The Equipment Lease That Breached a Loan Covenant Nobody Reread

The situation

Niloufar had built a managed IT support company in Burlington over eight years, growing it from a one-person operation into a business with about a dozen employees and revenue in the low millions. She held the largest share and ran daily operations. Halima, a full-time elementary school teacher, had put in early capital and held a smaller stake as a passive shareholder who checked in a few times a year. Abdi, the third shareholder, managed client accounts and held the remaining shares. The three of them had never had a formal falling-out or a legal problem — which was part of why nobody had looked closely at their paperwork in years.

The company operated on a line of credit from its bank, secured against its equipment and receivables, that it had drawn down three years earlier to smooth out cash flow during a slow stretch. The loan agreement came with the standard covenants lenders attach to secured commercial credit: minimum working capital ratios, a requirement to deliver financial statements within a set period after each fiscal year end, and a clause requiring the lender's written consent before the company took on any additional secured debt.

The trigger for our involvement was not a crisis. Niloufar had brought on a fourth potential investor to help fund an expansion, and as part of preparing the company for that investment, she asked our firm to run a contract hygiene review — a systematic pass through the company's active agreements to confirm nothing was inconsistent, expired, or in conflict with anything else the company had signed. It is the kind of review most small companies never commission until something forces the question, because it produces no immediate benefit and costs real time to do properly.

What the review found

Fourteen months earlier, the company had needed new servers and networking equipment to support a large new client contract. Rather than pay cash or go back to its existing bank, Niloufar had arranged equipment financing directly through the equipment vendor's finance arm — a common, ordinary way for a growing company to acquire hardware, and on its face a sensible decision that preserved the company's cash and its existing line of credit.

What nobody checked at the time was the company's existing loan agreement with its bank. That agreement, still in force from the earlier line of credit, required the bank's written consent before the company took on any new secured debt — and the equipment financing was secured against the equipment itself, which made it exactly the kind of arrangement the covenant was written to catch. No consent had been requested. No one at the company had connected the new equipment lease to a three-year-old loan agreement sitting in a folder nobody had reopened.

Under the loan agreement, an unconsented breach of that kind was an event of default, meaning the bank had the contractual right to demand immediate repayment of the full outstanding balance — at that point still roughly $340,000 — or to impose new terms as a condition of not doing so. The company had not missed a single payment on either the line of credit or the new equipment financing. Both were current. But the default was not about payment history; it was about a term in the contract that had been breached the moment the equipment lease was signed, regardless of whether the company ever missed a dollar.

This is the risk contract hygiene reviews exist to catch. Loan covenants are frequently written broadly enough to capture transactions that feel routine from the operating side of a business — a new lease, a new supplier financing arrangement, even certain guarantees — because from the lender's side, any new claim on the company's assets changes the risk they originally priced. A company can be current on every payment it owes and still be in default of an agreement it signed, simply because it did something the contract required advance permission for.

What we did

1. Confirmed the breach and its exposure before doing anything else. We reviewed the loan agreement's exact covenant language, the equipment financing agreement, and the security registered against the equipment to establish precisely what had happened, when, and what remedy the bank was contractually entitled to pursue. Getting this picture complete and accurate mattered more than moving quickly, because a wrong assumption at this stage could have led to disclosing more — or less — than the situation called for.
2. Assessed whether disclosure was the right call before the bank found out independently. The company was not obligated to volunteer the breach immediately, and some business owners in this position are tempted to wait and hope it never surfaces. We advised against that. Banks periodically review credit files, and if this one surfaced the breach on its own rather than hearing about it from the company, the relationship damage and the leverage in any subsequent negotiation would both be worse. A company that discloses its own problem before being caught is usually treated as a going concern managing an oversight; a company caught after the fact is treated as a credit risk.
3. Prepared a waiver request with the fix already built in. Rather than approach the bank with an open-ended admission of default, we prepared a written request for a formal waiver of the technical breach, accompanied by a clear account of what had happened, confirmation that both the line of credit and the equipment financing were current on payments, and a proposed go-forward practice — written internal sign-off from all three shareholders before any new financing was arranged — meant to prevent a repeat.
4. Negotiated the terms of the waiver rather than accepting the bank's first draft. The bank's initial response offered a waiver conditioned on a reduced credit limit and quarterly financial reporting instead of annual. We negotiated the reporting frequency down to semi-annual, which the company could sustain without hiring additional bookkeeping support, and pushed back on the proposed credit limit reduction, which the bank ultimately dropped in exchange for a one-time waiver fee of roughly $8,000.
5. Rebuilt the shareholders' internal process so it would not happen again. We drafted a short internal protocol requiring any new financing, lease, or guarantee above a set threshold to be checked against the company's existing loan covenants and signed off by all three shareholders before execution. Halima and Abdi, both of whom had been unaware the loan agreement's consent requirement existed, asked for a plain-language summary of the covenant terms, which we provided so that future decisions would not depend on any one person's memory of a document signed years earlier.

The outcome

The bank granted the waiver. The company kept its full line of credit at its original limit, avoided acceleration of the $340,000 balance, and avoided the far more disruptive scenario of having to refinance on short notice with a new lender at a moment when its own bank had just flagged it as having breached a covenant — a fact that would likely have come up in any new lender's due diligence. The equipment financing continued on its original terms, since the vendor's finance arm was never party to the dispute and had no reason to be involved.

The cost was real. The $8,000 waiver fee came directly out of the company's cash flow at a time it was trying to fund an expansion, and the semi-annual reporting requirement added an ongoing administrative burden the company had not previously carried. The prospective fourth investor's due diligence also surfaced the episode, since it was now part of the company's recent history, and required an additional round of explanation before the investment closed on its original terms about six weeks later than originally planned.

Niloufar, Halima and Abdi avoided the worst-case outcome — a demand for immediate repayment that would have forced the company to find $340,000 or a replacement lender within a compressed window, either of which could have jeopardized the business itself. But the episode was not a clean win. It was a default that had sat undetected for over a year, caught only because a routine review happened to be commissioned for an unrelated reason, and resolved at a real financial and administrative cost that a five-minute check of the loan agreement, fourteen months earlier, would have avoided entirely.

What you can learn from this