A negative pledge is really not a pledge at all. A negative pledge is a promise by a borrower to not allow any liens to be placed upon some or all of the borrower’s assets. Negative pledge language is often found in standard bank loan agreements as one of many covenants (promises) made by the borrower. As with other covenants in the loan agreement, violation of a negative pledge is usually an event of default. A negative pledge can also be a stand alone document. Frequently stand alone documents are for negative pledges of real estate assets and are in a form that allows recording in the real estate records of the county in which the subject real estate is located.
What do you get with a Negative Pledge? A negative pledge is not a pledge of assets and does not give a lender any rights in the assets being “negatively pledged.”
A lender should keep in mind that a negative pledge is only a contractual obligation of the party signing the negative pledge. Therefore, third parties who may place a lien on the assets are not bound by the agreement. In most circumstances the lender would have no cause of action against a third party who places a lien on the assets which have been “negatively pledged.”
It is possible that a lender could have a claim under the legal theory known as “tortious interference” against the third party who places a lien on negatively pledged assets. For a lender to have a possibility of being successful on such a claim, a third party would need to have actual notice of the negative pledge. This is why it is recommended that a negative pledge on real estate be recorded in the real estate records of the county in which the subject real estate is located. Though the recording of the negative pledge does not provide actual notice to a third party, it provides the possibility that a third party will find the negative pledge in a title search. Negative pledges may be useful to lenders in controlling actions of borrowers. However, they should not be overvalued by lenders by considering them to be any type of lien on assets or a guarantee of a claim against any third party that violates the negative pledge.