Negative Pledge Clause – The key importance of a Negative Pledge Clause

A negative pledge Clause is a provision that prohibits the borrower from making a pledge over any asset specified in the provision. This is made to avoid borrowers from tampering with the lender’s security. The property involved should not be used in other sources of financing.  This is often found among bond indentures and traditional loan structures.

Negative Pledge Clause - The key importance of a Negative Pledge Clause

WHAT YOU SHOULD KNOW

  • Do you know that negative pledge clauses are also referred to as covenants of equal coverage?
  • Do you know that negative pledge clauses also states. That issuer’s investors must be granted an equal lien if the. Bond issuer grants liens against any assets in the future?
  • In a negative pledge clause, do you know that. The borrower is obligated to engage in financial transactions while the. Lender maintains priority in case the borrower defaults and to as well. Seize their assets?

How a Negative pledge Clause Works

Negative pledge clauses basically support. Bondholders to protect their investments. As long as the legal documents and. Agreement involves a negative pledge clause, it automatically prevents a bond issuer. From taking on future debt that will compromise the delegated obligations of bondholders.

ALSO READ:  Bond - How Bonds Work And Bonds Characteristics

A negative pledge clause also limits the possibility that a. Particular asset will be pledged more than a time, this is to see that conflict is. Avoided over properties or assets the lending institution is legal to possess if the. Borrower defaults.

The key importance of a Negative Pledge Clause

The leverage of the safety a negative pledge offers often allows. Bond issuers to borrow funds of a slightly lower rate. With a lower interest rate, he is benefited because there is a sure win for the issuer and bondholder.

Nonetheless, the negative pledge clause minimizes risks to the risk faced by bondholders as they are limited in the number of activities the issuer can participate in. Thus, this can mean preventing the issuer from using the same assets to secure another debt obligation or more.

The negative pledge clause mitigates risks to bondholders by restricting the activities in which the issuer can participate. Generally, this can mean preventing the issuer from using the same assets to secure another debt obligation.

ALSO READ:  Exposure at Default (EAD) - loss a bank is exposed to as borrowers default

The downside of a negative pledge clauses

Negative pledge clauses when violated will result in a defaulted loan, perhaps, a technical default. Even when this happens, lenders are generally given 30 days covenant break before they can proceed to sort it out according to the negative pledge clauses obligations.

Observed case scenario

A financial institution provides an unsecured loan to an individual with a negative pledge clauses along with the contract. This was done to protect their institution by preventing the borrower from using its own assets to secure other sources of financing. if the borrower secures other loans, this posses the first lending institute less secure because they will be divided attention and a greater amount of debt obligation inevitable.

The same is applicable in home mortgages. It may include an agreement that restricts the borrower from using the mortgaged property as collateral against any new loan.

Leave a Reply

Your email address will not be published. Required fields are marked *

This site uses Akismet to reduce spam. Learn how your comment data is processed.