What it means
The clause exists because unsecured lending depends on the assets staying unencumbered. If a borrower pledges its buildings and receivables to a new lender, the original unsecured lender still has the same promise to repay but a far worse position in any insolvency, having effectively been demoted without agreeing to it.
The wording is usually broad. It covers mortgages, charges, liens and any other arrangement having the economic effect of security, which stops a borrower from achieving the same result through a sale and leaseback or a factoring arrangement dressed up as something else.
Almost every negative pledge is qualified by carve-outs. Typical permitted liens include security existing at the date of the agreement, purchase money security over newly acquired equipment, statutory liens such as tax charges, and a general basket capped at a percentage of total assets or a fixed dollar amount.
Some versions include an equal and rateable sharing provision. If the borrower does grant security to anyone, it must give the same security to the protected lender at the same time, which usually makes the new borrowing unattractive enough that it never happens.
Finance teams therefore treat the permitted liens basket as a scarce resource. Every equipment lease, invoice discounting line or supplier retention-of-title arrangement can consume part of it, so a growing company can run out of capacity long before it runs out of assets.
In practice
Real-world examples.
Example
A software company raises $30,000,000 of unsecured notes containing a negative pledge. Two years later it wants a secured working capital line against its receivables, and the bank agrees to lend on an unsecured basis at a higher margin rather than trigger the clause.
Example
A property investor's bank loan includes a negative pledge over three unmortgaged office buildings. When the investor tries to raise development finance against one of them, the existing bank requires either repayment of part of its loan or a share of the new security.
Example
A sovereign borrower issues international bonds with a negative pledge preventing it from securing future debt on export revenues. A proposed oil-backed prepayment facility is redesigned as an unsecured forward sale so that the bond terms are not breached.
Formula
Calculation
Permitted security capacity = (basket percentage x total assets) - security already granted.
Take a logistics group with total assets of $250,000,000 and a bond covenant allowing permitted liens of up to 10% of total assets. The basket is therefore 10% x $250,000,000 = $25,000,000.
The group already has $18,000,000 of secured obligations, made up of equipment finance leases and a small mortgaged depot. Remaining capacity is $25,000,000 - $18,000,000 = $7,000,000, so a proposed $12,000,000 secured fleet facility would exceed the basket by $5,000,000 and would need either restructuring as unsecured debt or a formal consent from the bondholders.Case study
Seen in the real world.
Ashgrove Logistics is a fictional haulage business used here as an illustrative example. Ashgrove had $250,000,000 of total assets and $120,000,000 of unsecured notes carrying a negative pledge with a 10% permitted liens basket, giving $25,000,000 of allowed security.
Over three years the finance team quietly used up most of that capacity. A $9,000,000 depot mortgage, $6,500,000 of trailer finance leases and $2,500,000 of forklift hire purchase left only $7,000,000 available, a figure nobody had tracked centrally because each deal had been approved on its own merits.
When the operations director proposed a $12,000,000 secured contract to replace the ageing tractor unit fleet, the shortfall of $5,000,000 surfaced two weeks before signature. Ashgrove ended up leasing part of the fleet on an operating basis and refinancing the depot mortgage to free capacity, at an estimated extra cost of $210,000 a year. The illustrative moral is that a negative pledge basket needs a single owner and a live register, not a series of separate approvals.
Watch out
Common mistakes.
- Assuming a negative pledge stops all secured borrowing. Nearly every clause allows a defined basket of permitted liens, and the practical question is how much of that basket is already used.
- Only counting bank debt against the basket. Finance leases, hire purchase, retention of title and some receivables financing can all count as security under a widely drafted clause.
- Confusing a negative pledge with a charge over assets. A negative pledge gives the lender no security at all; it simply stops anyone else from taking any.
Questions
People also ask.
Is a negative pledge the same as a negative covenant?
It is one specific type of negative covenant, focused solely on the granting of security over assets.
What happens if a borrower breaches it?
The breach is normally an event of default, and where an equal and rateable clause applies the protected lender may also demand the same security the new lender received.
Does it apply to subsidiaries?
Usually yes, since the clause is normally drafted to cover the borrower and its material subsidiaries, otherwise assets could simply be moved out of reach.
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