Pre-Closing Covenants in M&A: Protecting Value Between Signing and Closing

18.6.2026 | ARROWS law firm

The period between signing the agreement and the actual handover of the company involves a number of risks. From both a legal and commercial perspective, so-called pre-closing covenants are crucial at this stage. These mechanisms protect the value of the transaction and limit undesirable actions by the seller without breaching competition law. This article discusses how to set them up correctly and the most common pitfalls in legal practice.

In the image, we see lawyers from ARROWS, a Prague-based international law firm specialising in pre-closing obligations.

The importance of covenants between signing and closing
Basic types of pre-closing covenants
Key types of covenants to protect the value of the transaction
The relationship between material adverse change and pre-closing covenants
Competition law and the limits of the buyer’s control

Key takeaways

Pre-closing covenants determine how the seller may deal with the business, an ownership interest, or real estate in the period from signing the agreement until its settlement (closing). The aim is for the buyer to receive the asset in the condition in which it was valued.
If these covenants are drafted vaguely or are missing altogether, the buyer bears a high risk of devaluation of its investment.
The most common arrangement requires the seller to run the business in the ordinary course of business. Without the buyer’s prior consent, the seller must not take fundamental steps such as taking on new loans or selling assets.
The details of how the ordinary course is defined and the specific carve-outs determine whether the covenant will actually work in practice.
Excessively broad control by the buyer may run into the prohibition of early implementation of a concentration (gun jumping). The European Union has previously confirmed multi-million-euro fines in situations where the buyer was able to influence the target business even before the merger was officially approved.
A material adverse change clause allows the buyer to walk away from the transaction if there is a serious deterioration of the target.
Setting these covenants is tough commercial negotiation about risk allocation and the degree of control during the interim period. The legal wording must closely follow the overall financial structure of the transaction.
An experienced adviser must align pre-closing covenants with the purchase price adjustment mechanism, representations, and the overall strategy of both negotiating parties.

In practice, these parameters are most often fine-tuned already when preparing the transaction documentation as part of contracts and negotiations.

The importance of covenants between signing and closing

The time lag between signing the agreement and the actual settlement of the transaction (closing) is, in modern practice, more the rule than the exception. This interim state creates natural tension between the interests of both parties.

During this period, the seller tends to make rather short-term decisions, while the buyer is already focused on the long-term stability of the business. These covenants clearly define which steps require the buyer’s consent and what standards of care the seller must maintain. It is important to distinguish them from conditions precedent and from representations and warranties.

While conditions precedent condition the closing itself, pre-closing covenants are active rules of conduct for the interim period. In practice, these covenants serve a protective role by preventing the loss of key customers, the departure of management, or undesirable indebtedness. At the same time, they have a cooperative function, as they facilitate the handover of data and preparation for the takeover. Without precisely drafted rules, even a promising transaction can end in a protracted dispute because the agreement does not address the boundaries of ordinary operations.

The risk of subsequent disputes in transactions is also linked to the topic of insurance, which is discussed in the update Transaction risk insurance (W&I): How to close a deal without the risk of litigation.

Pre-closing covenants must always be tailored to the specific business and industry. A generic template cannot simply be adopted, because each business model requires a different level of protection. That is why the attorneys of ARROWS, a Prague-based law firm, always base contract drafting on how the business actually operates and on the risks that may arise during the interim period.

Situations leading to an interim period

An interim period arises wherever ownership rights cannot be transferred immediately upon signing the agreement. It is often necessary first to obtain approvals from regulators, financing banks, or to complete internal restructuring.

In mid-sized transactions without the need for regulatory approval, the buyer needs time to secure financing or vacate premises. The preparation of the closing itself is administratively demanding. It is necessary to arrange a notary, a bank escrow, and to provide updated extracts from public registers or confirmations of no outstanding debts.

The attorneys of ARROWS, a Prague-based law firm, have extensive experience with international deals, where the interim period tends to be longer and requires coordination of different legal systems If the transaction involves multiple jurisdictions (e.g., signing in one country and closing in another), it is advisable to involve the team for international law..

Basic types of pre-closing covenants

The first pillar of pre-closing arrangements is the general covenant to operate the business in the ordinary course of business. This ensures that the buyer receives the company in an operating setup corresponding to the due diligence performed.

The second pillar consists of specific prohibitions on certain actions, such as selling assets or incurring debt, without the buyer’s consent. The third pillar is made up of cooperation covenants, which impose on both parties the obligation to cooperate in preparing the closing, handing over data, and communicating with authorities.

The agreement must clearly define financial thresholds and the consequences of breaching these rules to prevent speculative withdrawal from the transaction.

Key types of covenants to protect transaction value

Protecting transaction value requires a combination of several types of contractual arrangements that cover different aspects of how the business operates during the interim period.

Operating in the ordinary course of business

A covenant to operate the company in the ordinary course of business is the most important protective element. It ensures that the buyer acquires the business in an operating condition consistent with the state identified during due diligence.

However, a strict interpretation of this concept can be risky if market conditions change and the company needs to respond. The attorneys at ARROWS, a Prague-based law firm, work closely with financial advisers to ensure the wording accurately reflects real operational needs.

Restrictions on material transactions and disposals

This set of covenants restricts significant legal actions by the seller that could harm the value of the business. This includes prohibitions on incurring new debt, selling assets, or entering into disadvantageous contracts.

These restrictions are typically tied to specific financial thresholds to avoid unnecessary approvals for minor operational actions. The attorneys at ARROWS, a Prague-based law firm, help align the contract wording with financial plans and internal processes in such cases.

No-shop / no-talk

Exclusivity arrangements (no-shop and no-talk) prohibit the seller from seeking other interested parties or negotiating with them. These clauses protect the buyer’s investment in preparing the transaction and conducting due diligence.

In corporations with a larger number of shareholders, exclusivity must be aligned with the statutory bodies’ duties to act with due managerial care. ARROWS, a Prague-based law firm, helps set exclusivity so that it protects the buyer without unreasonably blocking the seller for too long.

Difference between warranties and pre-closing covenants

It is important to distinguish between warranties, which describe the state at a specific point in time, and behavioural covenants aimed at the future. A breach of covenants gives the buyer stronger leverage, including the option to postpone closing.

The choice between these tools is a strategic decision. The attorneys at ARROWS, a Prague-based law firm, analyse with clients which risks are more effectively addressed preventively and which should be handled through subsequent compensation.

Relationship between material adverse change and pre-closing covenants

Material adverse change clauses and pre-closing covenants are two key, but distinct, pillars of investor protection during the interim period of a transaction.

How material adverse change clauses work

Material adverse change clauses allow the buyer to withdraw from the agreement if, during the interim period, an event occurs that fundamentally devalues the target business.

In legal practice, the threshold for invoking this clause is set very high and requires a long-term and material impact on financial performance. In addition, the clause applies exclusively to new events occurring during the interim period. It cannot be invoked for earlier hidden defects that were only subsequently discovered during this period.

Aligning the clause with operational covenants

While pre-closing covenants regulate specific conduct by the seller, a material adverse change clause covers external systemic influences and unforeseeable events beyond the parties’ control.

In practice, both tools must be aligned so that approved actions do not conflict with the definition of a material adverse change. The attorneys at ARROWS, a Prague-based law firm, help clients set financial thresholds so that they precisely match the actual financial model.

Most common mistakes in negotiations

A common mistake is an overly vague definition of an adverse change. While it may give the buyer a sense of flexibility, in reality it only increases legal uncertainty and the risk of protracted litigation.

The definition of an adverse change must exclude general economic factors affecting the entire sector. Another mistake is the absence of intermediate remedies. Instead of immediate withdrawal from the agreement, it is often economically more advantageous to agree on a mechanism for an automatic adjustment of the purchase price.

Competition law and limits on buyer control

Competition law sets clear and strict boundaries for the buyer’s control of the target business during the interim period.

Prohibition of premature implementation of a concentration

Until the concentration is approved by the Office for the Protection of Competition (ÚOHS) or the European Commission, the buyer must not in fact exercise control over the target business. A breach is referred to as gun jumping.

The contractual arrangement itself, if it grants the buyer overly broad veto rights over day-to-day operations, constitutes a breach of the law. The attorneys of ARROWS, a Prague-based law firm, help to balance these limits safely and prevent draconian fines.

Secure setup of information flows

Sharing detailed business information, especially between competitors, is prohibited during the interim period. For these purposes, a so-called clean team is typically established in practice, composed of selected individuals and external advisers.

Fast communication and deemed consent in the event of the buyer’s inaction minimize the risk that the transaction will be assessed as de facto management of the business. ARROWS, a Prague-based law firm, can help you prepare a practical internal manual for secure data sharing during the interim period.

Transactions subject to regulatory approval

When a concentration is being approved by the Czech Office for the Protection of Competition (ÚOHS) or the European Commission, the risks multiply. Until the decision becomes final and binding, both companies must act on the market as fully independent and competitive undertakings.

If a longer approval process is expected, pre-closing undertakings must not paralyze the operation of the business. It is necessary to choose flexible limits that allow the company to operate smoothly.

Possible issues	How ARROWS helps (office@arws.cz)
Gun jumping and high fines: the risk that the competition authority will assess interim covenants as premature acquisition of control.	The attorneys of ARROWS, a Prague-based law firm, will review the draft agreement from the perspective of the standstill obligation. They will propose adjustments to veto rights and help set up secure information flows and a clean-team regime.
A paralyzed business during the interim period: overly strict covenants prevent normal operations and the business loses flexibility.	ARROWS, a Prague-based law firm, will help set reasonable value thresholds and substantive carve-outs. This allows the business to operate smoothly, while the buyer remains fully protected against materially adverse steps.
Unclear liability for breach: disputes over whether minor or formal breaches entitle the buyer not to close the transaction.	The attorneys at ARROWS, a Prague-based law firm, will set thresholds for material breach. They will allocate consequences between damages, price adjustments, and the right not to proceed to closing, and will prepare a notice-and-cure process.
Coordination errors in communication with regulators: insufficient cooperation between the parties leads to delays in the proceedings.	ARROWS, a Prague-based law firm, will provide comprehensive representation in the transaction notification process. It coordinates filings, communicates with ÚOHS or the European Commission, and at the same time aligns the covenants with the regulatory strategy.
Reputational damage from a public dispute: the parties’ conflict escalates in both the media and commercial spheres, damaging the target’s value.	The attorneys of ARROWS, a Prague-based law firm, will help set contractual mechanisms for rapid dispute resolution. They will use tools such as mediation, expert determination, or arbitration and, where appropriate, provide representation in proceedings.

Negotiating undertakings in practice

Negotiating pre-closing undertakings requires finding a balance between the interests of the buyer and the seller.

The buyer’s perspective: control and stability

The buyer wants to minimize the risk of the business losing value before it is taken over. The ideal state for the buyer is the ability to veto all key decisions and have unlimited access to reporting.

Modern practice recommends focusing on key value drivers rather than striving for absolute control over the business. The approval process must be fast and operational. Setting short deadlines for responses and deemed consent in the event of inaction protects the business from operational delays.

The seller’s perspective: operational flexibility

The seller requires that flexibility for day-to-day operations be preserved and that its potential liability be predictable. The seller resists the buyer unjustifiably interfering with the running of the company before the purchase price is paid.

Minor administrative errors should never give the buyer the right to withdraw from the transaction. The seller typically insists on cure periods and on limiting overall liability by a financial cap and a time limit, similarly to quality warranties.

Procedural setup of contractual mechanisms

The key to a smooth interim period is clear procedural rules. The agreement must include a notice-and-cure mechanism for breaches with an appropriate time limit.

Defining materiality thresholds is essential to prevent speculative attempts to cancel the deal due to formal errors. Establishing clear communication channels and designating specific responsible persons on both sides prevents operational paralysis and disputes in the interim.

Model situations from transactional practice

The following examples illustrate how to set pre-closing undertakings correctly in different market scenarios.

Sale of a manufacturing business with bank financing

In the sale of a manufacturing company with ongoing approval proceedings before ÚOHS, a long interim period arises. The business must operate smoothly, repay loans, and carry out planned investments. The buyer requires restrictions on indebtedness, but the seller must not be paralyzed in responding to market demand.

The solution is to permit investments that are in line with a pre-approved financial plan. The indebtedness restriction then does not apply to ordinary drawdowns under existing working-capital facilities. ARROWS, a Prague-based law firm, in such cases proposes safe limits and provides comprehensive representation of clients before ÚOHS.

Technology company with deferred payment

In the sale of a technology company with part of the purchase price tied to future performance (earn-out), the undertakings are key for both parties. The founders usually remain in management.

The buyer wants to prevent artificial inflation of short-term sales, while the founders require assurance that the investor will not deliberately slow down the business’s development after closing. Specialists at ARROWS, a Prague-based law firm, have extensive experience in structuring these complex earn-out arrangements.

Real estate transaction with an extensive portfolio

When transferring commercial real estate with dozens of tenants, the interim period lasts several months. During this time, leases are terminated, repairs are carried out, or insurance claims are handled. The agreement must not operationally paralyze the seller and force them to seek consent for every minor change to an existing lease.

In practice, pre-approved criteria (leasing guidelines) are used. If a new lease agreement meets the specified economic parameters, the seller may enter into it without the buyer’s prior approval.

Conclusion

Pre-closing covenants determine whether the buyer acquires the business in the expected condition and whether the seller can manage it effectively in the interim without the risk of contractual penalties.

The legal reality of these arrangements is complex, as it requires aligning competition law, value protection, and purchase price mechanisms. The attorneys at ARROWS advokátní kancelář have long specialized in M&A transactions and, for clients’ security, are insured for professional liability with a limit of CZK 400,000,000.

If you are dealing with a specific transaction, we will be happy to discuss your priorities with you and propose a safe covenant setup via email at office@arws.cz.

FAQ - Pre-closing covenants in practice

1. At what stage of transaction preparation should we start addressing pre-closing covenants?
These covenants should not be dealt with only when finalizing the final wording of the agreement. Ideally, their basic concept—such as key veto rights and exclusivity—should be incorporated already into the initial document (the term sheet or LOI). This helps avoid situations where the expectations of both parties fundamentally diverge. To set these priorities from the outset, contact ARROWS advokátní kancelář at office@arws.cz.

2. How can I tell that the proposed covenants are risky from a competition law perspective?
A warning sign is provisions that give the buyer the right to approve ordinary operational decisions, set pricing policy, select standard suppliers, or influence day-to-day business strategy in detail before the merger is approved. If the covenants enable the buyer to exercise de facto control over the business, there is a risk of high fines for gun jumping. The attorneys at ARROWS advokátní kancelář can help you assess the draft; contact us at office@arws.cz.

3. What should we do if the counterparty refuses materiality thresholds and requires the right to withdraw for any breach?
Such a setup is unacceptable, because even a marginal administrative error would give the buyer room for a tactical withdrawal from the agreement. The standard is a strict distinction between minor breaches and material breaches that jeopardize the purpose of the transaction. If the counterparty insists on an extreme regime, we recommend involving transaction specialists from ARROWS advokátní kancelář at office@arws.cz.

4. Does it make sense to address pre-closing covenants even in smaller transactions?
Yes, even in smaller transactions these covenants are important if there is a time gap between signing the agreement and settlement. They help set clear boundaries for how the company will be managed in the interim and which strategic steps require the new investor’s consent. ARROWS advokátní kancelář will help you set covenants proportionate to the size of the deal; email us at office@arws.cz.

5. How do pre-closing covenants affect the purchase price structure?
In a locked-box structure with a fixed price as of a historical date, these covenants are absolutely key, because the buyer bears the economic risk from the reference date and needs strict protection against value leakage. With completion accounts, the price is adjusted to the actual closing date, so any decrease in value is reflected in the final price. To choose the optimal structure, contact ARROWS advokátní kancelář at office@arws.cz.

6. What role do pre-closing covenants play in potential litigation?
In disputes over whether the buyer was entitled to refuse closing, the covenant wording is the most important piece of evidence. Clear, specific, and financially quantified wording significantly increases the chance of a successful and swift defense; vague provisions, by contrast, lead to protracted and unpredictable disputes. If you need an expert assessment, contact ARROWS advokátní kancelář at office@arws.cz.

Notice: The information contained in this article is of a general informational nature only and is intended for basic orientation in the matter under the legal framework as of 2026. Although we take maximum care to ensure accuracy, legal regulations and their interpretation evolve over time. We are ARROWS advokátní kancelář, an entity registered with the Czech Bar Association (our supervisory authority), and for maximum client security we are insured for professional liability with a limit of CZK 400,000,000. To verify the current wording of regulations and their application to your specific situation, it is necessary to contact ARROWS advokátní kancelář directly (office@arws.cz). We accept no liability for any damages arising from the independent use of the information in this article without prior individual legal consultation.

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