The Restricted Payments Covenant in ABL — How Dividends, Distributions, Share Repurchases, and Tax Distributions Are Governed by the Credit Agreement

The restricted payments covenant is the negative covenant that governs how much cash the borrower can pay out of the credit-agreement perimeter to owners, affiliates, or holders of subordinated debt while the ABL facility is outstanding. Dividends to shareholders, distributions to LLC members, S-corporation tax distributions, share repurchases and buybacks, redemptions of preferred equity, payments on subordinated debt, and management-fee payments to a sponsor all sit inside the same covenant framework. Sponsor-owned businesses, family-owned S corporations, LLC pass-through entities, and management-owned companies all live inside this covenant every quarter, whether they know it or not.

This article is the borrower-facing guide to how the restricted payments covenant works in an ABL credit agreement, what the standard baskets and payment conditions look like, and where CFOs should negotiate. Over four decades in asset-based lending — as a lender, as founder of ABLC, as author of Asset Based Lending Disciplines, and as a trainer of more than 5,000 ABL professionals at GE Capital, JP Morgan Chase, Lloyds, and Barclays — I have watched the restricted payments basket be the covenant that most often gets underestimated at closing and then binds two or three years later. This article is educational and is not legal, tax, or investment advice; the covenant language should be reviewed with qualified counsel.

What "Restricted Payments" Actually Covers

The credit agreement's defined term "Restricted Payment" typically sweeps in every form of cash movement out of the loan-party perimeter to equity holders, affiliates outside the perimeter, or holders of subordinated instruments. In practice this includes:

• Dividends paid to holders of common or preferred stock of the borrower or a guarantor.
• Distributions made by an LLC or limited partnership to its members or partners.
• Share or unit repurchases and redemptions, including buybacks and preferred-stock redemptions.
• Payments on subordinated debt — regularly scheduled interest, mandatory amortization, and any voluntary prepayments or redemptions of sellers notes, mezzanine debt, or intercompany subordinated notes.
• Management fees, monitoring fees, and transaction fees paid to a private-equity sponsor or its affiliates.
• Loans or advances to shareholders, members, partners, or affiliates outside the credit group.
• Certain payments to related parties to the extent they fall outside ordinary-course arm's-length trade.

What is not a restricted payment: ordinary-course trade payables to unaffiliated third parties, employee compensation, tax payments to governments, and payments among loan parties inside the credit group. The credit agreement's list of exclusions is where much of the drafting attention sits.

The Standard Framework: Prohibition Plus Baskets

Modern ABL credit agreements do not simply prohibit restricted payments. They prohibit them subject to a series of defined exceptions and "baskets" — buckets of permitted payments the borrower can make if the conditions are met. The baskets are the operational core of the covenant and the primary borrower negotiation surface.

The tax distribution basket

For S corporations, LLCs, partnerships, and any other pass-through entity, the tax distribution basket is the most important item in the covenant. Because pass-through income is taxed at the owner level, the entity has to distribute enough cash for owners to pay their federal, state, and (where applicable) local income taxes on the entity's income. Blocking these distributions creates real hardship — owners face tax bills on income they have not received.

The standard tax distribution basket typically permits:

• Distributions in an amount equal to the highest combined marginal federal, state, and local income tax rate applicable to any owner, multiplied by the entity's taxable income for the period, less prior distributions and any tax benefits allocated to owners.
• Timing typically aligned with quarterly estimated tax payment deadlines (April, June, September, January) and April 15 for the prior-year final true-up.

Borrowers with pass-through structures should ensure the tax distribution basket is uncapped and mechanically aligned with tax law, not subject to the availability or payment conditions that apply to discretionary baskets. This is the single most important restricted-payments negotiation for family-owned and sponsor-owned pass-through businesses.

The general (or "restricted-payment") basket

The general basket permits discretionary dividends, buybacks, or other restricted payments up to a defined dollar cap per fiscal year, or a cumulative cap over the life of the facility. A typical middle-market ABL might allow $1-5 million per year in aggregate discretionary restricted payments, subject to the payment conditions below. The basket size is negotiable — sponsor-backed borrowers with lower leverage often negotiate higher baskets, and stressed borrowers see smaller ones.

The available amount basket (builder basket)

Larger and sponsor-oriented ABL facilities frequently include an "Available Amount" or "Builder Basket" that grows with cumulative retained cash flow. The mechanic accumulates a portion of excess cash flow (or net income, or EBITDA less debt service, depending on drafting) each period, allowing the borrower to use the growing bucket for restricted payments, permitted investments, or junior-debt prepayments. Available Amount baskets are common in unitranche and larger sponsor deals and rarer in traditional middle-market ABL.

Subordinated-debt payments

Regularly scheduled interest on subordinated debt is typically permitted as a stand-alone carve-out from the restricted payments covenant, subject to no default and payment conditions. Voluntary prepayments of subordinated debt are typically permitted only inside the general basket or the Available Amount basket, or subject to specific "yank-the-bank" mechanics tied to net leverage and excess availability tests. Any subordinated debt should be covered by a subordination agreement or intercreditor arrangement that reinforces the restricted-payments covenant with contractual payment blockers.

Payment Conditions: The Trigger Above the Baskets

Beyond the basket sizes themselves, ABL credit agreements condition permitted restricted payments on the borrower being in a defined healthy state at the moment of payment. This is the "Payment Conditions" test, and it typically requires all of the following on the payment date and after giving effect to the payment:

• No default or event of default exists or would result from making the payment.
• Excess availability under the ABL facility, calculated on a pro forma basis after the payment, is at or above a defined threshold — commonly 20-25% of the revolving commitment or the borrowing base, whichever is less.
• Fixed-charge coverage ratio for the trailing 12 months meets a defined level, often 1.0x or 1.1x — even if the ABL is otherwise covenant-light and the FCCR is springing.
• Officer certification confirming the above, delivered to the agent before or contemporaneously with the payment.

The payment condition mechanics tie the restricted payments covenant directly to the availability and covenant framework we describe in our guides to springing FCCR covenants and excess availability triggers and the broader ABL term sheet. The practical effect is that a borrower whose availability tightens loses the ability to make discretionary restricted payments even if the basket is uncapped.

Tax distributions from pass-through entities are typically carved out from the excess-availability payment condition — the recognition that tax obligations do not pause just because the borrower's availability is tight. This carve-out is the borrower's second most important negotiation point after the size of the tax basket itself.

Management Fees and Sponsor Payments

Private-equity sponsor-owned borrowers face a particular restricted-payments issue: the sponsor typically extracts a management fee, monitoring fee, or transaction fee from the portfolio company. These fees are restricted payments under most credit agreement definitions and are governed by the covenant.

Standard treatment includes:

• Ordinary-course management fees up to a defined dollar or percentage cap — commonly 1-3% of EBITDA, with an annual dollar cap — are permitted subject to no default.
• Transaction fees for acquisitions, dispositions, and financings — permitted only inside the general basket or a specific transaction-fee carve-out, subject to payment conditions.
• Deferred fees during periods when the payment conditions are not met — the fees continue to accrue but cannot be paid until conditions are restored.

Sponsors and their portfolio-company CFOs should ensure the management-fee mechanic in the ABL credit agreement matches the fee structure in the sponsor's operating agreement or management services agreement. Mismatch produces unnecessary friction when quarterly fees come due.

Interaction With Cash Dominion

Under a full or springing cash dominion structure, all incoming cash is swept to a lender-controlled account and applied against the revolver. When cash sweeps to reduce revolver balance, the borrower has to redraw availability to make any payment — including a restricted payment. Practically, this means:

• A cash-generative borrower cannot accumulate cash on the balance sheet to fund a dividend; the sweep prevents it.
• A dividend or distribution is funded from a new draw on the revolver, which necessarily requires availability and satisfaction of the payment conditions.
• Timing matters — the borrower needs to plan the payment condition test around the payment date, not the payment approval date.

The full mechanics of springing versus full cash dominion are covered in our guide to cash dominion structures in ABL.

Where Borrowers Should Negotiate

Restricted payments are one of the most negotiable pieces of the credit agreement, and the difference between a workable covenant and a constricting one is measured in a few defined thresholds. High-value negotiation points include:

• Tax distribution basket — uncapped, mechanically aligned with tax law, and carved out from the excess-availability payment condition.
• General basket size — set at a level that meaningfully accommodates historical dividend or buyback practice, not at a token figure the borrower will exceed in year one.
• Excess-availability threshold — 20% is common; a lower threshold (17.5% or 15%) gives more operating room. Some deals use a "greater of" formulation with a fixed dollar minimum.
• FCCR test — a 1.0x test is meaningfully easier than 1.1x. Some deals dispense with the FCCR test altogether above defined availability thresholds.
• Available Amount / Builder Basket — a builder basket that accumulates over time gives sponsor-oriented borrowers real optionality for future acquisitions or dividends.
• Management fee sizing and deferral — a cap that matches the actual management services agreement, with deferral rather than forfeiture during payment-condition-off periods.
• Subordinated debt scheduled payments — a stand-alone carve-out permitting regularly scheduled interest independent of the general basket, subject only to no default.

Where the tax distribution basket sits, and how the general basket and payment conditions are drafted, largely determine whether the ABL facility fits the borrower's ownership structure. These are the questions to bring into term sheet negotiation, not to discover in the credit agreement.

Practical CFO Workflow

Once the facility closes, the CFO's job is to operationalize the covenant. That means:

• Building a restricted payments tracker — a workbook that shows each basket's balance, cumulative usage, and remaining capacity, refreshed monthly.
• Pre-testing payment conditions before any dividend, distribution, buyback, or subordinated-debt payment — confirming no default, pro forma excess availability, and pro forma FCCR before the payment is made.
• Coordinating tax distribution timing with quarterly estimated payments and the year-end true-up, so distributions align with real tax obligations rather than surprising the lender.
• Documenting officer certifications at the time of each payment and archiving them with the compliance certificates.

How DCE Advises on Restricted Payments

Don Clarke Enterprises is an independent loan-placement consulting firm. We do not lend, underwrite, fund, approve, or guarantee credit. What we do is advise borrowers and their CFOs on how the restricted payments covenant will be drafted, how the tax distribution basket and payment conditions should be sized for the borrower's ownership structure, and where to focus the negotiation. Family-owned and sponsor-backed borrowers face very different sets of issues, and both benefit from bringing the ownership structure into the covenant conversation at term sheet stage rather than at credit-agreement stage. The matching problem is the same one we describe across our work on the ABL credit package and on choosing the right ABL lender: align the borrower with the lender whose covenant framework actually fits the ownership and cash-distribution profile.

Don Clarke is a member of the Secured Finance Network Hall of Fame (2021) and a recipient of SFNet's Lifetime Achievement Award. He authored Asset Based Lending Disciplines, the first textbook in the field, and has trained more than 5,000 ABL professionals at GE Capital, JP Morgan Chase, Lloyds, and Barclays. That depth on the lender side is the lens we bring to restricted-payments advisory work.