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Understanding the Negative Pledge Clause in Loan Agreements

When borrowers obtain financing from lenders, they are usually required to sign loan agreements that outline the terms and conditions of the loan. These agreements typically contain various covenants and restrictions that the borrower must follow, one of which is the negative pledge clause.

A negative pledge clause is a type of covenant that prohibits the borrower from pledging certain assets as security for other loans or debts without the prior written consent of the lender. The assets that are subject to the negative pledge clause can include real property, personal property, shares of stock, and intellectual property rights.

The purpose of the negative pledge clause is to protect the lender's security interest in the borrower's assets. If the borrower pledges assets to another creditor, the lender's security interest may be diluted or compromised. Therefore, the negative pledge clause ensures that the lender's security interest remains intact and that the lender is not disadvantaged by the borrower's actions.

The negative pledge clause is often found in loan agreements for large commercial transactions, such as corporate finance, project finance, or structured finance. In these types of transactions, the borrower may have multiple lenders, each with their own security interest in the borrower's assets. The negative pledge clause ensures that the borrower cannot grant security to one lender that would take priority over the security interest of another lender.

Borrowers should be aware of the negative pledge clause and its implications before signing a loan agreement. If the borrower breaches the negative pledge clause, the lender may be entitled to declare a default and accelerate the loan, which means that the borrower will have to repay the entire loan amount immediately. In addition, the borrower may be liable for damages if the lender suffers any losses as a result of the breach.

To avoid breaching the negative pledge clause, borrowers should ensure that they obtain the lender's written consent before pledging any assets to another creditor. If the borrower needs to grant security to another creditor, they should negotiate with the lender to obtain a waiver or a release of the negative pledge clause.

In conclusion, the negative pledge clause is an important covenant in loan agreements that protects the lender's security interest in the borrower's assets. Borrowers should be aware of the implications of the negative pledge clause and should take steps to avoid breaching it. Lenders, on the other hand, should carefully draft the negative pledge clause to ensure that it is enforceable and that it provides adequate protection for their security interest.


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About the author

Sabbir Rahman is Managing Director of Langdon Capital. He has held prior roles with Morgan Stanley, Lazard and Barclays Investment Bank. He has executed over £60 billion in notional value of transactions across financing, M&A and derivatives with global corporates, private equity funds and financial sponsor groups.

About Langdon Capital

Langdon Capital provides in-house transaction services to C-suites and Boards of publicly-listed, PE-backed and VC-backed businesses during the negotiation, execution and due diligence of debt and equity capital raising transactions and senior interim resourcing solutions across finance, treasury, strategy and corporate development | contact | visit

This is not financial advice or any offer, invitation or inducement to sell or provide financial products or services or to engage in any form of investment activity.

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