Negative Pledge Clause

A negative pledge clause is a contractual provision that prevents a borrower from granting security interests (pledging assets) to other lenders if doing so would weaken the position of the existing lender. Common in bond indentures and unsecured loan agreements, it protects creditors’ priority and reduces the risk that the borrower’s assets will be encumbered by later creditors.

Key points
* Protects lenders by stopping borrowers from granting senior or pari passu security that would reduce existing lenders’ claims.
* Common in unsecured loans and bond agreements; sometimes included in mortgage documents.
* Breach typically triggers a technical default, giving lenders remedies such as acceleration of repayment or litigation.
* Can lower borrowing costs by reducing lender risk, but limits the borrower’s ability to use assets for future financing.

How it works
* The borrower agrees not to create liens, mortgages, or other encumbrances on specified assets that would take priority over—or equal to—the lender’s claim.
* If the borrower later tries to secure additional financing with those assets, the negative pledge prevents that action or allows the original lender to take contractual remedies.
* Clauses can be narrow (cover specific assets) or broad (cover all assets), and may include exceptions (e.g., permitted liens, refinancings).

Benefits
* Lowers credit risk for lenders, often enabling a lower interest rate for the borrower.
* Preserves lenders’ priority in the event of bankruptcy or default.
* Reduces the likelihood of disputes among creditors over the same collateral.

Drawbacks and limitations
* Restricts the borrower’s flexibility to raise secured financing or sell encumbered assets.
* An inadvertent breach can trigger a technical default, potentially harming the borrower even if the underlying business is sound.
* Enforcement can be challenging—proving a breach and obtaining relief may be time-consuming and costly.
* Lenders’ remedies usually apply against the borrower, not against third parties that receive the collateral.

Related terms
* Negative covenant: A broader category of contractual promises that prohibit certain actions (e.g., selling assets, exceeding leverage ratios). A negative pledge is a specific type of negative covenant focused on creating security interests.
* Double negative pledge: A provision that prohibits entering into other negative covenants with third parties—effectively preventing the borrower from granting similar protections to others that would dilute an original lender’s position.

What happens if the clause is broken
* The agreement will specify remedies; common responses include:
* Declaring a technical default.
* Accelerating repayment (making the full loan immediately due).
* Suing the borrower for breach.
* Lenders generally cannot pursue third parties who received the collateral; their recourse is against the borrower.
* Many agreements include cure periods (e.g., 30 days) allowing the borrower to remedy the breach before lenders take default actions.

When to expect one
* Unsecured lending and bond issues frequently include negative pledge clauses to compensate for lack of collateral.
* Mortgages or other secured loan documents may include negative pledges preventing the borrower from further encumbering the same property without consent.

Practical considerations for borrowers and lenders
* Borrowers should negotiate carve-outs for routine business needs, permitted liens, or refinancing to maintain flexibility.
* Lenders should clearly define covered assets, permitted exceptions, and remedies to reduce ambiguity and enforcement disputes.
* Both parties should assess how the clause interacts with other covenants (financial covenants, events of default) and with insolvency law in relevant jurisdictions.

Conclusion
A negative pledge clause is a useful tool for protecting lender priority without requiring immediate collateral. It can lower borrowing costs but imposes constraints on a borrower’s future financing and asset use. Carefully drafted language and negotiated exceptions help balance creditor protection with borrower flexibility.