Mistakes, Disputes and Official Sources
Loan covenants, defaults and annual reviews: how business loans go wrong without a missed payment
Financial covenants, non-monetary defaults, cross-default and annual reviews in Australian small business loans, with a worked covenant breach and what to do next.
A business loan can go into default even when every repayment is made. Contracts usually include covenants (promises to keep certain ratios, provide financial statements, maintain insurance or not change ownership without consent) and non-monetary default clauses, and many facilities have annual reviews. Breaching a covenant or missing a reporting deadline can give the lender rights to raise the rate, demand more security or, in serious cases, call in the loan. Track every obligation, test your ratios before the lender does, and talk to the lender early if a breach is coming.
This guide is part of business loan mistakes to avoid. General information only; get legal advice on your contract.
Types of default
| Type | Examples | How serious |
|---|---|---|
| Monetary default | Missed or late repayment, exceeding an overdraft limit | Usually the most direct trigger for action |
| Financial covenant breach | Debt service cover, interest cover or LVR below the agreed level | Common in larger and property-secured facilities |
| Reporting breach | Annual accounts, BAS or valuations not provided on time | Easy to avoid, easy to miss |
| Insurance breach | Required insurance lapses | Can be serious for secured assets |
| Change of control | Selling shares, adding directors, changing the trustee without consent | Often requires lender consent |
| Cross-default | Default on another facility (even with another lender) treated as default on this one | Can spread one problem across all your debts |
| Material adverse change | Lender forms a view that your position has deteriorated | Wording varies; often scrutinised |
The Banking Code and non-monetary defaults
Banks that subscribe to the Banking Code of Practice have made commitments that limit when they will act on certain non-monetary defaults in small business loans, and about the covenants included in those loans and how a bank uses valuations. The Code sets out exceptions, for example where there is fraud, or where the customer's circumstances put the bank's ability to recover at real risk. Since the 2025 Code applies to small businesses with less than $5 million in total debt (and that meet the turnover and employee tests), more borrowers fall within these protections than under the previous Code. Read the relevant chapter of the current Code rather than relying on a summary.
Non-bank lenders are not bound by the Banking Code, so their contracts may give them broader rights.
Separately, unfair contract terms laws can apply to standard-form small business contracts. Wide default and material adverse change clauses are among the terms regulators have scrutinised. See the rules guide.
Worked example: a debt service cover breach
A manufacturing business has a loan with an annual covenant: DSCR of at least 1.5 times, tested on audited annual accounts.
- Last year: EBITDA $300,000; annual debt repayments $150,000; DSCR = 2.0
- This year: a major customer left. EBITDA $210,000; repayments still $150,000; DSCR = $210,000 ÷ $150,000 = 1.4
The business has not missed a payment, but it will breach the covenant when the accounts are delivered.
What the owner can do before the test date:
- Calculate the ratio early, from management accounts, rather than discovering it when the lender does.
- Prepare an explanation and plan: what changed, what is being done (new customers, cost cuts), and a forecast showing the ratio recovering.
- Ask for a waiver or covenant reset in writing before the breach is formally reported. Lenders often prefer a planned conversation to a surprise.
- Consider reducing debt service: an extended term on part of the loan would lower annual repayments. For example, if repayments fell to $135,000, DSCR would be $210,000 ÷ $135,000 = 1.56, back above the covenant.
- Expect conditions: a waiver may come with a fee, a higher margin or more frequent reporting.
Interest cover and LVR covenants
- Interest cover = EBIT ÷ interest expense. With EBIT of $180,000 and interest of $60,000, cover is 3.0. Rising rates can breach an interest cover covenant without any change in the business: if interest rises to $75,000, cover falls to 2.4. Test this when variable rates rise; see fixed vs variable.
- LVR covenant: if a revaluation shows the property has fallen in value, the loan-to-value ratio may exceed the agreed maximum. Check what the contract and any applicable code say about when the lender can order revaluations and act on them.
Annual reviews
Overdrafts, lines of credit and many term facilities are reviewed periodically. At review the lender may ask for updated financial statements, tax returns, BAS, debtor lists and valuations, and may change pricing or limits, or decide not to continue the facility. For subscribing banks, the Code includes commitments about giving notice if a facility will not be continued. Diary the review date and prepare documents in advance. See overdraft vs line of credit.
If you receive a default notice
- Read it carefully: what default is alleged, what you must do, and by when.
- Get legal advice immediately; time limits are short.
- Contact the lender in writing to discuss a remedy or plan.
- Contact a financial counsellor through the Small Business Debt Helpline.
- If the company may be insolvent, speak to a registered insolvency practitioner about options, including the safe harbour and small business restructuring.
- If you believe the lender is acting unfairly, use its complaints process and then consider AFCA. See complaints and official sources.
Enforcement of security follows the contract, the PPSA for business assets (see the PPSR guide) and state and territory laws for land, which set notice steps before a lender can take possession of or sell mortgaged property.
Covenant tracking checklist
- List every covenant, reporting obligation and deadline from each loan contract.
- Put test dates and review dates in a shared calendar.
- Calculate DSCR, interest cover and LVR quarterly from management accounts.
- Keep insurance certificates current and send copies when required.
- Seek consent before changing ownership, directors, trustee or business structure.
- Note cross-default clauses: which other debts could trigger this one?
Frequently asked questions
Can a bank call in my loan if I have never missed a payment?
It depends on the contract and any applicable code. Some non-monetary defaults can give a lender rights, though the Banking Code limits how subscribing banks use them for small business loans.
Does a covenant waiver cost money?
Often there is a fee or a pricing change. Ask before agreeing.
What is a cross-default clause?
A term making a default on another debt, sometimes with another lender, a default on this loan. It means one problem can affect all your facilities.
Should I tell the lender before a breach?
Usually yes. Early, planned disclosure tends to lead to better outcomes than a breach discovered at review.
Sources
- Australian Banking Association — Banking Code of Practice — small business lending, covenants and defaults
- ASIC — unfair contract terms and insolvency information for directors
- Australian Financial Complaints Authority — disputes about defaults and enforcement
- Australian Small Business and Family Enterprise Ombudsman — help for small businesses in dispute with lenders
