Negative pledge is a provision in a
contract
A contract is a legally enforceable agreement between two or more parties that creates, defines, and governs mutual rights and obligations between them. A contract typically involves the transfer of goods, services, money, or a promise to tran ...
which prohibits a party to the contract from creating any
security interest
In finance, a security interest is a legal right granted by a debtor to a creditor over the debtor's property (usually referred to as the ''collateral'') which enables the creditor to have recourse to the property if the debtor defaults in makin ...
s over certain property specified in the provision.
Negative pledges often appear in security documents, where they operate to prohibit the person who is granting the security interest from creating any other security interests over the same property, which might compete with (or rank ''
pari passu
''Pari passu'' is a Latin phrase that literally means "with an equal step" or "on equal footing". It is sometimes translated as "ranking equally", "hand-in-hand", "with equal force", or "moving together", and by extension, "fairly", "without pa ...
'' with) the security of the first
secured creditor
A secured creditor is a creditor with the benefit of a security interest over some or all of the assets of the debtor.
In the event of the bankruptcy of the debtor, the secured creditor can enforce security against the assets of the debtor and avo ...
under the security document in which the negative pledge appears.
In Australia, negative pledge lending took off after a substantial deal by
Pioneer Concrete in 1978.
Trevor Sykes
Trevor William Sykes (born 14 September 1937) is an Australian finance journalist who until his retirement in 2005 wrote the Pierpont column in the Australian Financial Review
''The Australian Financial Review'' (abbreviated to the ''AFR'' ...
, ''The Bold Riders'', second edition, 1996, {{ISBN, 1-86448-184-6, pages 7-10 It was a new way of lending, which allowed the banks to lend to corporations, something previously the domain of life insurers.
Negative pledge clauses are almost universal in modern unsecured commercial loan documents. The purpose is to ensure that a borrower, having taken out an
unsecured loan
In finance, unsecured debt refers to any type of debt or general obligation that is not protected by a guarantor, or collateralized by a lien on specific assets of the borrower in the case of a bankruptcy or liquidation or failure to meet the t ...
, cannot subsequently take out another loan with a different lender, securing the subsequent loan on the specified assets. If the borrower could do this, the original lender would be disadvantaged because the subsequent lender would have first call on the assets in an
event of default
Default is the occurrence of an event or circumstance against which a party to a contract seeks protection.
For example, a contract may state that the recording of a lien against certain property is a default. If the default is left uncured a ...
.
See also
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Second lien
The vast majority of all second lien loans are senior secured obligations of the borrower. Second lien loans differ from both unsecured debt and subordinated debt.
First lien secured loans
In the event of a bankruptcy or liquidation, the asse ...
*
Seniority
*
Pari passu
*
Senior debt
*
Subordinated debt
*
Secured creditor
*
Unsecured creditor
An unsecured creditor is a creditor other than a preferential creditor that does not have the benefit of any security interests in the assets of the debtor.
In the event of the bankruptcy of the debtor, the unsecured creditors usually obtain a ''p ...
References
Contract law
Contract clauses