Clause primer
Negative pledge clause
The borrower promises not to grant security over its assets (or a defined class of them) to other creditors, subject to listed exceptions.
Legal information, not legal advice. What a clause does depends on its exact words, the rest of the agreement and the governing law.
Also called: limitation on liens, lien covenant, negative pledge covenant. Where you find it: Credit agreements, note purchase agreements, bond indentures, receivables purchase and securitization documents, and some guarantees.
SAMPLE CLAUSE (INVENTED FOR THIS PRIMER)
The Borrower shall not, and shall cause each Subsidiary not to, create, incur, assume or permit to exist any Lien on any of its property or assets, whether now owned or later acquired, except Permitted Liens. "Permitted Liens" means (a) Liens existing on the Closing Date and listed in Schedule 7.2, (b) Liens for taxes not yet due or being contested in good faith, (c) purchase money Liens securing Indebtedness permitted under Section 7.1(d), limited to the asset financed, and (d) other Liens securing obligations not exceeding $5,000,000 in aggregate at any time outstanding.
How it works
Scope of the promise
"Create, incur, assume or permit to exist" covers liens the borrower grants and liens that arise or come with acquired assets. Extending the promise to subsidiaries prevents the group from moving security out of the borrower entity. Check whether the clause reaches all subsidiaries or only restricted or material ones.
Existing liens schedule
Liens in place at closing are grandfathered only if scheduled. Check the schedule against lien search results and whether refinancings are permitted.
Ordinary course carve-outs
Tax and similar statutory liens arise by operation of law, so the borrower needs room for them.
Basket
A general basket allows small secured obligations without a waiver. Check how and when the cap is measured.
Why it is there
An unsecured lender prices its loan on the assumption that it will share equally with other unsecured creditors in the borrower's assets. If the borrower later gives security to a new creditor, those assets are taken out of the pool available to the unsecured lender. The negative pledge protects that position by limiting the borrower's ability to rank other creditors ahead.
How it works with other clauses
- It is drafted alongside the debt covenant so that permitted debt and permitted lien baskets line up.
- Some forms include an "equal and ratable" clause requiring the borrower to secure the protected debt equally if it grants prohibited security, which changes the practical remedy.
- In receivables programs, the definition of "Lien" may capture an outright sale of receivables, so the clause must be read against any permitted securitization or factoring basket.
Negotiating it
Who it protects: Lenders and noteholders
If it protects you
- Keep the definition of "Lien" broad enough to cover title retention, sale and leaseback and receivables sales that function as financing.
- Limit purchase money and acquired-asset exceptions to the specific asset and its proceeds.
- Tie any general basket to a fixed cap or a cap that does not grow with leverage.
If it runs against you
- Standard ask: a schedule of existing liens with a right to refinance them on the same assets.
- Ask for carve-outs for liens arising by law, cash management and netting arrangements, and any planned supply chain finance or receivables program; fallback is a dollar basket sized to cover them.
- Seek a general basket expressed as the greater of a fixed amount and a percentage of total assets.
Escalate before accepting: A negative pledge with no general basket and no carve-out for liens arising by operation of law, because routine operations would put the borrower in default.
What AI explanations get wrong
- Treating the negative pledge as giving the lender security. Check that the clause is only a promise; it creates a contract claim, and a third party who takes a lien usually gets priority unless other law or knowledge rules apply.
- Missing that a receivables sale can count as a lien. Check the definition of "Lien" and of "security interest" in the governing agreement.
- Ignoring the subsidiary scope. Check which entities the covenant binds and whether newly acquired subsidiaries are covered.
Where the law varies
Whether a third-party secured creditor who knew of the negative pledge can be liable, or have its priority affected, depends on governing law and the facts. The equal and ratable remedy is treated differently across jurisdictions, so check governing law before relying on it.
TOOLS
Need a primer like this for a clause in front of you? The Clause Primer Kit, included in All-access, produces one in this format inside the AI tool you already use, with checks built in. For reviewing whole agreements, see the Agent Kit 1: Contract Review and Negotiation.