Negative Covenant

A bond covenant preventing certain activities, unless agreed to by the bondholders. Negative covenants are written directly into the agreement creating the bond issue, are legally binding on the issuer, and exist to protect the best interests of the bondholders. Also referred to as "restrictive covenant".

Investopedia Says:
Think of a negative covenant as a promise not to do something. Usually, negative covenants limit the amount of dividends a firm can pay to shareholders and restrict the ability of the firm to issue additional debt. Generally, the more negative covenants exist in a bond issue, the lower the interest rate on the debt will be since the restrictive covenants make the bonds safer in the eyes of investors.

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A provision found in an employment agreement or a contract of sale of a business that prohibits an employee or seller from competing in the same area or market.

A negative covenant is commonly used by businesses, particularly those that depend upon trade secrets for their success. An employer wants to ensure that a former employee will not parlay information, skills, customer lists, and personal relationships with clients acquired on the job to gain a better position with a competitor or to start his or her own business. An employer also wants to protect his or her business in the competitive marketplace against the use of the unique personal skills of a former employee. An employer can achieve these objectives by including a negative covenant in the employment contract. Such a provision specifies that the employee will not work for a competitor or start a competing business for a period of time after leaving the employer. The covenant must be reasonable in its scope and duration. It cannot bar the employee from working at all, anywhere, or for an unreasonable length of time.

A court enforces a negative covenant by granting an injunction prohibiting the employee from working in a competitive enterprise as described in the covenant. It will do so only when necessary to protect the former employer's legitimate interests.

A contract for the sale of a business often includes a negative covenant at the insistence of the buyer. A buyer wants to protect and capitalize on the good will of the business he or she buys. He or she must have an opportunity to get to know and serve the customers if the business is to continue to be successful. The value of the business is undermined if the seller can open a competing enterprise next door, thereby keeping some of the good will that was sold to the buyer. A negative covenant under which the seller agrees not to open a competing enterprise for a reasonable period of time within a reasonable distance from the original business is a frequent provision in a sales contract.