Negative Pledge Clause

A negative pledge clause is a promise by a borrower that it will not create or allow any security interest over its assets in favour of other creditors, except where the agreement permits. It is found in loan agreements, bond documents and many sovereign borrowing contracts. The clause protects a lender, especially an unsecured one, from being pushed down the queue by creditors who later take a lien over the borrower's best assets.

The clause is a covenant about the borrower's behaviour rather than a security interest in its own right: the lender does not gain any charge over the assets. It sits alongside other general undertakings such as limits on disposals and on new borrowing, and works together with a cross-default clause and a pari passu clause (a promise that the debt ranks equally with other unsecured debt) to preserve the lender's position.

Imagine lending money to a friend without asking for anything in return except a promise: "You won't hand your car keys to anyone else as a guarantee for another loan." If your friend later borrows elsewhere and gives that lender the car as backup, the new lender would be paid from the car first and you would be left with whatever is left over.

A negative pledge is that promise written into a loan contract. It keeps the borrower's assets available to all its ordinary creditors equally, so the lender who trusted the borrower without security is not quietly overtaken by someone who arrived later. If the borrower breaks the promise, the lender usually gets the right to demand repayment.

A typical clause has three parts. First, a broad prohibition on granting any mortgage, charge, pledge or other security over present or future assets. Second, a list of permitted security, often called "permitted liens" or "baskets". Third, a definition of what counts as security, which may extend to arrangements with a similar economic effect, such as sale-and-leaseback deals, factoring with recourse or title-retention structures.

Common permitted exceptions include:

• Existing security. Liens already in place at signing and disclosed to the lender.
• Liens arising by law. Security that arises automatically, such as tax liens or a supplier's lien, in the ordinary course of business.
• Purchase-money and project security. Security over an asset given to the lender that financed that same asset.
• A general basket. A capped amount of other secured debt, often expressed as a fixed sum or a percentage of total assets.

Some clauses add an "equal and rateable" provision: if the borrower does grant security to someone else, it must give the same security to the protected lender at the same time. Others are purely prohibitive, so a breach is an event of default.

In investment-grade lending and corporate bond indentures, a negative pledge is often the main protection for unsecured lending. It lets strong borrowers raise money without pledging assets while assuring creditors that they will not be subordinated in practice. In bonds the clause is often narrowed to cover only security given for other capital-markets debt, leaving bank borrowing outside it.

In leveraged finance, where loans are already senior secured debt, the clause is usually called a "limitation on liens" and controls how much other secured debt can rank alongside or ahead of the existing lenders. It interacts with the borrower's debt seniority and with intercreditor agreements between lender groups.

Multilateral lenders such as the World Bank Group include negative pledge provisions in their general conditions for loans to member countries, and many government bonds contain them. For a sovereign, the clause stops it from earmarking export revenues or central bank reserves to favoured creditors, which could leave other holders exposed in a sovereign default.

The main weakness is that a negative pledge is a contractual promise only. If a borrower breaches it, the new secured creditor generally keeps its security unless it knew of the breach and the governing law offers a remedy against it. The original lender's remedy is to call an event of default, accelerate its loan and claim damages, which may be of little value once the borrower is in difficulty and its assets are already pledged elsewhere.

Lenders reduce this gap with tight definitions of "security" and "quasi-security", low basket sizes, representations that no undisclosed security exists, and checks of public registers of charges. In the UK, for example, a company charge is registered at Companies House, and it is common practice to note the existence of a negative pledge in that filing. The value of the clause therefore depends heavily on monitoring and on the wider documentation, including any financial covenant package and limits on new debt.

• Loan Market Association (LMA)
• World Bank