What Is a Restrictive Covenant?

What Is a Restrictive Covenant?

Let me explain what a restrictive covenant is: it's a clause in an agreement that restricts, limits, prohibits, or prevents the actions of someone named in an enforceable agreement. You'll find these commonly in real estate deeds and leases, where they dictate how owners and tenants can use a property. In bond obligations, they limit the amount issuers can pay in dividends to investors.

You need to differentiate between the two main types: negative and positive covenants. Negative covenants are actions you can't take, while positive covenants are actions you must take. For instance, a negative covenant in real estate might prevent you from raising chickens on your property, whereas a positive one could require you to mow your lawn. In loan documents, you might see a negative pledge clause that bans the borrower from using a given asset to secure other loans.

Understanding Restrictive Covenants

As the name suggests, a restrictive covenant is an agreement that restricts one of the parties in a contract from taking specific actions. For example, it may limit how much public companies pay their shareholders in dividends or put a cap on executive salaries. If you fail to abide by these, you could face fines and other penalties, including legal action.

These 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 setup minimizes bondholders' default risk because when more money goes to shareholders, less is available to meet payment obligations to lenders.

Here's a fast fact: the more negative covenants a bond issue has, the lower the interest rate will be on the debt; these restrictions make the bonds safer in the eyes of investors.

Restrictive Covenants in Real Estate

Restrictive covenants are common in real estate. They mandate that owners and tenants avoid or take specific actions to preserve the value and enjoyment of the adjoining land. These 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. Generally, covenants are valid only if they're reasonable and benefit all property owners within the community.

A fast fact for you: a Declaration of Covenants, Conditions, and Restrictions (CC&Rs) is a legal document that outlines the rules for a planned community. If you buy a home in such a community, you generally must become a member of the homeowner association and follow the CC&Rs.

These covenants can cover aspects like minimum setback lines, minimum home size, number of bedrooms, building height and placement, architectural guidelines, fence height and type, property use, types of animals allowed, flagpole height, signage, landscaping, maintenance, outbuildings, swimming pools, vehicles allowed, and the number of people who can occupy the property.

In general, covenants are unenforceable if they violate homeowners' rights, federal or state laws, or are applied inconsistently or arbitrarily. If you're considering an agreement with restrictive covenants, make sure you understand what you're getting into before signing.

History of Restrictive Housing Covenants

Historically, restrictive covenants were used in real estate deals to influence the demographics of many U.S. communities. 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, between the 1920s and 1940s in Washington State, covenants kept underrepresented groups out of some Seattle-area neighborhoods, forcing Black, Jewish, and Asian Americans to form their own segregated communities.

An important note: the Goodwin Company attached racially restrictive covenants to property it sold in Washington State from 1924 to 1938, stating that property could not be sold to or occupied by anyone not of the White race, except domestic servants employed by White occupants.

In 1948, the U.S. Supreme Court ruled these racially charged provisions unconstitutional under equal protection laws in the case of Shelley v. Kraemer. This came after Missouri's top court blocked a Black family, the Shelleys, from taking possession of a home in St. Louis due to a restrictive covenant.

A warning: mortgage lending discrimination is illegal. If you think you've been discriminated against based on race, religion, sex, marital status, use of public assistance, national origin, disability, or age, file a complaint with the Consumer Financial Protection Bureau or the U.S. Department of Housing and Urban Development (HUD).

Despite the ruling, racial deed restrictions remain on the books in nearly every state, though they're no longer enforceable and the offensive language persists.

What Is the Fair Housing Act?

The Fair Housing Act is a federal law that protects people from discrimination when they rent or buy a home, get a mortgage, seek housing assistance, or engage in other housing-related activities. It prohibits discrimination based on race, color, national origin, religion, sex (including gender, gender identity, sexual orientation, and sexual harassment), familial status, and disability. This act is also known as Title VIII of the Civil Rights Act of 1968.

Who Enforces Restrictive Covenants?

If you live in a planned community, the homeowners association (HOA) and individual lot owners have the right to enforce covenants. However, violations can become unenforceable through laches, which is the loss of a right due to undue delay or failure to assert it. For example, if you build a fence that violates the covenants and the HOA doesn't enforce it until years later, they could lose their rights, meaning you get to keep your fence.

What Is a Restrictive Covenant Agreement in Real Estate?

A restrictive covenant in real estate mandates that owners and tenants avoid or take specific actions to preserve the value and enjoyment of the adjoining land. For example, they can prevent making certain renovations, having pets, parking RVs in the driveway, or raising livestock. Covenants that pass from owner to owner are said to 'run with the land.'

The Bottom Line

Restrictive covenants are common in real estate, employment, and bond agreements. In real estate, they dictate how a property is used, the types of renovations allowed, or the number of people who can live there. Historically, they were used for racial segregation but were ruled unconstitutional by the U.S. Supreme Court in 1948. Today, they must comply with laws like the Fair Housing Act, and violations can result in penalties or legal action.