Covenants Reconsidered In Preparation for New Lease Accounting Rules (ASC 842; IFRS 16)

A joint effort by the Financial Accounting Standards Board (“FASB”) and the International Financial Reporting Standards Foundation (“IFRS”) will fundamentally reset the accounting treatment of leases under both US-GAAP and IFRS.  Under legacy rules, “operating” leases could avoid balance sheet treatment applied to “capital” leases, as operating and capital leases were thought to result from different underlying motivations.  Under the new lease accounting rules — codified as Accounting Standards Codification No. 842 (“ASC 842”) and IFRS No. 16 (“IFRS 16”) — the distinction between operating and capital leases will be significantly reduced and all leases with terms in excess of one year will be included on the balance sheet as “right to use” assets and lease liabilities (in the case of the lessees) or capital assets (in the case of lessors). The net effect of this change in accounting principles will be to increase indebtedness of net lessees and increase the capital assets of net lessors.  During the upcoming implementation period, it is imperative for users of financial statements to understand the scope and implications of these changes.  In particular, contractual covenants typical in debt financing arrangements will need to be carefully analyzed and crafted to avoid adverse consequences such as inadvertent default.


The implementation of new lease accounting rules under US-GAAP and IFRS will have the effect of eliminating off-balance sheet treatment of operating leases and will increase the lease balance sheet liabilities of net lessees. 

Under legacy rules, operating leases were presumed to solely represent a payment for the right to use an asset and not a method of financing the purchase of such asset.  As a result, operating leases were treated as a rent expense without significantly implicating the balance sheet (other than small accruals for rent past due at the end of a period).  In contrast, a capital lease was viewed as a financing arrangement secured by a leased asset.  As a result, the entire capital lease obligation was accrued as a liability upon the beginning of a lease and was subsequently amortized as payments were made over several years.

Under the new lease accounting rules, operating leases (other than operating leases with terms less than one year – including renewals) and capital leases will both be reflected as lease liabilities to be amortized over the life of such leases.  The new rules will significantly increase the amount of lease liability on a lessee’s balance sheet as the long-term obligation of an operating lease is moved from a borrower’s explanatory footnotes to the face of the balance sheet.  Under the new lease accounting rules, components of a lease contract that constitute services will be expensed and excluded from balance sheet treatment.  Also under the new lease accounting rules, while operating leases will be treated similarly to how capital leases have been treated historically, operating leases and capital leases will continue to be separately identified and quantified in companies’ financial statements.

The aggregate impact of the new lease accounting rules is astounding.  Studies have estimated that the new lease accounting rules will add an additional $2 trillion in liabilities on U.S. public companies alone.


The new lease accounting rules will have a staggered implementation requirements.  Public companies applying US-GAAP will be required to implement ASC 842 for fiscal years beginning on or after December 15, 2018 (generally, calendar year 2019) and private companies applying US-GAAP will be required to implement ASC 842 for fiscal years beginning on or after December 15, 2019 (generally, calendar year 2020).  All companies applying IFRS will be required to implement IFRS 16 for fiscal years beginning on or after January 1, 2019.  Companies also have the discretion to early-adopt ASC 842. 


Contractual covenants that measure compliance according to financial measures such as total indebtedness are at risk of falling out of compliance as a result of the implementation of new lease accounting rules as balance sheet indebtedness will generally increase significantly.  Various credit arrangements, including term loan facilities, revolving facilities, high yield notes and other arrangements, typically provide for debt covenants and financial compliance covenants that could be impacted.

Financial Ratio Covenants.  Often in credit agreements and high-yield notes, companies will need to periodically comply with certain financial ratios such as a net leverage ratio.  Compliance with such covenants can be measured either at the end of each quarter or pro forma upon the incurrence of new indebtedness.  For example, a typical ratio will measure the amount of consolidated indebtedness at period end to consolidated EBITDA over the past four fiscal quarters.  Depending on the applicable definition of indebtedness, the new lease accounting rules may result in a substantial increase in balance sheet indebtedness (with limited impact on EBITDA) for many borrowers and, as a result, compliance with financial ratios could become problematic.

Debt Covenants.  Often in credit agreements and high-yield notes, the amount of indebtedness or secured liens permitted by obligors is limited subject to certain permitted baskets, including a basket specifically for leases treated as a capital lease or liability on the face of a borrower’s balance sheet under GAAP.  As the new lease accounting rules take effect and operating leases are reflected on the balance sheet, borrowers with significant operating leases should pay particular attention to the criteria for the previously negotiated lease basket and may need to amend these provisions to increase the basket or exclude operating leases, reclassify existing indebtedness to find additional capacity, or risk a potential default.


In order to avoid the adverse consequences of the new lease accounting rules, recent credit agreements and high-yield covenant packages have been including certain borrower-favorable protections.

“Freezing” GAAP for Operating Leases.  Recently, certain borrowers have been negotiating for a carve-out from the definition of indebtedness for leases treated as operating leases prior to the implementation of ASC 842, thereby “freezing GAAP” as of the date of the facility and avoiding implementation of the new lease accounting rules for purposes of covenant compliance.  This would have no impact on the presentation of financial statements but would provide a permanent adjustment to allow for covenant evaluation under legacy rules. 

“Freezing GAAP” is consistent with the approach generally taken in many high yield covenant packages, where GAAP is defined to mean the generally accepted accounting principles in effect on a given date (either the issue date or the issue date of an earlier debt facility).  In light of the new lease accounting rules, borrowers should be especially mindful that they are entitled to an adjustment from their audited financial statements to revert to calculations permitted under legacy rules in measuring covenant compliance.  Depending on the exact terms of a particular debt facility, “freezing GAAP” may resolve potential issues in financial covenants, but may not address the inclusion of operating leases in a capital lease basket or other related complications.

Amendment Provisions. Typically in credit agreements (and occasionally in high yield notes), permissive amendment provisions will allow amendments to address changes in GAAP to be requested by the borrower, subject to the approval of the agent and a threshold quorum of lenders.  Borrowers intending to address changes in GAAP through such amendment provisions should submit notices to lenders as required by the terms of the facility.  Generally, the adverse impact of changes in accounting will be suspended while awaiting approval of such an amendment.

In contrast to loans under credit agreements, the mechanics of amending high-yield notes may prove too cumbersome to apply effectively in this manner. 

Thoughtful Negotiation of Ratios and Baskets.  Going forward, borrowers and lenders under credit arrangements will need to factor into their thresholds the amount of additional indebtedness resulting from the new lease accounting rules.  Especially during the implementation period beginning next year, the appropriate quantification of indebtedness ratios, coverage ratios and capital lease obligation baskets will need to factor in the projected effect of the new lease accounting rules to avoid inadvertently hamstringing a borrower or applying a covenant without sufficient teeth to protect a lender.  Lenders should also ascertain the true underlying financial health of a borrower through due diligence and pro forma adjustments that fairly compare pre- and post-ASC 842 financial statements.  Due to the effect of frozen GAAP provisions, similarly situated borrowers may differ in which lease accounting rules will be applied in assessing covenant compliance.  Reliance on prior year financial statements, industry comparables or old rules of thumb in setting limits could have unintended and adverse consequences.


Beyond contractual mechanics, the implementation of the new lease accounting rules will necessitate an evolution of how the financial community thinks about lease financing generally.  Borrowers may try to reduce the impact of the new lease accounting rules by negotiating lease terms that present less indebtedness on the balance sheet.  For example, because the length of a lease will directly relate to the magnitude of a lease liability, lessees may opt for shorter terms with options for renewal, or even terms that are less than a year to qualify for off-balance-sheet treatment.  Lessees may also negotiate for triple net leases, where a smaller amount of fixed rent will be carried as indebtedness on the balance sheet, with the lessee then paying a pro-rata share of ongoing expenses (i.e. taxes, insurance, and maintenance) that are captured off-balance-sheet.  The projected impact of the new lease accounting rules and the impact of borrowers’ mitigation strategies will need to be evaluated carefully.


Proponents of ASC 842, and its IFRS counterpart, IFRS 16, believe that the new lease accounting rules will create transparency and comparability of a company’s assets and liabilities and will avoid disparate balance sheet treatment for similar transactions.  While thoughtful implementation will likely achieve this result, transition to the new rules will present a dynamic environment with traps for the unwary, particularly in crafting workable credit covenant packages. 

Certain issues and considerations are beyond the scope of this brief alert; please contact us if you would like to explore the implications of the new lease accounting regime on your business.

Special thanks to law clerk Leo Liu for his research in preparation of this Client Alert.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© King & Spalding | Attorney Advertising

Written by:

King & Spalding

King & Spalding on:

Readers' Choice 2017
Reporters on Deadline

"My best business intelligence, in one easy email…"

Your first step to building a free, personalized, morning email brief covering pertinent authors and topics on JD Supra:
*By using the service, you signify your acceptance of JD Supra's Privacy Policy.
Custom Email Digest
- hide

JD Supra Privacy Policy

Updated: May 25, 2018:

JD Supra is a legal publishing service that connects experts and their content with broader audiences of professionals, journalists and associations.

This Privacy Policy describes how JD Supra, LLC ("JD Supra" or "we," "us," or "our") collects, uses and shares personal data collected from visitors to our website (located at (our "Website") who view only publicly-available content as well as subscribers to our services (such as our email digests or author tools)(our "Services"). By using our Website and registering for one of our Services, you are agreeing to the terms of this Privacy Policy.

Please note that if you subscribe to one of our Services, you can make choices about how we collect, use and share your information through our Privacy Center under the "My Account" dashboard (available if you are logged into your JD Supra account).

Collection of Information

Registration Information. When you register with JD Supra for our Website and Services, either as an author or as a subscriber, you will be asked to provide identifying information to create your JD Supra account ("Registration Data"), such as your:

  • Email
  • First Name
  • Last Name
  • Company Name
  • Company Industry
  • Title
  • Country

Other Information: We also collect other information you may voluntarily provide. This may include content you provide for publication. We may also receive your communications with others through our Website and Services (such as contacting an author through our Website) or communications directly with us (such as through email, feedback or other forms or social media). If you are a subscribed user, we will also collect your user preferences, such as the types of articles you would like to read.

Information from third parties (such as, from your employer or LinkedIn): We may also receive information about you from third party sources. For example, your employer may provide your information to us, such as in connection with an article submitted by your employer for publication. If you choose to use LinkedIn to subscribe to our Website and Services, we also collect information related to your LinkedIn account and profile.

Your interactions with our Website and Services: As is true of most websites, we gather certain information automatically. This information includes IP addresses, browser type, Internet service provider (ISP), referring/exit pages, operating system, date/time stamp and clickstream data. We use this information to analyze trends, to administer the Website and our Services, to improve the content and performance of our Website and Services, and to track users' movements around the site. We may also link this automatically-collected data to personal information, for example, to inform authors about who has read their articles. Some of this data is collected through information sent by your web browser. We also use cookies and other tracking technologies to collect this information. To learn more about cookies and other tracking technologies that JD Supra may use on our Website and Services please see our "Cookies Guide" page.

How do we use this information?

We use the information and data we collect principally in order to provide our Website and Services. More specifically, we may use your personal information to:

  • Operate our Website and Services and publish content;
  • Distribute content to you in accordance with your preferences as well as to provide other notifications to you (for example, updates about our policies and terms);
  • Measure readership and usage of the Website and Services;
  • Communicate with you regarding your questions and requests;
  • Authenticate users and to provide for the safety and security of our Website and Services;
  • Conduct research and similar activities to improve our Website and Services; and
  • Comply with our legal and regulatory responsibilities and to enforce our rights.

How is your information shared?

  • Content and other public information (such as an author profile) is shared on our Website and Services, including via email digests and social media feeds, and is accessible to the general public.
  • If you choose to use our Website and Services to communicate directly with a company or individual, such communication may be shared accordingly.
  • Readership information is provided to publishing law firms and authors of content to give them insight into their readership and to help them to improve their content.
  • Our Website may offer you the opportunity to share information through our Website, such as through Facebook's "Like" or Twitter's "Tweet" button. We offer this functionality to help generate interest in our Website and content and to permit you to recommend content to your contacts. You should be aware that sharing through such functionality may result in information being collected by the applicable social media network and possibly being made publicly available (for example, through a search engine). Any such information collection would be subject to such third party social media network's privacy policy.
  • Your information may also be shared to parties who support our business, such as professional advisors as well as web-hosting providers, analytics providers and other information technology providers.
  • Any court, governmental authority, law enforcement agency or other third party where we believe disclosure is necessary to comply with a legal or regulatory obligation, or otherwise to protect our rights, the rights of any third party or individuals' personal safety, or to detect, prevent, or otherwise address fraud, security or safety issues.
  • To our affiliated entities and in connection with the sale, assignment or other transfer of our company or our business.

How We Protect Your Information

JD Supra takes reasonable and appropriate precautions to insure that user information is protected from loss, misuse and unauthorized access, disclosure, alteration and destruction. We restrict access to user information to those individuals who reasonably need access to perform their job functions, such as our third party email service, customer service personnel and technical staff. You should keep in mind that no Internet transmission is ever 100% secure or error-free. Where you use log-in credentials (usernames, passwords) on our Website, please remember that it is your responsibility to safeguard them. If you believe that your log-in credentials have been compromised, please contact us at

Children's Information

Our Website and Services are not directed at children under the age of 16 and we do not knowingly collect personal information from children under the age of 16 through our Website and/or Services. If you have reason to believe that a child under the age of 16 has provided personal information to us, please contact us, and we will endeavor to delete that information from our databases.

Links to Other Websites

Our Website and Services may contain links to other websites. The operators of such other websites may collect information about you, including through cookies or other technologies. If you are using our Website or Services and click a link to another site, you will leave our Website and this Policy will not apply to your use of and activity on those other sites. We encourage you to read the legal notices posted on those sites, including their privacy policies. We are not responsible for the data collection and use practices of such other sites. This Policy applies solely to the information collected in connection with your use of our Website and Services and does not apply to any practices conducted offline or in connection with any other websites.

Information for EU and Swiss Residents

JD Supra's principal place of business is in the United States. By subscribing to our website, you expressly consent to your information being processed in the United States.

  • Our Legal Basis for Processing: Generally, we rely on our legitimate interests in order to process your personal information. For example, we rely on this legal ground if we use your personal information to manage your Registration Data and administer our relationship with you; to deliver our Website and Services; understand and improve our Website and Services; report reader analytics to our authors; to personalize your experience on our Website and Services; and where necessary to protect or defend our or another's rights or property, or to detect, prevent, or otherwise address fraud, security, safety or privacy issues. Please see Article 6(1)(f) of the E.U. General Data Protection Regulation ("GDPR") In addition, there may be other situations where other grounds for processing may exist, such as where processing is a result of legal requirements (GDPR Article 6(1)(c)) or for reasons of public interest (GDPR Article 6(1)(e)). Please see the "Your Rights" section of this Privacy Policy immediately below for more information about how you may request that we limit or refrain from processing your personal information.
  • Your Rights
    • Right of Access/Portability: You can ask to review details about the information we hold about you and how that information has been used and disclosed. Note that we may request to verify your identification before fulfilling your request. You can also request that your personal information is provided to you in a commonly used electronic format so that you can share it with other organizations.
    • Right to Correct Information: You may ask that we make corrections to any information we hold, if you believe such correction to be necessary.
    • Right to Restrict Our Processing or Erasure of Information: You also have the right in certain circumstances to ask us to restrict processing of your personal information or to erase your personal information. Where you have consented to our use of your personal information, you can withdraw your consent at any time.

You can make a request to exercise any of these rights by emailing us at or by writing to us at:

Privacy Officer
JD Supra, LLC
10 Liberty Ship Way, Suite 300
Sausalito, California 94965

You can also manage your profile and subscriptions through our Privacy Center under the "My Account" dashboard.

We will make all practical efforts to respect your wishes. There may be times, however, where we are not able to fulfill your request, for example, if applicable law prohibits our compliance. Please note that JD Supra does not use "automatic decision making" or "profiling" as those terms are defined in the GDPR.

  • Timeframe for retaining your personal information: We will retain your personal information in a form that identifies you only for as long as it serves the purpose(s) for which it was initially collected as stated in this Privacy Policy, or subsequently authorized. We may continue processing your personal information for longer periods, but only for the time and to the extent such processing reasonably serves the purposes of archiving in the public interest, journalism, literature and art, scientific or historical research and statistical analysis, and subject to the protection of this Privacy Policy. For example, if you are an author, your personal information may continue to be published in connection with your article indefinitely. When we have no ongoing legitimate business need to process your personal information, we will either delete or anonymize it, or, if this is not possible (for example, because your personal information has been stored in backup archives), then we will securely store your personal information and isolate it from any further processing until deletion is possible.
  • Onward Transfer to Third Parties: As noted in the "How We Share Your Data" Section above, JD Supra may share your information with third parties. When JD Supra discloses your personal information to third parties, we have ensured that such third parties have either certified under the EU-U.S. or Swiss Privacy Shield Framework and will process all personal data received from EU member states/Switzerland in reliance on the applicable Privacy Shield Framework or that they have been subjected to strict contractual provisions in their contract with us to guarantee an adequate level of data protection for your data.

California Privacy Rights

Pursuant to Section 1798.83 of the California Civil Code, our customers who are California residents have the right to request certain information regarding our disclosure of personal information to third parties for their direct marketing purposes.

You can make a request for this information by emailing us at or by writing to us at:

Privacy Officer
JD Supra, LLC
10 Liberty Ship Way, Suite 300
Sausalito, California 94965

Some browsers have incorporated a Do Not Track (DNT) feature. These features, when turned on, send a signal that you prefer that the website you are visiting not collect and use data regarding your online searching and browsing activities. As there is not yet a common understanding on how to interpret the DNT signal, we currently do not respond to DNT signals on our site.

Access/Correct/Update/Delete Personal Information

For non-EU/Swiss residents, if you would like to know what personal information we have about you, you can send an e-mail to We will be in contact with you (by mail or otherwise) to verify your identity and provide you the information you request. We will respond within 30 days to your request for access to your personal information. In some cases, we may not be able to remove your personal information, in which case we will let you know if we are unable to do so and why. If you would like to correct or update your personal information, you can manage your profile and subscriptions through our Privacy Center under the "My Account" dashboard. If you would like to delete your account or remove your information from our Website and Services, send an e-mail to

Changes in Our Privacy Policy

We reserve the right to change this Privacy Policy at any time. Please refer to the date at the top of this page to determine when this Policy was last revised. Any changes to our Privacy Policy will become effective upon posting of the revised policy on the Website. By continuing to use our Website and Services following such changes, you will be deemed to have agreed to such changes.

Contacting JD Supra

If you have any questions about this Privacy Policy, the practices of this site, your dealings with our Website or Services, or if you would like to change any of the information you have provided to us, please contact us at:

JD Supra Cookie Guide

As with many websites, JD Supra's website (located at (our "Website") and our services (such as our email article digests)(our "Services") use a standard technology called a "cookie" and other similar technologies (such as, pixels and web beacons), which are small data files that are transferred to your computer when you use our Website and Services. These technologies automatically identify your browser whenever you interact with our Website and Services.

How We Use Cookies and Other Tracking Technologies

We use cookies and other tracking technologies to:

  1. Improve the user experience on our Website and Services;
  2. Store the authorization token that users receive when they login to the private areas of our Website. This token is specific to a user's login session and requires a valid username and password to obtain. It is required to access the user's profile information, subscriptions, and analytics;
  3. Track anonymous site usage; and
  4. Permit connectivity with social media networks to permit content sharing.

There are different types of cookies and other technologies used our Website, notably:

  • "Session cookies" - These cookies only last as long as your online session, and disappear from your computer or device when you close your browser (like Internet Explorer, Google Chrome or Safari).
  • "Persistent cookies" - These cookies stay on your computer or device after your browser has been closed and last for a time specified in the cookie. We use persistent cookies when we need to know who you are for more than one browsing session. For example, we use them to remember your preferences for the next time you visit.
  • "Web Beacons/Pixels" - Some of our web pages and emails may also contain small electronic images known as web beacons, clear GIFs or single-pixel GIFs. These images are placed on a web page or email and typically work in conjunction with cookies to collect data. We use these images to identify our users and user behavior, such as counting the number of users who have visited a web page or acted upon one of our email digests.

JD Supra Cookies. We place our own cookies on your computer to track certain information about you while you are using our Website and Services. For example, we place a session cookie on your computer each time you visit our Website. We use these cookies to allow you to log-in to your subscriber account. In addition, through these cookies we are able to collect information about how you use the Website, including what browser you may be using, your IP address, and the URL address you came from upon visiting our Website and the URL you next visit (even if those URLs are not on our Website). We also utilize email web beacons to monitor whether our emails are being delivered and read. We also use these tools to help deliver reader analytics to our authors to give them insight into their readership and help them to improve their content, so that it is most useful for our users.

Analytics/Performance Cookies. JD Supra also uses the following analytic tools to help us analyze the performance of our Website and Services as well as how visitors use our Website and Services:

  • HubSpot - For more information about HubSpot cookies, please visit
  • New Relic - For more information on New Relic cookies, please visit
  • Google Analytics - For more information on Google Analytics cookies, visit To opt-out of being tracked by Google Analytics across all websites visit This will allow you to download and install a Google Analytics cookie-free web browser.

Facebook, Twitter and other Social Network Cookies. Our content pages allow you to share content appearing on our Website and Services to your social media accounts through the "Like," "Tweet," or similar buttons displayed on such pages. To accomplish this Service, we embed code that such third party social networks provide and that we do not control. These buttons know that you are logged in to your social network account and therefore such social networks could also know that you are viewing the JD Supra Website.

Controlling and Deleting Cookies

If you would like to change how a browser uses cookies, including blocking or deleting cookies from the JD Supra Website and Services you can do so by changing the settings in your web browser. To control cookies, most browsers allow you to either accept or reject all cookies, only accept certain types of cookies, or prompt you every time a site wishes to save a cookie. It's also easy to delete cookies that are already saved on your device by a browser.

The processes for controlling and deleting cookies vary depending on which browser you use. To find out how to do so with a particular browser, you can use your browser's "Help" function or alternatively, you can visit which explains, step-by-step, how to control and delete cookies in most browsers.

Updates to This Policy

We may update this cookie policy and our Privacy Policy from time-to-time, particularly as technology changes. You can always check this page for the latest version. We may also notify you of changes to our privacy policy by email.

Contacting JD Supra

If you have any questions about how we use cookies and other tracking technologies, please contact us at:

- hide

This website uses cookies to improve user experience, track anonymous site usage, store authorization tokens and permit sharing on social media networks. By continuing to browse this website you accept the use of cookies. Click here to read more about how we use cookies.