how a negative pledge clause works
negative pledge clauses help lenders or bondholders protect their investments when a bond indenture includes a negative pledge clause it prevents the bond issuer from taking on future debt that could compromise its ability to meet obligations to existing bondholders a negative pledge clause also limits the likelihood that a particular asset will be pledged more than once preventing conflict over which lending institution has the right to the asset if the borrower defaults mortgages sometimes include negative pledge clauses that prevent the borrower from encumbering their home advantages and disadvantages of a negative pledge clausebecause a negative pledge clause reduces the risk of a loan or bond issue it often allows the borrower to get a slightly lower interest rate this creates a win win situation that benefits both the lender and borrower the negative pledge clause mitigates risks to bondholders by restricting the activities in which the issuer can participate most often this means preventing the issuer from using the same assets to secure another debt obligation on the downside violating a negative pledge clause can trigger a default on the loan albeit a technical default lenders generally give an allotted amount of time such as 30 days to remedy a covenant break before moving ahead with default procedures lowers risk for the lenderlower interest rates for the borrowerensures that lenders will have recourse if the borrower declares bankruptcylimits the borrower s ability to sell or borrow against their assets in the future may cause borrower to default if they inadvertently break the covenant they are difficult to enforce for lenders special considerations