negative pledge clause what it is how it works sample

What is a negative pledge clause?

A negative pledge clause is a provision often found in loan agreements or bond indentures. Its purpose is to restrict the borrower or issuer from taking specific actions that could jeopardize the lender's or bondholder's interests. Specifically, the clause prohibits the borrower from creating certain types of security interests or liens on its assets that would rank ahead of or equally with the security interests of the lender or bondholders.

Here's how a negative pledge clause generally works:

1. Inclusion in Loan Agreement or Bond Indenture: The negative pledge clause is included as a specific provision in the loan agreement or bond indenture between the borrower (debtor) and the lender or bondholders (creditors).

2. Prohibited Actions: The clause typically prohibits the borrower from creating or allowing certain security interests or liens on its assets. These could include pledges of assets as collateral for other debts or loans.

3. Ranking of Security Interests: The negative pledge clause is designed to ensure that the lender or bondholders maintain a certain priority or ranking in the event of the borrower's default. By restricting the creation of additional security interests or liens, the lender or bondholders aim to protect their position in the order of claims on the borrower's assets.

4. Exceptions: Some negative pledge clauses may include exceptions or carve-outs that specify certain circumstances where the borrower is allowed to create security interests or liens. These exceptions are often negotiated between the parties and may include permitted liens, such as liens securing obligations under existing agreements.

5. Cross-Default Provisions: Negative pledge clauses may be linked to cross-default provisions. This means that a breach of the negative pledge clause could trigger a default under the loan agreement or bond indenture, allowing the lender or bondholders to take corrective actions or exercise their rights.

Here's a simplified example of a negative pledge clause:

"Negative Pledge: The Borrower hereby covenants and agrees that it will not, and will not permit any of its subsidiaries to, create, assume, or suffer to exist any lien or security interest on any of its assets, tangible or intangible, present or future, except for Permitted Liens, without the prior written consent of the Lender."

In this example:

• "Negative Pledge" is the title of the clause.

• "Permitted Liens" would be defined elsewhere in the agreement, specifying exceptions or circumstances where the borrower is allowed to create liens without violating the negative pledge clause.

The specific terms and conditions of a negative pledge clause can vary based on the negotiations between the parties and the requirements of the lending or bond arrangement. It's important for both borrowers and lenders to carefully review and understand the implications of such clauses before entering into financing agreements.