Distribution Lock-Up

Glossary Term • Advanced • 3 min read

Audience: Lenders • Model Developers • Auditors
Last Reviewed: July 2026
Updated: Version 1.0

Executive Summary

A distribution lock-up is a contractual test applied at each cash waterfall period that blocks a distribution to equity when a defined condition is not met, most commonly a minimum DSCR or LLCR threshold, or full funding of reserve accounts, even where nominal cash is available after debt service in that period. The lock-up threshold is frequently set higher than the minimum DSCR covenant itself, providing an early warning buffer, and a lock-up event is distinct from a covenant breach or default, since it retains cash within the project structure rather than triggering a contractual remedy.

Key Takeaways

✓ A distribution lock-up blocks a distribution to equity when a defined coverage ratio or reserve condition is not met, even where nominal cash is available after debt service.
✓ The lock-up threshold is frequently set higher than the minimum DSCR covenant, providing an early warning buffer before an actual covenant breach.
✓ A lock-up event is distinct from a covenant breach or default; it retains cash within the project rather than triggering a contractual remedy such as acceleration.
✓ Locked-up cash is typically directed to further debt repayment or reserve accounts, per the specific terms of the financing documents, rather than simply held idle.
✓ A distribution lock-up modelled as a soft warning flag rather than a hard block on the distribution calculation does not actually enforce the contractual restriction.

Definition¶

A distribution lock-up is a contractual test, applied at each cash waterfall period, that blocks a distribution to equity when a defined condition is not met — most commonly a minimum DSCR or LLCR threshold, or full funding of reserve accounts — even where nominal cash remains available after debt service in that period.

Why It Matters¶

The lock-up threshold is frequently set higher than the minimum DSCR financial covenant itself, meaning distributions stop as an early warning signal before the project actually breaches its core covenant. This distinguishes a lock-up event from a covenant breach or default: a lock-up retains cash within the project structure as a preventative measure, without triggering the contractual remedies (acceleration, event of default) that follow an actual breach.

Technical Background¶

Lock-Up Test Structure¶

IF DSCR(period) ≥ Lock-Up Threshold AND Reserve Accounts Fully Funded AND No Continuing Default
   → Distribution Permitted
ELSE
   → Distribution Blocked; cash retained (typically directed to debt repayment or reserve accounts)

Position in the Cash Waterfall¶

The lock-up test sits at the cash waterfall's final tier, immediately before the distribution calculation, following any cash sweep mechanism. See Cash Waterfall Construction for the full tier sequencing treatment.

Destination of Locked-Up Cash¶

Locked-up cash is typically directed to further debt repayment or reserve account funding rather than simply held idle, per the specific terms of the financing documents — a modelling detail that must be represented explicitly rather than assumed.

Common Errors¶

Error	Description	Risk
Lock-up modelled as a soft flag	The test calculates and displays whether the condition is met, but does not actually prevent the distribution formula from paying out	The model does not enforce the contractual restriction it purports to represent
Lock-up threshold matched to the covenant	Lock-up threshold set equal to the minimum DSCR covenant rather than the higher early-warning level specified in the financing documents	Removes the early warning buffer the financing structure is designed to provide
Locked-up cash destination unmodelled	Cash blocked from distribution but its actual redirection (debt repayment or reserves) not represented	Understates the cash retained within the project or misstates its ultimate application

Best Practices¶

Model the distribution lock-up as a hard block directly wired into the distribution calculation, using the specific threshold and conditions (coverage ratio, reserve funding status, continuing default) the financing documents define, and represent the actual destination of locked-up cash rather than treating it as simply unavailable.

Continue Reading¶

Prerequisites¶

What Is a Project Finance Model Audit? — the parent pillar

Cash Waterfall Construction

Financial Model Audit Engine (FMAE) — deterministic structural auditing referenced throughout this guide

How OXXON tests thisRun a free structural check with FMAE

Frequently Asked Questions

What is a distribution lock-up?

A contractual test, typically based on a coverage ratio or reserve funding condition, that blocks a distribution to equity when the condition is not met, even where nominal cash remains available after debt service in that period.

How is the lock-up threshold typically set relative to the DSCR covenant?

Frequently higher than the minimum DSCR covenant itself, providing an early warning buffer, so distributions stop before the project actually breaches its core covenant.

What happens to locked-up cash?

It is typically directed to further debt repayment or reserve account funding, per the specific terms of the financing documents, rather than held idle or automatically released later.

Is a distribution lock-up the same as a covenant breach or default?

No. A lock-up event retains cash within the project structure without triggering a default or acceleration; it is a preventative mechanism, distinct from the contractual remedies that follow an actual covenant breach.

How should a distribution lock-up be modelled?

As a hard block on the distribution calculation, tested against the specific coverage ratio or reserve funding condition the financing documents specify, not as a soft warning flag that does not actually prevent the distribution from being paid.

Cash Waterfall

A cash waterfall is the contractually defined priority sequence in which cash generated by a project is allocated to successive payment obligations. In a project finance structure, the cash waterfall determines the order in which operating costs, debt service (interest and principal), reserve contributions, and equity distributions are paid from the project's revenue. Senior obligations are paid first; junior obligations and distributions are paid only after senior obligations are fully satisfied. The DSCR and other coverage covenants are calculated at specific points within the waterfall to determine whether cash can flow to the next level.

Cash Sweep

A cash sweep is a mechanism within a project finance cash waterfall that applies surplus cash, remaining after operating costs, scheduled debt service, and reserve account funding, to accelerate debt repayment beyond the amount scheduled through debt sculpting. Cash sweeps are commonly structured either as mandatory, applying all surplus cash to debt, or conditional, triggered only when a coverage ratio falls within a defined range or a surplus threshold is exceeded, and their presence and terms are a specific, negotiated feature of a project finance financing structure.

DSCR (Debt Service Coverage Ratio)

The Debt Service Coverage Ratio (DSCR) is the primary metric lenders use to assess a project's ability to service its debt from operating cash flow in a given period. It is calculated as cash available for debt service (CADS) divided by total debt service (interest plus scheduled principal) due in that period. A DSCR of 1.00x means the project generates exactly enough cash to cover its debt obligations for the period; lenders typically require a minimum DSCR above 1.00x, specified in the loan agreement, to provide a buffer against downside performance. DSCR is one of the most frequently independently recalculated figures in a project finance model audit, given its direct link to covenant compliance.

Financial Covenant

A financial covenant is a binding contractual obligation contained in a loan agreement or indenture that requires the borrower to maintain specified financial metrics within defined thresholds throughout the life of the debt facility. Breach of a financial covenant constitutes an event of default under the loan agreement, typically triggering lender rights including acceleration of the loan, restriction of distributions, or enforcement of security. Financial covenants are distinct from affirmative covenants (positive obligations to do something) and negative covenants (obligations not to do something). Financial covenants are quantitative: they are tested by calculating a financial ratio or metric from the borrower's financial statements or, in project finance, from the project's financial model.

Cash Waterfall Construction

The cash waterfall is the defined priority order in which a project's cash is applied each period, operating costs, debt service, reserve account funding, and distributions, with each tier's payment conditional on the tiers above it being satisfied first. This guide sets out how to build the waterfall as an explicit, tier-by-tier calculation, including cash sweep mechanics that accelerate debt repayment from surplus cash, and the distribution lock-up tests that block a distribution when a coverage ratio or reserve condition is not met.