Restricted Payments Covenant

A restricted payments covenant limits the borrower’s ability to make distributions to equity holders, pay dividends, repurchase ownership interests, or make certain intercompany transfers without satisfying specified financial tests or obtaining lender consent. In CRE loans these covenants ensure that cash generated by the property remains available to service debt and fund operations, especially in the early stabilization period. The covenant typically ties permitted payments to maintenance of covenant ratios such as DSCR or LTV and may provide baskets for routine operating distributions or capped sponsor fees.

Sponsors should map planned investor distributions against the restricted payments mechanics and maintain covenant compliance before executing cash waterfalls. When structuring a deal, negotiate clearly defined baskets, carve-outs for ordinary course payments, and exceptions for tax distributions or asset management fees. Borrowers anticipating major capital calls or cash-outs can build temporary waivers or conditional distributions into the loan negotiation. Lenders will want triggers and reporting to verify that restricted payments are only made when tests are met, reducing the need for after-the-fact approvals.

Restricted payments covenants protect lenders by preventing premature equity extraction that could undermine the borrower’s ability to service debt, fund capital needs, or cure operating shortfalls. They align incentives so sponsors cannot deplete collateral cash flow before loan maturity. For sponsors, predictable and negotiated restricted payment terms provide clarity on when returns can be taken and how operations must be managed to support distributions. Well-drafted covenants balance lender protection with sponsor liquidity needs and are critical in loan structuring, investor expectations, and long-term cash planning.