Definition, How They Work, and Examples

What Is a Restrictive Covenant?

A restrictive covenant is a condition that restricts, limits, prohibits, or prevents the actions of someone named in an enforceable agreement. In bond obligations, restrictive covenants limit the amount issuers can pay in dividends to investors. Restrictive covenants are common in real estate deeds and leases, where they restrict how owners and tenants can use a property.

It’s important to differentiate between the two main types of covenants: negative and positive. Negative covenants are actions you can’t take, while positive covenants are actions you must take. For example, a negative covenant in real estate could prevent you from raising chickens on your property. On the other hand, a positive covenant could require you to mow your lawn. Loan documents might have a negative pledge clause banning the borrower from using a given asset to secure other loans.

Understanding Restrictive Covenants

As the name implies, a restrictive covenant is an agreement that restricts one of the parties in a contract from taking specific actions. For example, a restrictive covenant may limit how much public companies pay their shareholders in dividends. It may also place a cap on executive salaries. Failure to abide by restrictive covenants can result in fines and other penalties, including legal action.

Restrictive covenants are commonly used to prevent a bond issuer from issuing more debt until one (or more) series of bonds mature. The issuer may also be restricted from paying dividends above a certain amount to shareholders. This restriction minimizes bondholders’ default risk because when more money is paid to shareholders, less money is available to meet payment obligations to lenders.

Restrictive covenants are also found in:

Restrictive Covenants in Real Estate

Restrictive covenants are common in real estate. They mandate owners and tenants to avoid or take specific actions intended to preserve the value and enjoyment of the adjoining land. Restrictive covenants are established in a deed—or a separately recorded document called a declaration of restrictive covenants. Homeowner associations (HOAs) stipulate covenants, conditions, and restrictions (CC&Rs) to safeguard property values in the community. Covenants are generally considered valid only if reasonable and of benefit to all the property owners within the community.

Restrictive covenants can cover things such as:

• Minimum setback lines
• Minimum home size (square footage)
• Number of bedrooms
• Building height, width, and placement on the property
• Architectural guidelines (e.g., construction materials, styles, and colors)
• Fence height and type
• Property use (e.g., business and rental use)
• Types of animals allowed on the property (e.g., no livestock)
• Flagpole height and flag size
• Signage (e.g., for sale or political signs)
• Landscaping
• Maintenance (e.g., lawn mowing, tree trimming)
• Outbuildings
• Swimming pools
• The number and type of vehicles allowed on the property
• The number of people who can occupy the property

In general, covenants are unenforceable if they violate homeowners’ rights, violate federal or state laws, or are applied inconsistently or arbitrarily.

History of Restrictive Housing Covenants

Historically, restrictive covenants were used in real estate deals to influence the demographics of many communities in the U.S. These restrictions kept certain populations out of specific neighborhoods and encouraged racial, ethnic, and cultural segregation.

It wasn’t uncommon for real estate contracts to bar Black and Jewish Americans from buying properties. For example, covenants were used between the 1920s and 1940s in Washington State to keep underrepresented groups out of some Seattle-area neighborhoods. Black, Jewish, and Asian Americans were forced to look for housing elsewhere and eventually formed their own segregated communities.

In 1948, the U.S. Supreme Court ruled that these racially charged provisions were unconstitutional under the country’s equal protection laws after hearing the case of Shelley v. Kraemer. The ruling came after Missouri’s top court blocked the Shelleys, a Black family, from taking possession of the home they bought in 1945 in St. Louis. The Kraemers, a White family who lived nearby, sued to prevent the Shelleys from moving into the neighborhood, citing a restrictive covenant prohibiting people of color from occupying the property.

Despite the ruling, racial deed restrictions remain on the books in nearly every state in the U.S. While the covenants are no longer enforceable, the offensive language still exists.