Debt Covenant Breach: Case Study of Two Real Companies

Debt covenant breach in M&A is rising and matters for deal execution and post-close value. I’ve watched 2025 tighten capital controls and market volatility create more breach events, especially in acquisition financing. Covenant-lite structures are common in the US and Europe, but breaches still trigger lender action, sometimes long after closing. This isn’t theory; lenders push back with restructurings, workouts, or CRO appointments when covenants fail or look likely to fail.

From my experience in diligence and post-close monitoring, the driver isn’t only leverage levels. Hidden or unrecorded debt and liabilities are frequent breach sources. In 2025, studies show up to 40% of detected covenant breaches traced to unrecorded obligations. That means a thorough, forward-looking risk check on the target’s off-balance-sheet items is non-negotiable for buyers and lenders. And when breaches occur, lenders don’t just watch; they act. We’ve seen a pattern of third-party advisor involvement, cost-cutting mandates, and renegotiated terms to restore viability. In some cases, the lender’s toolkit expands to drawstop-only covenants, which prevent new drawings but don’t automatically trigger default. This nuance buys time but keeps pressure on the buyer to restore compliance.

Data points from 2025 reinforce the practical impact. About 15% of M&A deals included post-closing covenants designed to anticipate breaches, signaling a shift toward preventive controls rather than reactive fixes. Earn-outs remain a focal point; 58% of earn-out (Contingent payment tied to post-close performance milestones) deals featured seller-protective covenant language to safeguard the upside if a breach occurs.

This aligns with the need to calibrate performance metrics and governance obligations after close. In the merger space, enforcement of earn-outs has become a bargaining chip, sellers push for covenants that protect payment rights, while buyers push for flexibility to adjust terms in light of market shifts.

A real-world touchstone is the J&J and Auris Health case. J&J breached commercially reasonable efforts and misrepresented intentions, and the ensuing dispute centered on earn-out payments. The Delaware Court of Chancery’s ruling underscores that a buyer’s conduct and representations materially affect earn-out outcomes, especially when post-close performance is tied to regulatory milestones or continued product support. In other words, the entitlement to earn-outs hinges on compliant behavior and accurate disclosure, not just numbers on a trailing dashboard. This case has strengthened seller protections in complex transactions and has pushed buyers to tighter compliance with stated covenants and milestones.

The deal ecosystem is adjusting on multiple fronts. Sellers are negotiating covenants that prohibit new debt or impose restrictions designed to protect earn-out rights. Buyers push back on overprotective covenants (but the trend is toward clearer prohibitions and more precise covenants around financing events).

Lenders routinely bring in advisory help, BDO USA and others emphasize that engaging a third party before a breach occurs can save time and money, and win more favorable outcomes in negotiations or restructurings. In Europe, drawstop-only covenants have gained traction in at least 20% of European super senior revolvers in 2025, reflecting a preference to halt new debt rather than trigger immediate defaults.

The regulatory and shareholder environment adds another layer. Public M&A carries higher scrutiny, and undisclosed liabilities are a persistent risk after closing. This scrutiny contributes to a higher likelihood of covenant breaches being discovered post-close, even with strong deal processes. For deal teams, that means robust post-closing audits and a focused review of all debt instruments, intercompany loans, and off-balance-sheet arrangements. In 2025, escrow studies covering 2,400+ transactions show holdbacks remain a critical risk mitigation tool, but they require precise alignment with covenant terms and potential breach scenarios. The practical implication is that escrow agreements must be read and negotiated with an eye toward how a breach could affect holdbacks and distributions.

From a lender perspective, the response playbook has become more standardized but remains nuanced. Key actions include immediate assessment with third-party advisors, targeted cost-reduction plans, and renegotiation of covenants or terms to restore covenant compliance within the remedy window.

The typical remedy window has stretched by up to 30 days in new agreements, acknowledging deal complexity and the need for longer discussions with sponsors and management. In practice, this means lenders expect a clear plan, cost targets, and measurable milestones within a defined timeframe to avoid default triggers.

For practitioners, this means sharpened deal architecture and diligence. Build covenants that reflect realistic post-close realities: the likelihood of temporary revenue dispersion, working-capital fluctuations, and potential regulatory delays. Ensure earn-outs have covenants that account for normal operating conditions and provide measured guards for deviations due to events outside management control. Structure debt terms to deter unrecorded liabilities and to facilitate timely cure periods if a breach looms. When breaches occur, have a pre-negotiated path for third-party advisory support, creditor committees, and, if needed, a CRO or similar governance mechanism to restore value quickly.

Practical notes and action itmes:

• Integrate robust post-closing checks for hidden liabilities, especially in industries with rapid product evolution or regulatory milestones.
• Include post-closing covenants and earn-out protections that are specific, measurable, and tied to objective milestones.
• Plan for a structured remedy timeline that aligns with the complexity of the business and provides clear milestones for remediation.
• Build lender and advisor escalation paths into the deal documents, so a breach triggers a predefined sequence of steps rather than ad hoc negotiations.
• Consider drawstop-only covenants in applicable markets to slow liquidity risk without triggering broad default exposure.
• Use holdback escrows strategically, with clear alignment to covenants and anticipated breach scenarios.
• Prepare for regulatory and shareholder scrutiny by documenting disclosures, risk factors, and undisclosed liabilities with audit-grade precision.

In sum, debt covenant breach in M&A is not a theoretical risk but a concrete, increasingly systemic issue in 2025. The J&J-Auris Health case illustrates how breaches interact with earn-outs and representations, shaping deal terms for years. Sellers and buyers alike must embed strong covenant language, aligned remedies, and disciplined post-close governance to protect value. For practitioners, continuous learning is essential: keep reviewing earn-out literature, lender guidance, and case outcomes to anticipate patterns and respond quickly. Stay focused on the math, the timing, and the governance that actually moves the needle. If you want more on terms like holdbacks, covenants, and earn-outs, check out the Matactic glossary and sign up for our free M&A course.