Q&As

What are the consequences of taking or granting security in breach of a negative pledge?

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Published on LexisPSL on 12/08/2016

The following Banking & Finance Q&A provides comprehensive and up to date legal information covering:

  • What are the consequences of taking or granting security in breach of a negative pledge?
  • What is a negative pledge?
  • Why might a company grant security in breach of a negative pledge?
  • Consequences for the chargor company
  • Consequences for the existing lender
  • Consequences for the new chargee
  • Prohibition on assignment of receivables

What are the consequences of taking or granting security in breach of a negative pledge?

What is a negative pledge?

A negative pledge is a contractual undertaking which prohibits or restricts the party granting the undertaking from creating encumbrances over its assets. In lending transactions, a negative pledge is commonly given by the borrower to the lender and it is often one of the most important negative undertakings in a facility agreement.

Negative pledge clauses are primarily intended to ensure that:

  1. an unsecured lender will continue to rank pari passu with all other unsecured creditors of the borrower with all assets of the borrower available for distribution if there are no secured creditors

  2. in syndicated loans, different lenders of the same class will continue to rank equally, and

  3. the borrower is prevented from incurring excessive liabilities (by restricting the amount of security a borrower can create, the lender can indirectly restrict the amount of debt it can incur)

For information about negative pledges, see Practice Note: Negative pledges.

Why might a company grant security in breach of a negative pledge?

Despite the adverse consequences of doing so, companies do sometimes grant security in breach of a negative pledge. The most common reasons for a company to do this are:

  1. being unaware of the terms of the documents to which they are a party; the company may simply not realise

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