Limitation on Restricted Payments | Bondfish Glossary
Limitation on restricted payments is a bond covenant that caps the issuer’s dividends, share buybacks and similar payouts to shareholders, keeping cash available to service debt.
What it means
“Restricted payments” are outflows of value from the company to parties who rank behind bondholders — chiefly dividends to shareholders, repurchases of the company’s own stock, early repayment of subordinated debt, and certain investments outside the business.
The covenant, standard in high-yield bond indentures, blocks these payments unless the issuer passes defined tests. The classic mechanic is a builder basket: capacity to pay grows over time (typically with a share of cumulative net income and new equity raised) and can only be used if the company also meets a leverage or coverage test and is not in default. A list of carve-outs (“permitted payments”) allows small or routine items.
Why it matters for bond investors
This covenant is the main defense against shareholders stripping cash out of a leveraged company. A weak restricted-payments covenant — large baskets, generous carve-outs — makes it easier for the issuer to pay big dividends even as credit quality deteriorates, leaving less cushion for bondholders. Covenant strength here is one reason two high-yield bonds with similar yields can carry very different real risk.
Related terms
- High-yield bonds
- Dividend
- Subordinated bond
- Default
- Limitation on liens
- Limitation on sale of assets
This definition is for general information only and is not investment advice. Bond investing involves risk, including possible loss of principal.