Covenants In NZ Business: Meaning And How They Work

If you’ve ever signed a contract and noticed a clause that says you “must do” (or “must not do”) something, you’ve probably seen a covenant - even if it wasn’t labelled that way.

In plain English, covenants are promises. They’re the parts of an agreement that set out ongoing commitments, restrictions, or standards that one party agrees to follow.

For small businesses in New Zealand, understanding the meaning of covenants (and how covenants work in real life) can help you negotiate better deals, reduce risk, and protect the value you’re building - especially when you’re hiring staff, taking on funding, buying a business, or signing a lease.

Below, we’ll break down what covenants are, where you’ll see them in NZ business, and the practical steps you can take to make sure your covenants are clear, enforceable, and fit your commercial goals. This article is general information only and isn’t legal advice.

What Is A Covenant In A Contract (And Why Does It Matter For Your Business)?

The legal meaning of covenants is straightforward: a covenant is a promise made by one party to another, usually written into a contract or deed.

These promises can be:

• Positive covenants (you promise to do something), like “you must maintain insurance” or “you must provide monthly financial reports”.
• Negative covenants (you promise not to do something), like “you must not disclose confidential information” or “you must not compete for 12 months”.

They matter because covenants are often the part of the agreement that:

• protects your business’s money (e.g. payment, security, solvency requirements);
• protects your relationships (e.g. non-solicitation of clients or staff);
• protects your assets and IP (e.g. confidentiality, non-use of trade secrets); and
• sets the rules of the road for what happens if something goes wrong (e.g. breach, default, termination).

As a business owner, you’ll usually see covenants in agreements where one party is taking on risk - and wants the other party to behave in a particular way to reduce that risk.

For example:

• A landlord may want covenants about how you use the premises.
• A lender may want covenants about your cashflow, reporting, or debt levels.
• A buyer may want covenants from you as the seller to protect goodwill after a sale.
• You (as the business) may want covenants from staff or contractors to protect clients, systems, and confidential information.

Covenants are only useful if they’re drafted properly and form part of a legally binding contract. If the contract itself isn’t enforceable, or the covenant is too vague, you can end up with a clause that looks strong on paper but is hard to rely on in practice.

Where Will You Commonly See Covenants In NZ Business?

Covenants show up across a wide range of business documents. Here are some of the most common places small businesses run into them.

1) Employment And Contractor Agreements (Restraints, Confidentiality, IP)

If you hire employees or engage contractors, covenants are often how you protect the business beyond “day-to-day performance” obligations.

Common covenants in this space include:

• Confidentiality (not disclosing or misusing business information) - usually supported by a Confidentiality Clause.
• Non-compete restraints (not starting or joining a competitor for a period) - often documented as a Non-Compete Agreement or included in the employment/contractor terms.
• Non-solicitation (not poaching your customers/clients or staff).
• IP assignment / IP protection covenants (making sure work created is owned by the business, not the individual).

In New Zealand, restraints (like non-competes) aren’t automatically enforceable just because you wrote them down. Whether they’re enforceable depends heavily on the circumstances, and they generally need to be reasonable and necessary to protect a legitimate business interest (for example, trade secrets, client relationships, and goodwill).

This is exactly why covenants need to be tailored. If they’re too broad (e.g. “you can’t work in the industry anywhere in NZ for 3 years”), they may be difficult to enforce. If they’re too narrow, they may not protect you at all.

2) Shareholder And Founder Arrangements

If you’re running a company with co-founders or multiple shareholders, covenants are often how you keep everyone aligned and avoid disputes later.

These covenants often sit inside a Shareholders Agreement and/or your Company Constitution, and might include promises about:

• how decisions must be made (e.g. reserved matters requiring unanimous approval);
• what directors/shareholders must do (e.g. act in good faith, provide information);
• restrictions on transferring shares (e.g. pre-emptive rights);
• restrictions on shareholders competing with the business; and
• what happens if someone exits (good leaver/bad leaver-style outcomes, valuation mechanics, etc.).

From a small business perspective, these covenants can be the difference between a smooth scale-up and a business that gets stuck due to internal conflict.

3) Finance Documents (Loan Covenants And Security)

When you borrow money (from a bank, private lender, or sometimes even under a vendor finance arrangement), you’ll often be asked to agree to loan covenants.

These covenants are typically designed to protect the lender by monitoring your business’s financial health and preventing actions that could increase risk.

Loan covenants might require you to:

• provide regular financial reports (monthly/quarterly);
• maintain certain financial ratios (like debt service coverage);
• avoid taking on further debt without consent;
• maintain key insurance policies; and
• notify the lender of major changes to the business.

Often, these finance arrangements also involve security documentation, like a General Security Agreement, which can give a lender rights over business assets if there’s a default.

Even if you’re confident you’ll comply, it’s important to understand what events technically count as a breach - because a breach can sometimes trigger default rights, higher interest, or enforcement options (even where you haven’t “missed a payment”).

4) Commercial Leases And Property Arrangements

Leases often include covenants about how you use and maintain the premises, and what you can and can’t do as a tenant.

Common lease covenants include:

• permitted use (what activities you can run from the space);
• repair and maintenance standards;
• outgoings and payment obligations;
• fit-out approval requirements; and
• assignment/subleasing restrictions.

If you’re signing a lease, these covenants can have major operational impacts - for example, if your permitted use is too narrow, it could stop you from adding new products or services later.

5) Business Sale Agreements (Protecting Goodwill)

If you’re buying or selling a business, covenants are usually central to the deal - because the buyer is often paying for goodwill (the benefit of the existing brand, customers, systems, and reputation).

Common business sale covenants include:

• restraints on the seller competing after completion;
• non-solicitation of customers, suppliers, and staff;
• handover and transition support obligations; and
• warranties and ongoing promises about the accuracy of information provided.

From a seller’s side, you’ll want covenants that are fair and not overly restrictive. From a buyer’s side, you’ll want covenants strong enough to protect what you’ve paid for.

How Do Covenants Work In Practice (And What Happens If Someone Breaches One)?

Most covenants are drafted as ongoing obligations - meaning they apply:

• during the term of the contract; and sometimes
• after the contract ends (particularly for confidentiality and restraint covenants).

If someone breaches a covenant, what happens next depends on:

• what the contract says about breach and remedies;
• how serious the breach is (minor vs material);
• what loss has been caused (if any); and
• what remedy is realistically available (and commercially worth pursuing).

Common Remedies For Breach

In NZ, a covenant breach can potentially lead to outcomes like:

• Damages (money to compensate for loss).
• Injunctions (a court order requiring someone to stop doing something, or sometimes to do something - usually where the legal test is met and it’s appropriate in the circumstances).
• Termination rights (ending the agreement, if the breach meets the required threshold under the contract and/or law).
• Step-in / enforcement rights (common in finance/security arrangements, where the documents provide for them).

With restraints, businesses often care less about money and more about stopping harmful conduct quickly (for example, stopping a former staff member from soliciting key customers). That’s why the wording, scope, and evidence around your covenants matter a lot - especially if you ever need urgent relief.

Practical Reality Check: Enforcement Is A Business Decision

Even where you have a clearly drafted covenant, enforcement can still involve time, cost, and distraction.

So, it’s worth thinking about covenants not only as a “legal weapon”, but as part of your risk management system:

• Do they clearly tell the other side what they can/can’t do?
• Do they deter risky behaviour?
• Do they give you leverage to negotiate a quick resolution if something goes wrong?

Getting the drafting right upfront is usually far cheaper than trying to fix an unclear covenant later.

Are Covenants Enforceable In New Zealand?

Generally, yes - covenants can be enforceable in New Zealand, as long as they’re properly drafted, legally valid, and appropriate for the context.

But enforceability often comes down to the type of covenant and the situation.

Restraint-Style Covenants Must Usually Be Reasonable

Where a covenant restricts someone’s freedom to work or trade (like non-compete or non-solicit obligations), NZ courts will typically scrutinise whether it’s reasonable in scope and duration, and whether it’s needed to protect a legitimate business interest.

“Reasonable” usually depends on factors like:

• Duration (how long does it last?)
• Geographic scope (what area does it cover?)
• Activity scope (what exactly is prohibited?)
• Role and access (did the person have access to key clients, pricing, strategy, or trade secrets?)
• Legitimate business interest (what are you genuinely protecting?)

This is why “template” restraints are risky - what’s reasonable for a senior salesperson with key accounts may not be reasonable for a junior team member with limited access.

Financial And Reporting Covenants Are Often Enforced As Written (But Definitions Matter)

In lending and commercial arrangements, covenants around reporting, insurance, financial ratios, and negative pledges are often more mechanical: either the covenant is met, or it isn’t.

However, there can still be interpretation issues if:

• definitions are unclear (e.g. what counts as “debt” or “material adverse change”);
• timelines are ambiguous; or
• the covenant doesn’t align with how your business actually operates (seasonality, irregular revenue, or rapid growth).

Contract Law Still Applies

Even if we don’t dive into the technicalities, it helps to know that NZ contract law principles (including those reflected in the Contract and Commercial Law Act 2017) still sit in the background. That means things like:

• clarity of terms matters;
• what the parties intended can matter; and
• the remedy for breach will depend on the contract, the facts, and the loss.

And, of course, if a covenant is used in a misleading way (for example, misrepresenting what a covenant means to get someone to sign), there may be risks under laws like the Fair Trading Act 1986.

How Do You Draft Good Covenants For Your Small Business?

When you’re on the “business owner” side of a covenant, the goal is usually to make the covenant:

• clear (so it’s easy to understand and comply with),
• specific (so it actually protects what you need), and
• enforceable (so it holds up if tested).

Here are practical drafting principles that tend to matter most.

1) Define The Key Terms (Don’t Assume Everyone Means The Same Thing)

Many covenant disputes come down to definitions.

For example, if you want a confidentiality covenant, define what counts as “Confidential Information” (and what doesn’t). If you want a non-solicit, define who counts as a “Customer” (current only? former? leads?).

The clearer the definition, the less room there is for arguments later.

2) Match The Covenant To A Legitimate Business Need

A strong covenant isn’t necessarily the broadest covenant. It’s the one that’s most aligned with what you genuinely need to protect.

Ask yourself:

• What asset are we protecting - clients, goodwill, systems, trade secrets, revenue stability?
• Who actually has access to that asset?
• What’s the realistic harm if they walk away and misuse it?

This is especially important for restraint covenants, where overreach can create enforceability issues.

3) Think About How You’ll Monitor And Prove Compliance

A covenant is only as useful as your ability to prove a breach.

For example:

• If you require reporting, specify format and timing (and keep records).
• If you restrict solicitation, define how you’ll identify the customer base covered by the clause.
• If you restrict disclosure, make sure your business actually treats the information as confidential (limited access, passwords, internal policies).

4) Make The Consequences Of Breach Clear

Consider including:

• what counts as a breach (and whether there’s a cure period);
• termination rights (where appropriate);
• indemnities (carefully drafted); and
• any specific enforcement rights (particularly in finance/security documents).

If you later need to adjust covenants (for example, because your role changes, the business pivots, or you restructure), it may be done through a formal variation - sometimes documented through a Deed Of Variation depending on the situation.

5) Don’t Rely On DIY Templates For High-Stakes Covenants

We get it - when you’re busy running a business, it’s tempting to grab a template and move on.

But covenants are one of those areas where a generic template can create very real risk, such as:

• restraints that are unenforceable (too broad or not linked to a legitimate interest);
• definitions that don’t match your business model;
• inconsistent obligations across documents; or
• missing enforcement mechanisms, making breaches harder to deal with.

If the covenant is important enough to include, it’s usually important enough to get right.

Key Takeaways

• In NZ business, covenants are essentially promises in a contract - they set ongoing obligations or restrictions that protect one party’s interests.
• You’ll commonly see covenants in employment/contractor arrangements, shareholder/founder documents, finance/security documents, leases, and business sale agreements.
• Some covenants (especially restraints like non-competes and non-solicits) usually need to be reasonable to be enforceable in New Zealand.
• Loan and reporting covenants can have serious consequences if breached - even where you’re still making payments - so it’s important to understand the definitions and triggers.
• The best covenants are clear, specific, tailored to your business, and practical to monitor and enforce.
• If your covenants don’t match your real-world operations, it’s often worth updating them properly (for example, through a deed of variation) rather than hoping a generic clause will “do the job”.

If you’d like help drafting, reviewing, or negotiating covenants (whether that’s in employment agreements, shareholder documents, finance arrangements, or a business sale), you can reach us at 0800 002 184 or team@sprintlaw.co.nz for a free, no-obligations chat.