What is a negative pledge – and why might I want one?

A negative pledge is a promise made by a borrower, guarantor or security provider (debtor) to a lender by which the debtor agrees that it will not give any other person any security or other claim over any of its assets, unless the lender agrees. The promise is usually included in the covenant section of a loan agreement, a guarantee or in security documents such as debentures and mortgages. The primary purpose of a negative pledge is to bolster the position of a lender amongst the debtor’s creditor pool as it seeks to limit the number of competing creditors who might have recourse to the debtor’s assets if the debtor becomes insolvent.

Consequences of breaching of a negative pledge

A negative pledge is a standard provision in secured and unsecured lending. Creating security in breach of the negative pledge is likely to result in an event of default (see our previous article A-Z of banking and finance: D is for default). The occurrence of an event of default will typically trigger, amongst other things, the rights of a lender to demand immediate repayment of the loan or to enforce security. Whether the security created in breach of the negative pledge is valid and enforceable is beyond the scope of this note, but there is an important practical step which the lender can take to enhance the effectiveness of a negative pledge given by a security provider.

Giving notice of a negative pledge: the importance of MR01s

In order for a security interest created by an English company or limited liability partnership to be valid in the event of the liquidation of the security provider, the security interest must be presented for registration at Companies House within 21 days of creation. Registration is completed by delivering a certified copy of the instrument creating the charge, together with the "prescribed particulars". Those prescribed particulars are effectively covered by the questions answered on the Companies House form MR01. That form includes a box that asks “Do any of the terms of the charge prohibit or restrict the company from creating further security that will rank equally with or ahead of the charge?”. When ticked, the resulting note displayed on the security provider’s register at Companies House may provide notice to other parties of the presence of a negative pledge. Most well-advised lenders, when seeking to take security from an English company, will conduct a search of the proposed security provider’s records at Companies House, and in doing so would get actual notice of the existing negative pledge.

Conclusion

The presence of a negative pledge does not outright prevent the debtor from granting security to another person. However, a negative pledge – and particularly one which is given by a security provider and noted on the registration of the first charge with Companies House – is an additional protection for a lender seeking to protect its security interest or, where unsecured, to preserve its ranking within a creditor group. Borrowers seeking additional finance will need to navigate carefully around the parameters of any existing negative pledge that they have made to prevent an event of default occurring.