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What is a negative pledge clause?

Negative pledge clauses are a kind of guarantee used to establish one or more limitations on powers of the debtor, in order to protect one or more creditors. In fact, the terms by which the debtor agrees not to perform certain actions are quite common and relevant when a debtor wishes to obtain some source of financing. That happens either through debt or equity (i.e. participation in equity by the creditor via stock, shares, profit participating loans, etc.).

Using a negative pledge is specially relevant in cases of receiving debt without a collateral. That is, if the creditor has no mortgage, pledge or other way of similar guarantee. However, the use of that kind of clauses can be agreed regardless of which it is established or not any real guarantee, as those already mentioned.

A common limitation on the debtor faculties is not to perform new debts after receiving the loan incorporating the negative pledge clause. Beside that, another common clause is to prevent the debtor to sell an important part of its assets, so that its disposal faculties will be focused only on selling the assets which are subject to its ordinary business.

Despite what has been said, these clauses cannot prevent the debtor to take on new debt. Another important point is that a negative pledge clause can allow the debtor to assume more debt in case it is agreed with a lower range. Thus, the first debtor requesting the negative pledge ensures repayment in preference to the subsequent.