What is a negative pledge clause?

What is a negative pledge clause?

• A. It prohibits any further secured bond issues or seniority changes unless equivalent security is provided.
• B. It requires cross-default provisions with other issuers.
• C. It guarantees collateral for all future issues.
• D. It ensures the issuer's assets are unpledged for all debt.

Answer: (A)

A negative pledge clause is a covenant that restricts the issuer from creating security interests over its assets for new debt or from changing the priority of existing debt, unless the lender is provided with equivalent security. This protects existing secured creditors by preventing the borrower from diluting their security by taking on more secured borrowings without offering at least as much security to them. This isn’t about cross-defaults, so it doesn’t require provisions that trigger defaults if other issuers fail. It also isn’t a promise to provide collateral for all future issues; that would be a form of positive pledge or explicit collateral guarantee. And it isn’t a clause that leaves assets unpledged for all debt—the point is to limit new secured encumbrances unless equal security is offered.

A negative pledge clause is a covenant that restricts the issuer from creating security interests over its assets for new debt or from changing the priority of existing debt, unless the lender is provided with equivalent security. This protects existing secured creditors by preventing the borrower from diluting their security by taking on more secured borrowings without offering at least as much security to them.

This isn’t about cross-defaults, so it doesn’t require provisions that trigger defaults if other issuers fail. It also isn’t a promise to provide collateral for all future issues; that would be a form of positive pledge or explicit collateral guarantee. And it isn’t a clause that leaves assets unpledged for all debt—the point is to limit new secured encumbrances unless equal security is offered.