Compliance Certificate: a Worked Example

A financial covenant is only a promise until someone measures it. The certificate is how the measurement reaches the lender: the borrower takes the accounts for the period, applies the definitions in the facility agreement, and states the result in a form agreed in advance. It turns months of negotiation over words like EBITDA and net debt into a sum of four or five lines.

It matters because accounts are not built to covenant definitions. Covenant earnings commonly add back some items and exclude others; debt may include obligations the balance sheet shows elsewhere; an agreement may freeze the accounting basis at signing. So the accounts can be correct and the certificate wrong. The Basel Committee's 2025 principles on credit risk list monitoring compliance with existing covenants among the measures of an effective credit monitoring system, and for most mid-market loans this document is where that monitoring starts.

It is usually delivered with the accounts the agreement requires, so its deadline follows the information undertakings: a set number of days after each quarter end or year end. An annual certificate is sometimes accompanied by an auditor's confirmation of the calculation, more often in larger leveraged deals than in mid-market bank lending. The no-default statement is the part most often skimmed. It speaks to the whole agreement, not just the ratios, so a signatory who has not asked whether anything else has been breached is confirming something unchecked.

The certificate is the company's statement, and signing it does not make a director a guarantor of the numbers. A materially wrong certificate can nonetheless be a misrepresentation under the agreement, and one signed in the knowledge that it is wrong can have consequences outside the contract.

A maker of fibreglass water tanks, constructed for this page like every figure in it, must keep net debt to EBITDA at or below 3.25 times, a level that belongs to this example and is not offered as a market norm. Its finance manager fills in the June certificate from the budget template and reports 3.00 times. The bank's analyst rebuilds the sum from the definitions.

No line in the first version was invented. The savings were real plans, but this agreement counts only savings achieved. The deferred price sat in other creditors, where the accounts properly put it, but the definition of borrowings included it. The cash existed, but was pledged against a performance bond, and the definition counted only unrestricted balances. Each of these is this agreement's wording; another agreement could treat all three differently.

The consequence is larger than a third of a turn. The covenant is breached, and the certificate's statement that no default was continuing was wrong when signed. The analyst calls the finance chief before writing anything. A corrected certificate goes in, the borrower asks for a waiver, and the bank grants it with a fee and a new requirement that the draft calculation reach it a week before signing. Had the margin stepped down on the strength of 3.00 times, some agreements would also require the under-charged interest to be paid.

A borrowing base certificate sets what may be drawn, from the current value of receivables and stock, often monthly. A compliance certificate releases no money: it reports whether a test was met. A business with an asset-based line can deliver both. Neither is an audit. Accounts carry whatever level of assurance the agreement requires, and the certificate carries only the word of whoever signed it. An interim certificate rests on unaudited management accounts, which is why a lender reconciles the year-end certificate to the signed accounts.

It also differs from the test date. The date fixes the day and period on which the numbers are struck; the certificate arrives weeks later. The lender learns the result when the certificate lands, or begins to wonder when it does not.

DEFINED IN ONE PARAGRAPH → · LOAN COVENANTS, EXPLAINED → · NET DEBT, AS THE DOCUMENT DEFINES IT →

A lender learns from the certificate in three ways. The headroom tells it how far the business has travelled towards the covenant, and the trend across four certificates says more than any one. The adjustments tell it where earnings are being assisted: an add-back line that grows each quarter is worth a question. And the way the document arrives matters. A finance team that sends the workings early and flags an awkward line has earned a different reading from one that sends a one-line result on the last permitted day.

Some documents put a price on delay. Where the margin follows a ratio, some agreements hold it at the top of the ratchet until the certificate is delivered, and a late certificate is itself a breach, subject to any cure period. For a borrower the practical protection is dull: build the calculation to the agreement's own definitions once, have someone who has read them check it, and send it with the workings attached.

THE MONTHLY PACK → · COVENANT HEADROOM →