The credit agreement is the constitution of a leveraged company. It defines what the borrower may do to the assets that secure your claim, and modern agreements permit far more than most lenders understood when they signed. Every significant liability management transaction of the past decade was executed using capacity that already existed in the documents.
Maintenance versus incurrence
Maintenance covenants are tested periodically regardless of whether the borrower does anything — a leverage ratio tested quarterly, for example. They give lenders a scheduled opportunity to intervene when performance deteriorates, which is why lenders value them and borrowers resist them.
Incurrence covenants are tested only when the borrower takes a specified action, such as incurring debt or making a restricted payment. A borrower whose performance is collapsing breaches nothing under an incurrence-only structure as long as it takes no action. Since roughly 2013, large-cap leveraged loans have been predominantly covenant-lite — incurrence-only, or with a maintenance covenant that applies solely to the revolver and springs at high utilisation. The practical effect is that lenders often first come to the table at a maturity or a liquidity event rather than at a covenant breach.
Baskets and capacity
Modern agreements permit a range of actions through defined baskets. Restricted payment baskets permit dividends and distributions. Investment baskets permit investments in subsidiaries and joint ventures, including entities outside the credit group. Debt baskets permit incremental facilities, sometimes on a pari passu or priming basis. Builder baskets grow with retained earnings, so a period of profitability creates capacity that persists after profitability ends.
Baskets are frequently expressed as the greater of a fixed dollar amount and a percentage of EBITDA — which means capacity expands with adjusted EBITDA, the number the borrower substantially controls. Baskets can also be reclassified and combined, so capacity that appears modest in any single provision becomes material when chained.
Unrestricted subsidiaries
The most consequential concept in modern credit documentation. An unrestricted subsidiary is designated outside the credit group: it is not bound by the covenants, its assets are not collateral, and it may incur its own debt without reference to the parent's restrictions. The designation mechanism exists for legitimate reasons — joint ventures, regulated entities, foreign operations — but it also permits a borrower to move valuable assets outside the reach of its lenders entirely.
The transfer is executed through the investment basket: the borrower makes an investment in the unrestricted subsidiary consisting of the assets in question. If the baskets permit it, the lenders' collateral has legally departed the credit group. This is the mechanism behind every dropdown transaction, and Chapter 18 works through it in detail.
How to read one
Do not read a credit agreement front to back. Start with the definitions of Restricted Subsidiary, Unrestricted Subsidiary, Consolidated EBITDA, and Permitted Investments — the operative content of a modern agreement lives in its definitions, and the covenant sections merely cross-reference them. Then read the negative covenants on debt, liens, investments, restricted payments, and asset sales, tracing every carve-out back to its definition.
Then read the amendment provisions and identify the sacred rights — the terms requiring unanimous or affected-lender consent rather than a simple majority. Pro rata sharing, principal, interest, and maturity are the usual list. Precisely how these are drafted determined the outcomes in both Serta and Mitel, and the difference between the two agreements was a handful of words.