|---|
| Financial covenant breach | DSCR 1.18 against a 1.25 minimum | Common; often waived for a fee if the trend is acceptable |
| Reporting breach | Annual statements late | Usually cured by delivering them |
| Payment default | Missed instalment | Serious; a grace period may apply |
| Cross-default | Default on another loan or lease | Can trigger all facilities at once |
| Material adverse change | A clause letting the lender act on a significant deterioration | Depends on wording |
| Unpaid government remittances | GST/HST or payroll arrears | Serious because the CRA can rank ahead of the lender |
Step by step: how lenders usually respond
- Notice and discussion. The account manager raises the breach, often after year-end statements arrive.
- Waiver or amendment. The lender agrees not to act on this breach, sometimes resetting the covenant, often for a fee and sometimes with a higher spread.
- Transfer to a special loans or credit management group if the problem looks lasting.
- Forbearance agreement. The lender agrees not to enforce for a period while you carry out a plan, usually in exchange for an acknowledgement of default, fees, extra reporting and sometimes more security or guarantees.
- Demand and notice. The lender demands repayment and, where the BIA applies, sends a notice of intention to enforce security under section 244, then waits 10 days unless you consent to earlier enforcement.
- Enforcement. Appointment of a receiver privately or by the court, sale of assets, and claims against guarantors.
A worked example: the cost of a covenant breach
A distributor with a $200,000 term loan reports a DSCR of 1.18 against a covenant of 1.25 after a slow year, though all payments are current. The lender offers a waiver with these illustrative terms:
- Waiver fee: $1,000.
- Spread increase of 0.50% until the ratio is back above 1.25 for a full year: $200,000 x 0.50% = about $1,000 a year in extra interest, falling as the balance falls.
- Quarterly reporting instead of annual.
Cost in the first year: about $2,000, plus the time to prepare quarterly statements. That is far less than the cost of refinancing under pressure, which is why accepting a reasonable waiver is often the right call. Ask whether the spread increase reverses automatically once the ratio recovers.
You can see how close you are to a breach by running the debt service coverage ratio example with your own figures each quarter.
Demand loans and reasonable notice
Many operating lines, and some term loans, are written as repayable on demand. The lender can demand at any time, but Canadian courts require it to give the borrower reasonable time to pay before enforcing, which depends on the circumstances and can be short. The BIA 10-day notice is in addition to this. Neither gives you a right to keep the loan.
Your options when trouble starts
- Talk early. Bring current figures, a 13-week cash flow forecast and a plan: cost cuts, an asset sale, new equity or a refinancing.
- Get advice before signing a forbearance agreement. These agreements often waive defences and add guarantees; read them with a lawyer.
- Refinance with another lender if the problem is the current lender's appetite rather than the business; see refinancing an expensive business loan.
- A proposal under the BIA. A business can file a notice of intention to make a proposal with a Licensed Insolvency Trustee, which brings a stay of proceedings by creditors, including secured creditors, while it prepares a proposal. The initial stay is 30 days and the court can extend it, up to six months in total. Creditors vote on the proposal.
- The CCAA (Companies' Creditors Arrangement Act) is for companies with debts over $5 million and is used by larger businesses.
- Bankruptcy is the last resort, ending the business and leaving guarantors exposed.
Guarantors
When the business defaults, the lender can demand payment from guarantors, usually without first selling the business's assets. A guarantor who pays may be able to claim against the business, but that claim is usually postponed to the lender. If your guarantee is unlimited and continuing, your personal exposure may be larger than the loan in trouble; see collateral and personal guarantees.
Quebec
In Quebec, a creditor that wants to exercise a hypothecary right must first register and serve a prior notice under the Civil Code of Québec, with minimum periods that are generally 20 days for movable property and 60 days for immovable property, in addition to any BIA notice. See Quebec differences.
Frequently asked questions
Can the bank freeze my account after a demand?
Lenders often have a right of set-off against your accounts with them under the loan documents. Read the set-off clause and expect it to be used after demand.
Will a covenant waiver be reported to credit bureaus?
Not usually as such, but a payment default or collection can affect personal reports of guarantors and business credit reports.
Can I complain if the lender demands repayment?
You can complain about how you were treated, for example inaccurate information or failure to follow its own process, but a complaint body will not stop a lender exercising contractual rights. See the complaints guide.
Who is a Licensed Insolvency Trustee?
A professional licensed by the federal Office of the Superintendent of Bankruptcy to administer proposals and bankruptcies. A first consultation is usually free.
Sources
- Justice Laws Website — Bankruptcy and Insolvency Act (sections 50.4, 69 and 244), Companies' Creditors Arrangement Act
- Office of the Superintendent of Bankruptcy — Licensed Insolvency Trustees and insolvency statistics
- Éditeur officiel du Québec / LégisQuébec — Civil Code of Québec, hypothecary rights
- BDC — managing cash flow difficulties
