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Starting or running a business in Australia is filled with exciting opportunities – and essential legal responsibilities. One area that often confuses business owners is the concept of a covenant in law. While these legal agreements can seem technical, understanding how covenants work is crucial to managing your risks, complying with contracts, and securing your business’s future.
If you’re launching a new venture or growing your existing business, keep reading for a practical guide to covenants in law, what they mean for your contracts, the legal obligations you might encounter, and how you can make sure you’re fully protected from day one.
What Is a Covenant in Law? Understanding the Basics
Let’s start simply: a covenant in law is a promise or obligation contained in a legal agreement. If you’ve ever signed a contract – whether it’s a lease, supply agreement, or partnership arrangement – chances are you’ve encountered covenants, even if you didn’t recognise them by name.
Here’s how the term breaks down:
- Covenant (Legal Definition): A formal promise to do (or not do) something, usually set out as a clause within a contract.
- Covenant meaning in law: Legally, it means more than a loose promise – once agreed, you’re bound to uphold the obligation or risk legal consequences such as damages or termination.
Covenants are one of the fundamental building blocks of commercial agreements – whether you’re leasing retail space, hiring staff, buying a business, or arranging supply chains. Knowing how these promises work can help you avoid costly disputes and protect your business interests.
Covenant Law: Why Does It Matter for Australian Businesses?
Australia’s contract law is clear: when you sign a contract, you’re agreeing to its terms – including any covenants it contains. These legal promises form the backbone of many business relationships.
Here are some sector examples where covenants can have a direct impact:
- Retail or office leases (e.g. covenants to pay rent or not make alterations without permission)
- Supplier agreements (e.g. covenants to purchase a minimum quantity, or only buy from a certain source)
- Employment contracts (e.g. non-compete covenants or confidentiality obligations)
- Shareholder and partnership agreements (e.g. covenants not to compete, or to contribute capital)
Put simply: not understanding your covenant law obligations can land you in hot water – potentially exposing your business to legal action, financial penalties, or loss of future opportunities.
On the flip side, well-drafted covenants can serve as key protections, enabling you to control outcomes, manage risk, and grow with confidence.
Types of Covenants: What Should I Watch Out For?
Covenants come in many shapes and sizes, but most business owners will encounter two broad types:
1. Positive (Affirmative) Covenants
These require a person or business to do something. For example:
- Pay rent on a certain date each month.
- Maintain business insurance according to a minimum coverage level.
- Carry out maintenance or repairs in leased property.
- Meet specified performance targets or reporting requirements.
2. Negative Covenants (Restrictive Covenants)
A negative covenant is an obligation not to do something. These are very common and often the subject of disputes:
- A promise not to run a competing business within a defined area (restraint of trade).
- A promise not to disclose confidential information about your business.
- A restriction on making unauthorised changes to premises or assets.
- A commitment not to assign (transfer) rights or duties under a contract without consent.
In some contexts, covenants can be mutual – both parties agree to uphold certain promises – or one-way, where only one party has obligations.
Where Do Covenants Appear in Business?
Covenants can pop up all over the place in typical business operations. Here’s where you’re likely to find them:
- Commercial Lease Agreements: Landlords and tenants are usually bound by long lists of covenants to maintain the property, pay outgoings, not make structural changes, and more. You can read about commercial leases in Australia here.
- Shareholder and Partnership Agreements: Covenants may require co-owners not to compete, to contribute capital, or to stay for a minimum term. Learn more about shareholder agreements.
- Employment Contracts: Commonly include restrictive covenants (restraints) preventing staff from working for competitors or poaching clients post-employment. Find out about non-compete agreements.
- Service Agreements & Supply Contracts: Often packed with covenants – like minimum orders, delivery timelines, or exclusivity promises. Explore more about goods and services agreements.
What Happens If You Breach a Covenant?
If you break a covenant in law – meaning you fail to carry out a promised action or you do something you’ve promised not to – you could face:
- The other party ending the contract (termination), especially for serious breaches.
- Claims for financial compensation (“damages”).
- Injunctions – a court order to make you stop (or start) doing something.
- Long-term business consequences, such as damaged reputation or loss of key trading relationships.
In some cases, specific performance may be ordered, which means a court can force you to fulfil the obligation as originally agreed.
Often, disputes about covenants are resolved through alternative dispute resolution (like mediation or negotiation) before heading to court. However, the serious consequences of a breach mean it’s vital to uphold your end of any legal agreement.
How Can I Proactively Manage Covenants In My Business?
The good news is that you can take steps to manage and monitor covenants before they become a problem. Here are some practical tips:
- Read Every Agreement Carefully: Before you sign, read every word (or have a legal expert review it). Don’t gloss over boilerplate clauses – covenants may be hidden in the detail. Need contract support? Sprintlaw has a guide on contract review.
- Negotiate Clauses You’re Not Happy With: Covenants can often be negotiated or amended before a contract is signed. Don’t assume standard terms are “set in stone.”
- Keep a Register of Your Key Covenants: Track ongoing obligations and important dates (like renewal, notification, or expiry periods).
- Communicate Clearly With Other Parties: If an issue arises, discuss it early to avoid escalation. Changes to covenants should always be agreed in writing.
- Seek Professional Advice for Complex Covenants: Especially in areas like employment, shareholder rights, or commercial property, get legal guidance early. Sprintlaw’s corporate governance guides can help set you on the right path.
Remember: not all covenants are enforceable. For example, some restraint of trade clauses are invalid if they are unreasonably broad or contrary to public policy. It’s wise to get expert input to ensure your covenants are fair, reasonable, and legally sound.
Key Legal Documents for Managing Covenants
Managing covenants effectively requires having the right legal documents in place from the beginning. Depending on your business, you may need:
- Commercial Lease Agreement: Sets out the rights, covenants, and obligations between landlord and tenant. Consider a tailored commercial lease agreement if you’re moving into a new premises.
- Service or Supply Agreement: Clearly details performance obligations, payment terms, and covenants around exclusivity or volume. See the goods & services agreement guide for more info.
- Shareholder or Partnership Agreement: Manages crucial covenants around ownership, decision making, and dispute resolution. Learn about partnership agreements.
- Employment Contract: Sets out positive and negative covenants, including non-disclosure and restraint clauses to protect your business from unfair competition.
- Non-Disclosure Agreement (NDA): A practical way to ensure covenants around confidentiality are clear and enforceable when sharing sensitive business info.
Not every business will need every document, but most will need several. The key is to make sure every important relationship in your business is protected by the right contract and that you understand what you’re committing to.
Are There Any Pitfalls With Covenants in Law?
Yes – here are some of the most common issues to watch for:
- Overly Restrictive Covenants: For example, a restraint clause that’s too broad may be invalid and unenforceable. Australian courts tend to limit covenants to what’s “reasonably necessary” to protect business interests.
- Failure to Update Covenants: If your business evolves – say, by expanding or entering new markets – it’s important that your covenants reflect your current operations.
- Ambiguous Language: Vague promises in a contract can lead to disputes down the track. Clarity is key.
- Not Following Statutory Requirements: Some contracts (like leases or franchise agreements) may have covenants mandated by law – these can’t be “contracted out of,” and failing to meet them can have serious legal consequences.
Avoiding these traps can save you major headaches later. When in doubt, reach out to a legal expert who can tailor your contracts and help you stay compliant.
How Can You Make Sure Your Covenants Are Enforceable?
There’s more to a legally binding covenant than simply writing it down. Here’s what makes a covenant in law enforceable in Australia:
- The contract is properly executed (signed according to the legal requirements, by all necessary parties).
- The promise or restriction is clear, specific, and not unreasonably broad.
- The covenant serves a legitimate business interest (e.g. protecting confidential information or customer relationships).
- It’s supported by “consideration” – usually, each party is providing value (for example, a business buys goods and agrees not to resell competing products).
- It does not seek to impose obligations that are unlawful or contrary to public policy.
As a general rule, the more specific and proportionate your covenants are, the more likely they are to be enforceable and effective in protecting your business.
What About Changing or Removing Covenants?
Circumstances change – sometimes covenants need to be updated or even removed altogether. This typically requires both parties’ agreement (in writing), or, in the case of “implied covenants” in leases or other longstanding arrangements, a formal variation via deed.
If you’re unsure about the process, Sprintlaw offers support for amending contracts or modifying agreements by deed.
Key Takeaways: Covenants in Law for Your Business
- Covenants in law are legally binding promises contained in contracts – understanding them is essential to managing your business risks.
- Covenants may require you to do, or refrain from doing, certain things – breaching these promises can trigger legal and financial consequences.
- Well-drafted covenants protect your business and enable you to build strong, secure relationships with landlords, clients, suppliers, and partners.
- Most businesses should have solid legal agreements covering key areas like leases, supply, employment, and ownership to manage covenants effectively.
- Always read contracts closely, negotiate unclear or unreasonable covenants, and get legal advice before signing.
- If your business changes or you’re unsure about your obligations, review and update your covenants as needed – the right legal support can make this simple and safe.
If you’d like a consultation to discuss how covenants in law affect your business, or to review your contracts for enforceability and protection, you can reach us at 1800 730 617 or team@sprintlaw.com.au for a free, no-obligations chat.
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