The Buyout That Would Have Triggered Their Own Loan Default

The situation

The corporation operated a dozen locations of a national franchise across southwestern Ontario, generating annual revenue in the tens of millions. It had been built over two decades by Kostas, a retired business owner who founded the company and still held the majority of its shares, and Navdeep, who owns a construction company and had bought into the franchise corporation years earlier as a minority shareholder to diversify beyond his own business. The corporation ran on a mix of internal cash flow and a term loan and revolving credit facility from its bank, used originally to fund store buildouts and equipment.

By early 2026, Kostas was fully retired and wanted to be repaid a long-standing shareholder loan he had left in the company during a slower stretch of growth. Navdeep, separately, wanted to reduce his stake — his construction company needed capital for a new project, and cashing out part of his shares in the franchise corporation was the simplest way to raise it. The two agreed in principle: the corporation would redeem a portion of Navdeep's shares and repay Kostas's shareholder loan, both funded from the corporation's own cash reserves. Before finalizing either payment, the corporation's finance lead, Simran, asked our office to review the transaction documents and confirm nothing in the company's existing agreements stood in the way.

What the review found

Contract hygiene review is exactly what it sounds like: before a company signs a new deal, it pulls every agreement that could be affected — loan documents, leases, supplier contracts, the franchise agreement itself — and checks the new deal against all of them. Most reviews turn up nothing more than a notice requirement or an outdated address. This one did not.

The corporation's credit agreement with its bank, signed years earlier when the loan facility was put in place, contained a standard set of financial covenants — ongoing promises the corporation had made to the lender in exchange for the loan. Two mattered here. The first was a negative covenant restricting restricted payments — a defined term in most credit agreements covering dividends, share redemptions, and repayments of shareholder debt — above a set threshold without the lender's prior written consent. The second was a minimum debt service coverage ratio, a financial test comparing the company's cash flow to its debt payments, checked every quarter. The credit agreement required the ratio to stay above a set floor; falling below it, even briefly, counted as an event of default.

Run separately, either payment would have been manageable. Combined, they were not. The share redemption to Navdeep and the loan repayment to Kostas together added up to roughly $2.4 million in restricted payments — well past the threshold that required the bank's sign-off, and something nobody on the corporation's side had flagged, because the credit agreement predated both the buyout conversation and most of the people now negotiating it. Worse, paying out that much cash in a single quarter would have pulled the company's own cash flow down enough to drop its debt service coverage ratio from roughly 1.28x to an estimated 1.15x — comfortably under the 1.25x floor the credit agreement required. On paper, the corporation would have gone from a company in good standing with its bank to one in technical default within the same fiscal quarter, without a single missed payment or any change in how the business was actually performing.

The stakes went beyond the term loan itself. Like many businesses that finance equipment and real estate improvements across several agreements, the corporation's equipment leases and one property lease both contained cross-default clauses — provisions that treat a default under one agreement as an automatic default under others. A covenant breach on the bank loan, even a purely technical one caused by the timing of two payments, could have rippled into those other agreements and put financing arrangements the corporation depended on for its day-to-day operations at risk, all without the bank taking any deliberate action against the company.

What we did

1. Mapped every agreement the payments could touch. Before advising on the buyout itself, we pulled the credit agreement, both equipment financing leases, and the property lease to trace which of the corporation's obligations were connected by cross-default language, so the exposure was understood in full rather than one document at a time.
2. Modelled the debt service coverage ratio under the actual payment structure. Working from the corporation's financial statements, we recalculated the projected ratio under the buyout as originally planned, confirming it would fall below the covenant floor, and then tested several alternative structures to find one that would not.
3. Restructured the timing and form of both payments. Rather than a single lump-sum redemption and loan repayment in one quarter, we recommended splitting Navdeep's buyout into two installments across separate fiscal quarters and converting part of Kostas's shareholder loan repayment into a structured payment schedule, keeping the ratio above the required floor throughout.
4. Approached the lender proactively for consent, before either payment was made. Rather than wait to see whether the restructured payments alone would clear the threshold, we prepared a written request to the bank explaining the ownership transition, attaching updated financial projections, and asking for advance consent to the restricted payments as restructured. Lenders are far more receptive to a request made before a covenant is at risk than to a waiver requested after a default has already occurred, and this bank had no reason to doubt a company with a clean payment history and a straightforward succession story.
5. Documented the consent and the amended payment schedule in writing. Once the bank agreed, we had the consent set out in a formal letter referencing the specific restricted payments it covered, so there was no ambiguity later about what had been approved and on what terms.

The outcome

The corporation never breached its credit agreement. Navdeep received the first installment of his share redemption on schedule, with the second following the next fiscal quarter as planned. Kostas's shareholder loan was repaid on the amended schedule rather than in one payment, which — as a side benefit neither had originally asked for — also smoothed the cash flow impact on the business itself. The bank's written consent sat in the corporation's file, confirming the lender had reviewed and approved the restructured payments in advance.

Because the breach never happened, there was no default to disclose to the equipment lessors or the landlord under the cross-default provisions, no renegotiation of loan terms under pressure, and no interruption to the corporation's day-to-day banking relationship. The total time from the initial contract review to the bank's written consent was about six weeks — slower than the parties had originally hoped to close the buyout, but far faster than untangling an actual covenant default would have taken, and without the added cost of emergency waiver fees a lender can charge once a breach has already occurred.

Kostas has since stepped back from day-to-day involvement entirely, and Navdeep's remaining stake continues to fund the construction company's growth on the schedule he wanted. Simran, who first asked for the review, now runs a version of the same check before any transaction over a set size moves forward — not because the corporation expects to find a problem every time, but because this one time, it did.

What you can learn from this