What is the purpose of a Protective Covenant?

A Protective Covenant serves a crucial role in loan agreements by establishing limits on borrower activities to protect the interests of lenders. These covenants are put in place to mitigate risk and ensure that the borrower adheres to certain operational and financial guidelines during the life of the loan.

For instance, a Protective Covenant might restrict a borrower from taking on additional debt or selling key assets without the lender's consent. This helps ensure that borrowers maintain a stable financial position and do not engage in actions that could jeopardize their ability to repay the loan. By outlining these limitations, lenders can better manage their risk and ensure that the borrower remains within acceptable operational parameters.

This is why the correct choice highlights the nature of Protective Covenants in safeguarding the financial relationship between the lender and the borrower. The other options focus on aspects related to compliance, financial performance, or processes that, while relevant in the broader context of loan agreements, do not specifically capture the primary purpose of a Protective Covenant.