Covenants

• Jurisdiction: Maryland

I. Covenants

A. In General

Technically, the term "covenant" is synonymous with "promise." As such, most of the provisions of a contract, and in particular the operative provisions, can be considered covenants. Lawyers frequently distinguish covenants from the operative and other provisions in a contract, however. The distinction is generally one of degree. When set forth separately from the operative provisions, covenants contain promises that are ancillary to the main purpose of the agreement. For example, the operative provisions of an employment agreement deal with the duties of the employee and the compensation, benefits, etc., to be provided by the employer. In addition, there may be a covenant not to compete. This covenant is certainly an important part of the agreement, but is somewhat ancillary to its main purpose.

The term is frequently used in relation to real property contracts, both sales and leases. Statutorily implied in every lease is a covenant of quiet enjoyment,¹ and it has long been recognized that every contract contains an implied covenant of good faith and fair dealing.² An obligation in a mortgage agreement to pay real property taxes has been referred to as a covenant,³ as have the duties of a trustee under a trust agreement,⁴ and an obligation to negotiate in a settlement.⁵ A clause making an operative promise irrevocable may be considered a covenant.⁶ An agreement in a loan contract not to incur additional debt or to use the proceeds of the loan in a certain manner are covenants, as is an agreement by a stockholder not to sell his or her stock.

In short, a covenant can be thought of as any obligation contained in the contract other than the main obligations which form the primary purpose of the agreement. From a drafting perspective, it is useful to think of covenants separately from operative provisions so that proper perspective in negotiations and focus in drafting and review can be achieved. It is counterproductive to get "stuck" on a covenant clause when the operative provisions have not been ironed out. From a negotiating perspective, it may make sense to give in a little on a covenant provision if it will help you to get the language you want with respect to an operative clause.

Covenants may be affirmative or restrictive. The nature of the burden determines whether the covenant is affirmative or restrictive. Affirmative covenants require some action should certain conditions occur, such as a covenant to repair defects or a covenant to provide documentation. Restrictive covenants obligate a party to refrain from doing something, such as covenants not to sue, compete, sell stock, or incur indebtedness.

Covenants may also be classified as conditional, mutual, or independent. A covenant is conditional if the obligation it describes only arises upon the prior performance of some act by the other party or the occurrence of some condition. Conditional covenants are usually affirmative, but a restrictive covenant can be independent as well. For example, a loan agreement may contain a provision whereby the borrower agrees not to incur further debt if its quarterly financial statements reflect certain financial ratios. A mutual covenant reflects obligations on the part of all parties to be performed simultaneously. A clause such as "neither of the parties hereto shall transfer their stock to any other person or entity during the term of this 'Agreement'" would be a mutual covenant. A covenant is independent when it obligates only one of the parties.

Drafting Tip

In formulating covenants, first consider whether the covenant is intended to be affirmative or restrictive. Then decide if the covenant should be conditional or unconditional, and finally whether it is intended to be mutual or independent. Thinking through these categories will help the drafter clarify his or her thinking as to how the language of the covenant should be composed.

B. Affirmative Covenants

In Columbia Club, Inc. v. American Fletcher Realty Corp.,⁷ the indemnity provision contained in an agreement was characterized as an affirmative covenant because, under the terms of the original agreement, one party expressly contracted to reimburse the other for any damages it incurred as a result of the performance of the contract's operative provisions (in this case, calling for the building of a commercial office tower). If a mortgage contains an affirmative covenant "that the mortgagor shall possess and enjoy [the mortgaged property] until default," these ownership rights are divested only if the mortgagor defaults in its performance of the mortgage covenants.⁸

Courts will not extend or enlarge the obligation of a lessee under a covenant to repair beyond the plain meaning of the language used and the intention existing at the time it was made. In PugetInvestment Co. v. Wenck,⁹ a lease required the lessee to "keep and use said premises in accordance with applicable laws and ordinances," and further provided that:

Unless otherwise provided in this lease, lessee, having ascertained the physical condition of said premises from a careful and complete inspection thereof, accepts said premises in present condition, no exceptions. At the commencement of the term of this lease lessee shall place and thereafter shall keep and maintain said premises in a neat, clean and sanitary condition and in a first class state of repair, all at lessee's expense.

The building was in a bad state of repair when the lease was entered into. These conditions were known to the lessee before the lease was executed. After taking possession, the lessee expended in excess of three thousand dollars in making repairs and adding improvements to the building. Shortly prior to the expiration of the lease, the lessor demanded that the lessee make substantial additional repairs. When the lessee failed to do so, a lawsuit ensued. The evidence at trial showed that the most of the conditions requiring the repairs demanded by the landlord existed at the time the lease was signed and were due to decay and wear and tear which had already taken place. Furthermore, many of the repairs were of a more or less permanent nature, and some of them had structural characteristics, amounting more to improvements than to replacements or repairs. As such, all of the requested repairs were principally for the benefit of the lessor. The evidence further showed that the building was in better condition at the end of the lease term than it was at the beginning. There had been some wear and tear during the term (excepted in the covenant to repair), and some glass breakage, for which the court allowed recovery.

The court addressed the issue of the affirmative covenant as follows:

It is perfectly competent for the parties to a lease to place upon the lessee the obligation of making very substantial and even structural repairs at the commencement of, or during the course of, the lease term. Such a covenant may call for repairs not necessary to the lessee's use of the premises, and of primary benefit to the lessor. However, when this is the intention, the covenant is usually specific in itemizing the work to be done. Here there was no itemization of repairs to be made by the lessee at the commencement of the term, except with respect to glass breakage. . . . The making of repairs which will substantially improve the condition and value of the premises, when required under the covenants of a lease, constitutes a part of the benefit the lessor expects to derive from the lease, along with the payment of rentals. Accordingly, where a comprehensive covenant of this kind is intended, there is usually a provision giving the tenant free occupancy for a specified period, or some indication that stipulated monthly payments have been lessened because of the other benefits the lessor is to receive. . . . In the instant case the lease does not waive rentals for any part of the term, or in any other way indicate that the monthly rentals were reduced in consideration of the lessee making substantial repairs for the primary benefit of the lessor. . . . [W]e are of the view that the term "first class state of repair," as here used, meant only such repairs as were reasonably necessary for the conduct of a private or public garaging business during the lease term in the kind of building in question. The items of repair which were disallowed did not fall in this category—some were improvements instead of repairs; some were suitable to a modern first-class garage but not to a third-class garage; some were structural repairs beneficial to the lessor but not required for the purposes of the lessee during the term of the lease.

Corbett v Derman Shoe Co.¹⁰ involved a lease containing the following terms:

The Lessors covenant that they will, at their own cost and expense, make repairs, both outside and inside the buildings, including the elevator and boilers to an amount in all not exceeding . . . $500 . . . per year and the Lessee covenants that it will at its own cost and expense make all repairs in excess of said . . . $500 . . . necessary to keep the premises in such repair, order and condition as the same are at the commencement of this lease, damage by fire and casualty excepted. . . . [Lessee shall] quit and deliver up the premises to the Lessors . . . at the end of the term, in as good order and condition, reasonable use and wearing thereof, fire and other unavoidable casualties excepted, as the same now are, or may be put into, by said Lessors; and not make or suffer any waste thereof. . . .

The lessee contended that this provision meant only that it would not look to the lessors for repairs in excess of $500 a year, but did not impose any affirmative obligation on the tenants.

The court disagreed, stating:

The indication of an intention that the repair covenant states directly, and reasonably, that the lessee will take affirmative action to maintain the [original] condition, is reinforced by the

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