Loan covenants define the ongoing obligations a borrower must satisfy throughout the life of a credit facility. In Iraqi transactions, covenants operate at the intersection of Iraqi civil and commercial law, CBI regulatory requirements, and where international lenders are involved internationally recognised documentation standards developed by bodies such as the Loan Market Association (LMA). Getting covenants right is critical: covenants that are too tight will lead to technical defaults; covenants that are too loose will fail to provide lenders with adequate early warning. This article examines how loan covenants work in Iraqi transactions and what both lenders and borrowers need to know.

The Legal Basis for Covenants Under Iraqi Law

Under the Iraqi Civil Code, loan agreements are binding contracts governed by general principles of contract law. Covenants whether financial, positive, or negative constitute contractual obligations of the borrower. Breach of a covenant that constitutes a material term of the loan agreement entitles the lender to treat the agreement as terminated and demand immediate repayment, in accordance with Articles 177 and 178 of the Iraqi Civil Code on breach and termination. The Iraqi Civil Code also recognises the principle of good faith in contract performance a principle that can be relevant when assessing whether a lender’s exercise of covenant enforcement rights is proportionate and commercially reasonable.

Financial Covenants in Iraqi Lending Practice

Financial covenants are periodic tests of the borrower’s financial health. In international lending, they are typically measured against audited or management accounts. In Iraqi transactions, the following financial covenants are commonly used: leverage ratio total debt to EBITDA, typically tested semi-annually against the borrower’s financial statements; debt service coverage ratio cash flow available for debt service divided by total debt service payments, critical in project finance transactions; minimum net worth requiring the borrower to maintain a minimum level of shareholders’ equity; and maximum capital expenditure limiting investment spending to protect liquidity. A key practical issue in Iraqi transactions is the quality and timeliness of financial reporting. CBI requirements mandate that licensed banks produce financial statements in accordance with IFRS, but non-bank corporate borrowers in Iraq may not produce IFRS-compliant accounts, creating challenges in defining and testing financial covenants.

Positive Covenants — Iraqi Regulatory Requirements

Positive covenants in Iraqi loan agreements typically include: an obligation to maintain all licences, permits, and authorisations required to carry on business in Iraq including licences issued by the Companies Registry, sector-specific regulators, and the CBI where applicable; an obligation to comply with all applicable Iraqi laws and regulations, including the AML Law No. 39 of 2015 and CBI instructions; an obligation to provide the lender with annual audited financial statements, quarterly management accounts, and immediate notification of any event of default or potential default; and an obligation to maintain insurance over charged assets at levels acceptable to the lender.

Negative Covenants — Key Restrictions in Iraqi Transactions

Negative covenants restrict the borrower from taking certain actions without lender consent. Standard negative covenants in Iraqi loan agreements include: a prohibition on incurring additional financial indebtedness above agreed thresholds; a negative pledge restricting the creation of security over the borrower’s assets in favour of other creditors; restrictions on disposal of material assets including real property registered in Iraq; restrictions on changes to the borrower’s corporate structure including mergers, demergers, and changes in the composition of the board of directors; and restrictions on distributions to shareholders where financial covenants are not met. In Iraqi practice, lenders must pay particular attention to Companies Law No. 21 of 1997 restrictions on distributions and capital reductions, which may interact with loan covenant restrictions.

CBI Requirements Relevant to Covenants

CBI lending instructions impose their own requirements that effectively function as regulatory covenants. Banks must include in their loan agreements: provisions requiring borrowers to maintain their primary banking relationship with the lending bank; provisions requiring notification of any material adverse change in the borrower’s business or financial position; provisions allowing the bank to conduct periodic reviews of the borrower’s financial condition; and provisions allowing the bank to demand additional collateral if the value of existing security falls below agreed thresholds. These CBI-mandated provisions must be incorporated into loan documentation alongside any commercially negotiated covenants.

International Standards — LMA Covenant Approach

Where international lenders participate in Iraqi transactions whether as lead arrangers, participants in syndicated facilities, or bilateral lenders LMA documentation standards are typically applied. LMA covenant provisions are detailed and highly negotiated. Key features of the LMA approach relevant to Iraqi transactions include: the distinction between maintenance covenants (tested periodically) and incurrence covenants (tested only when the borrower takes a specific action); equity cure rights allowing shareholders to remedy a financial covenant breach by injecting equity; and EBITDA definitions that must be adapted to reflect Iraqi accounting practices and the absence of standardised IFRS reporting among Iraqi corporates.

Negotiating Covenants in Iraqi Transactions

Borrowers in Iraqi transactions should focus on the following when negotiating covenants: ensuring financial covenant levels include adequate headroom above projected performance typically 20-30% cushion; negotiating cure periods of at least 30 days for covenant breaches before an event of default is triggered; seeking equity cure rights for financial covenant breaches; obtaining carve-outs from negative covenants for ordinary course transactions and existing indebtedness; and ensuring that financial covenant definitions align with the borrower’s actual accounting practices under Iraqi GAAP or IFRS as applicable.

How Etihad Law Firm Assists

Etihad advises corporate borrowers and lenders on the negotiation and drafting of loan covenants in Iraqi transactions, reviewing proposed covenant packages against CBI requirements and international standards, advising on covenant breaches and waiver negotiations, and representing clients in disputes arising from alleged covenant violations. We have particular experience in bridging Iraqi law requirements with international lender expectations.