We develop CovenantAI, an artificial intelligence-powered covenant monitoring methodology, to examine whether institutional investors strategically trade around covenant violations in leveraged loan markets. Documenting a persistent decline in loan prices during the 100 days preceding violations—with pronounced drops 20 days prior—we find cumulative abnormal returns of -0.84% during the [-20,-1] event window. Price effects are most severe for loans amended post-violation or remaining in technical default. Covenant violations significantly increase downgrade and bankruptcy probabilities, particularly among non-investment-grade loans held by Collateralized Loan Obligations (CLOs). We document substantial cross-sectional heterogeneity in CLO constraints driven by overcollateralization ratios and CCC-rated loan holdings. Loans predominantly owned by constrained CLOs exhibit steeper pre-violation price declines and significantly more negative abnormal returns. Our evidence demonstrates that constrained institutional investors preemptively divest loan positions in anticipation of covenant violations, with trading intensity reflecting both violation severity and investor-specific portfolio constraints.