What is a Negative Pledge Clause?
A negative pledge clause is lending agreement language designed to prevent borrowers from pledging the same collateral to lenders or otherwise taking actions that might jeopardize the security of existing lenders.
Negative Pledge Clause Example
For example, let's assume that Company XYZ borrows $10 million from Bank A. Bank A requires Company XYZ to pledge all $7 million of its factory assets and some of its securities as loan. The lending agreement includes a negative pledge clause.for the
Later, Company XYZ wants to borrow $2 million from Bank B. Bank B wants Company XYZ to pledge $1 million of factory assets as collateral for the loan. Because Company XYZ has a negative pledge clause in its loan agreement with Bank A, Company XYZ cannot pledge the $1 million of collateral, because doing so would reduce Bank A's security. Company XYZ might choose to pledge other assets to Bank B, ask Bank B for an unsecured loan if it has no other collateral to , or try to renegotiate its collateral agreement with Bank A.
Why Negative Pledge Clauses Matter
Negative pledge clauses are generally intended to ensure that a bank does not suffer from the subsequent actions of the borrower. Without such clauses, borrowers might have the lenders. In the event of default, these lenders would scramble to recover the same .