A negative pledge is simply an agreement between the owner of a charged asset and a lender stating that the owner will not create further security without the agreement of that lender. That agreement is often, but not exclusively, contained in a loan agreement or charge deed. Irrespective of in which finance document this agreement is found, it is common that such a pledge applies not only to a limited number of assets but often to all assets of the borrower, including assets acquired in the future. It is this latter point that is extremely important to appreciate.
What are the practical implications?
When it comes to real estate, it is usual for a negative pledge restricting further security to be given by a borrower, even when a first lender is only really concerned with being granted security over just one property. The effect is that if a borrower subsequently decides to grant future security over another property in which the first lender isn’t interested, including a property acquired later, consent of the first lender will often be required prior to the creation of this additional, standalone security.
In addition, lenders will typically require that the borrower and the lenders enter into a contract called a deed of priority, which sets out which lender should be paid first on the sale of an asset and which lender will have the right to take enforcement action against the borrower should the need arise.
All of this can lead to additional costs and delays that perhaps are not foreseen at the outset.
What if new security requires consent but that consent is not obtained?
Notwithstanding the presence of a negative pledge, a borrower sometimes grants security to a new lender without consent in respect of an asset to which a borrower believes an original lender has no concern. However, by virtue of an earlier negative pledge, an unpaid first lender is often entitled to be consulted prior to that new security being put in place. The borrower’s actions are often innocent, but nonetheless, they constitute a breach if the borrower agreed with the first lender that it would do something (i.e. obtain consent to a new charge) that it subsequently did not. Therefore, what can be the ramifications for the borrower in this instance? The actions of the borrower are likely to be an “event of default” under the terms of the loan. The precise sanctions that the first lender can impose following such an occurrence will depend upon the terms of the first lender’s loan. Still, it is usual that in such circumstances the first lender could enforce its security or seek immediate and full repayment of the outstanding loan balance (including unpaid interest together with any other sum for which the borrower is liable). An aggrieved lender may also be able to cancel undrawn amounts including ceasing to provide a “rolling credit facility” and/or apply a default interest rate to existing borrowings which will inevitably be higher than the interest rate previously attributable to the loan.
Events of default under loan agreements can trigger events of default or termination rights under other agreements, for example, other loan agreements or key supplier contracts entered into by the borrower. Further, if the event of default results in the lender demanding full and immediate repayment of the outstanding loan balance, this could mean that the borrower has no choice but to enter some kind of insolvency process.
The process of obtaining consent to security in which the first lender is not interested is usually straightforward, although it is not always swift. It is therefore advisable to make an early approach to a lender with the benefit of a negative pledge if delays are not to become troublesome. A well-advised borrower will, of course, be aware of the consequences of breaching its banking agreements and ensure that it does not break them.
Our Real Estate team has extensive expertise in commercial property finance transactions, often advising on refinancings as well as acquisitions and redevelopment matters. If you would like advice on negative pledges, or any other real estate finance matter, please contact our team at online.enquires@LA-law.com or contact David on the details above.