Negative Pledge Clause
Candlefocus EditorNegative pledge clauses are generally included in any loan agreement unless the borrower has enough assets to cover the debt or has a good credit reputation which shows that the borrower will be able to repay the debt. Due to the uncertainty of the borrower’s repayment, lenders consider implementing the negative pledge clause to protect themselves and ensure that their loan will be repaid with priority if the borrower defaults.
This clause is also sometimes referred to as “covenants of equal coverage” which applies to certain types of bonds like debentures, where many bonds could be issued and each bond promises the same return and no one bond have priority over the others. If a lien is granted against any one of these bonds it would be same as granting a lien against all of the other bonds. Therefore a negative pledge clause helps to ensure that the investors receive equitable return on their investments.
Negative pledge clauses are not just utilized in loan agreements but also included in certain mortgage contracts to prevent the borrower from using their home as collateral against other lenders. These clauses can also be used in corporate contracts in order to protect the stakeholders in case of debt restructuring or mergers and acquisitions.
The negative pledge clause has long provided protection and remedies for lenders in the event of default on loan repayment. Despite the widespread utilization of this clause, issues can arise if the assets of the borrower are not properly documented in the contract or the clause is not drafted correctly and not properly enforced, as this may increase risk for potential investors or other involved parties. It is therefore important that any loan agreement with a negative pledge clause is thoroughly examined prior to being accepted in order to reduce any potential risks and liabilities.