Restrictive Covenant -All you need to know about
A covenant imposing a restriction on the use of land so that the value and enjoyment of adjoining land will be preserved
Meaning of restrictive covenant
It is any type of agreement that requires the buyer to either take or abstain from a specific action
In real estate transactions, restrictive covenants are binding legal obligations written into the deed of a property by a seller
Key takeaways of restrictive covenant
1) it requires a real estate buyer to either take or abstain from specific actions
2) they can pertain to everything like kind of roof, colour or how many tenants may live in building
3) buyers who fail to meet restrictive covenants can incur penalties
4) sometimes restrictive covenants can be removed via payments to sellers, who must report such payments as capital gain income
5) restrictive covenants can include adequate provisions for adequate maintenance of property
6) restrictive covenants on a property can govern how it is used by the occupants
7) architectural guidelines set in restrictive covenants may limit renovation plans for a property
various rules about how the property can and cannot be used are known as restrictive covenant
Restrictive covenants are written into deeds of the property by the seller (beneficiary) and need to be agreed to by the purchaser
Main types of restrictive covenants
1) preventing alterations to be made to the property ie conversion of house into flats or building extensions
2) in the case of land which is sold, preventing the erection of any new buildings on the land
3) preventing land from being used for any business purposes
4) restrictions relating to access over lands
5) in terms of leasehold flats, there are often a variety of restrictive covenants designed to maintain shared conditions of communal living (eg keeping of pets, regulation of noise etc)
Requirements of restrictive covenants
1) typically be written in the deed
2) must be in writing due to the statute of frauds
3) original parties to the agreement must have intended that successors be bound by the agreement
4) a subsequent owner must have had actual notice, inquiry notice, or constructive notice (record) of the covenant at the time of purchase
5) covenant must relate to the use or enjoyment of land
6) covenant must not be personal in nature – it must benefit the land rather than an individual
7) it must affect how the land is used or the value of the land
8) the benefited land must be identifiable
Determining the value of restrictive covenants
It can be determined using a present value concept for the loss of future earnings
The factors needed to determine the present value of economic loss due to the lack of a complete covenant not to compete include
1) A base value of the subject company given the assumption that the seller is willing to sign a covenant not to compete which would completely restrict the seller from reentering the market
2) A measurement of the sellers ability to reenter the market and effectively compete with the subject company
3) A forecast of future earnings for the subject company, given the level of competition expected by a seller who has reentered the market during restricted period
4) A discount rate applicable to the level of earnings reflecting cost of capital
Enforcing Restrictive Covenants
However before taking legal action it is important to establish that you do have the right to enforce the covenant
Generally only the owner of the land intended to be benefited by the covenant, can enforce it
Overturn of restrictive covenant
If it is not enforceable then an application can be made to land registry to remove the covenants from the deed
It may be possible to negotiate with the party that had benefit of the covenant to remove by entering into a deed of release
Breach of covenant
It is the violation of an agreement or promise made in written contract or property deed
It can refer to an express or implied condition to which a party agrees
A covenant has always been part of any contract
Covenant waiver
These are temporary authorizations, upon failure to comply with one or more specific covenants
It is the debtor who by means of a letter, must address the creditors to request permission to default
Debt covenant
It is a number of restrictions that a borrower agrees to that are set by the lending institutions
The credit quality of a loan may be affected by a borrowers failure to comply with debt covenant term
Bond Covenant
It is a legally binding term of agreement between a bond issuer and a bondholder
Negative or restrictive covenants forbid the issuer from undertaking certain activities, positive or affirmative covenants require the issuer to meet specific requirements
Non financial covenants
These are promises or agreements made by borrowing party that are not financial in nature
They also serve the purpose of a safety net to the lender
They are usually undertaken by a lender as a measure to prevent the risks related to money-lending activities
Examples of non-financial covenants
1) corporate existence and qualifications
2) change in ownership
3) limiting or prohibiting mergers, acquisitions and consolidations
4) restrictions on substantial changes in borrowers business
5) limitations on sale of assets
6) limitations on up streaming funds
7) capital expense limitations
8) A reimbursement covenant
ignoring restrictive covenants
By ignoring it, you could potentially faces claim in damages for the breach in addition to any objections granted
Compiled by
Avinash Kulkarni
Chartered Engineer
Govt Regd Valuer
IBBI Regd Valuer
