Negative Pledge Clause

What Is a Negative Pledge Clause?

A negative pledge clause is a type of negative covenant that keeps a borrower from pledging any assets assuming doing so would risk the lender's security. This type of clause might be part of bond indentures and traditional loan structures.

How a Negative Pledge Clause Works

Negative pledge clauses assist lenders or bondholders with safeguarding their investments. At the point when a bond indenture incorporates a negative pledge clause, it keeps the bond issuer from assuming future debt that could compromise its ability to meet obligations to existing bondholders.

A negative pledge clause likewise limits the probability that a particular asset will be pledged at least a time or two, forestalling conflict over which lending institution has the option to the asset assuming the borrower defaults.

Mortgages some of the time incorporate negative pledge clauses that keep the borrower from burdening their home.

Benefits and Disadvantages of a Negative Pledge Clause

Since a negative pledge clause decreases the risk of a loan or bond issue, it frequently permits the borrower to get a somewhat lower interest rate. This makes a mutually beneficial arrangement that benefits both the lender and borrower.

The negative pledge clause mitigates risks to bondholders by limiting the activities in which the issuer can participate. Most frequently, this means keeping the issuer from utilizing similar assets to secure another debt obligation.

On the downside, disregarding a negative pledge clause can trigger a default on the loan, yet a technical default. Lenders generally give a dispensed amount of time, like 30 days, to cure a covenant break before moving ahead with default procedures.

At the point when a financial institution gives a unsecured loan to an individual or entity, it might remember a negative pledge clause for the contract to safeguard itself.

In this case, the clause keeps the borrower from utilizing its own assets to secure different wellsprings of financing. On the off chance that the borrower secures different loans, the original loan by the main institution turns out to be less secure, in light of the fact that the borrower currently has a greater amount of debt obligations, and the original institution might not have priority status for repayment.

On account of home mortgages, many loan agreements incorporate wording that confines the borrower from involving the sold property as collateral against any new loan, with the exception of refinancing.

Features

• Negative pledge clauses are in some cases remembered for mortgages to keep the borrower from involving their home as collateral for different lenders.
• A negative pledge clause guarantees that the original lender will keep up with priority on the off chance that the borrower defaults and their assets are seized.
• A negative pledge clause is a part of a loan contract that keeps the borrower from pledging their assets to another lender.
• Negative pledge clauses are likewise alluded to as "covenants of equivalent coverage."
• Negative pledge clauses might specify that assuming the bond issuer awards liens against any assets later on, an equivalent lien must likewise be allowed to the issuer's investors.

FAQ

What Is a Double Negative Pledge?

A double negative pledge is a vow not to go into negative covenants with any outsider. At the end of the day, a negative covenant prohibits other negative covenants. This type of agreement is regularly utilized by banks or different lenders to guarantee that they have a priority claim to a borrower's assets assuming they declare bankruptcy.

What Happens If a Borrower Breaks a Negative Pledge Clause?

The loan agreement will determine the type of recourse that is accessible to a lender in the event that the borrower sells or in any case hinders property protected by a negative pledge clause. This will typically permit the lender to sue the borrower, or [accelerate](/speed increase clause) the loan's repayment schedule. Nonetheless, the lender can't pursue action against any outsider, just the borrower.

What Is a Negative Covenant?

A negative covenant is a contractual agreement that ties keeps one party from making a certain move. All in all, it is an agreement to avoid something. Negative covenants could disallow a person or company from selling certain assets or taking on in excess of a certain amount of debt, for instance.