The new normal? – June 2021: Negative commitments in commercial real estate finance – Why do we need it? | Cadwalader, Wickersham & Taft LLP


Negative pledges are contractual constructs widely used in many financings – from simple mortgages to complex and large-scale real estate finance transactions – and, therefore, are often considered a standard market inclusion in finance documents. Having said that, why do the lenders insist that we have them? Why are they needed even in secured finance where the lender has first rank security? Why do lenders insist that they appear in collateral documents even though the loan agreement contains them? This article seeks to provide a broader understanding of the existence and purpose of negative pledges.

What is a negative pledge?

Negative collateral is a commitment made by the borrower and, where applicable, the debtors, not to constitute or leave any security on any of its assets. The generally accepted European market standard construction of a negative pledge clause can be found in clause 22 (General commitments) the Loan Market Association (“LMA”) form of the mortgage finance loan agreement, which goes further by stipulating that debtors “must not:

  • (i) sell, transfer or otherwise dispose of any of its assets on terms whereby they are or may be leased or redeemed by a debtor;
  • (ii) sell, transfer or otherwise dispose of any of its receivables with recourse;
  • (iii) enter into any agreement whereby money or profit from a bank or other account may be allocated, cleared or subject to a combination of accounts; or
  • (iv) enter into any other preferential agreement having a similar effect,

in circumstances where the arrangement or transaction is entered into primarily as a method of becoming financially indebted or to finance the acquisition of an asset.

Why are negative commitments necessary?

Negative collateral clauses are important in lending transactions. Like other negative clauses in a loan agreement, they are intended to give the lender control over the borrower’s activities by preventing it, at the lender’s expense, from creating security over its assets in favor and in support of the borrower. any debt owed to other creditors.

A negative collateral clause therefore becomes even more crucial for an unsecured lender because, in the absence of collateral, that lender would be vulnerable to the risk that security would be created by the borrower in favor of another creditor, placing him in front of the unsecured creditor on the insolvency of the borrower, which could have the effect of reducing the pool of assets available to unsecured creditors. As such, a negative collateral clause will help the unsecured lender to preserve their priority in the event of the borrower’s insolvency.

Why are negative pledges demanded by secured lenders?

Most European real estate financing is done without recourse, so the security group is locked in. However, whether or not a lender has a senior collateral, negative pledges should nonetheless be an important condition for secured lenders for both priority and practical reasons. For example, even if a lender has a mortgage or a fixed charge guarantee, then any other collateral given by the borrower must rank after the original collateral (assuming, of course, that it has been properly created and perfected), the new creditor may have performance rights that may hamper the position of the original lender, or hinder a restructuring by refusing to accept certain actions proposed by that original lender.

In addition, in cases where the secured lender has a floating charge collateral, under English law this priority could be compromised by any subsequent fixed charge collateral, as a fixed charge will have priority over a floating charge, even if this floating charge was created earlier in time.

Why do lenders require the negative pledge clause to be included in both the loan agreement and the collateral agreement?

As previously stated, the LMA form of the mortgage finance loan agreement does indeed contain a negative collateral clause, and it is expected to remain a feature of the loan agreement in any financing. However, the secured lender may also require that a negative collateral clause be written in the collateral documents.

The reason for this is that under the Companies Act 2006 (Part 25 Amendment) of 2013, almost all costs now have to be recorded, which means that the right of guarantee granted by the borrower to a secured lender, along with details of its details such as negative pledge clause, can be recorded in a public register accessible to all parties. A full and complete copy of the security document must also be submitted as part of the registration, with accessibility to a copy of the agreement being available to the public upon request. This has important implications for notifying subsequent lenders or potential creditors, and it greatly increases the likelihood that a subsequent creditor will be notified of negative collateral.

The notification can potentially be obtained in two ways:

  • (i) Effective Notification: If the new creditor is made aware of the negative pledge, or as part of its due diligence, the creditor examines the borrower’s charge register at Companies House and identifies this negative pledge, then the new creditor will have notice of the latter, and will therefore take its security subject to any security that the original lender may have; and
  • (ii) Implied notice: if the new creditor was not actually informed of the negative pledge, it can be argued that the implied notice is imputed to third parties by virtue of the registration of this security and the finding of the negative pledge , the result of which is that he must take collateral subject to any collateral the original lender may have. However, it should be noted that there is a debate around whether to register a security interest automatically giving rise to an implied notice, and therefore whether a party actually has an implied notice will depend on the facts of the scenario in question.

The borrower should not dispute the fact that a negative collateral clause is in both the loan agreement and the guarantee document, but it is important for him and his lawyer to ensure that the terms and conditions obligations under the negative pledge clause in the loan agreement and security documents are materially reflected.

What if there is an existing security granted in favor of a third party creditor?

Ultimately, the borrower must be able to carry on its business effectively and as such there may be instances where collateral will need to be given – for example, netting or offsetting agreements. credit balances which are often entered into in the ordinary course of the borrower’s banking arrangements. It is therefore important for the borrower and their counsel to carefully consider the negative collateral clause in the larger context of the transaction and to include exclusions and conditions, if any, as the terms default under AML are limited to the following:

  • (i) a guarantee granted in the context of the transaction and the financial documents (ie a guarantee granted in favor of the lender);
  • (ii) privileges resulting from the application of the law and in the ordinary course of business; and
  • (iii) the security which is released before the first draw.

If the borrower has an existing collateral, then the new lender will need to determine if they are willing to allow that collateral to survive and remain in place for the term of their loan. This is important because such a guarantee can be detrimental to the position of the new lender. To the extent that the lender accepts that the existing collateral remains, that collateral should be expressly excluded from the negative collateral clause as “authorized collateral”.

Additionally, if the new lender also takes collateral from the borrower, then it may consider putting in place a priority deed or inter-creditors agreement to govern the priorities of the security and performance rights. This will have to be concluded between the borrower and competing creditors and will therefore be subject to negotiation at that time.

What if the security was created in violation of a negative pledge?

It must be recognized that a negative collateral commitment is ultimately only a contractual obligation, and therefore in theory the borrower could in practice grant a guarantee despite this promise not to do so. Of course, a prudent borrower would and should abide by the terms of a negative pledge clause that he has accepted, but in a situation where a borrower creates collateral in violation of his negative pledge, the consequences of such collateral should be noted. actions for the borrower, the original lender and the new lender:

  • (i) Borrower: A violation of the negative collateral clause would likely constitute an event of default under the finance documents, and generally this would trigger some fundamental powers for the original lender.
  • (ii) Original lender: when an event of default has occurred and continues, the original lender will have the power to accelerate the loan and, if the loan is secured, to enforce its collateral, such than his mortgage on the property. As alternative actions, especially for unsecured lenders, it may also be possible to consider obtaining an injunction against the granting of collateral to a new lender, and whether the new lender had been informed of the negative collateral, then the original lender could sue them in tort for inducement to break the contract.
  • (iii) New lender: a key issue will be a priority. Ultimately, whether the collateral from the new lender takes precedence over the collateral from the original lender, or vice versa, depends on a number of factors and therefore needs to be considered on a case-by-case basis, such as:
  1. the nature of the guarantee (for example, a fixed charge will have priority over a floating charge);
  2. whether the security has been perfect (a security that has not been perfect may not be enforceable); and
  3. if the new lender has been notified of the negative pledge (if the new lender has been notified of the negative pledge, then its security will be subject to the guarantee of the original lender).

Final thoughts

Negative collateral clauses are a standard market clause in all real estate financing, and therefore, as a borrower, the goal should be to negotiate the right qualifications and exclusions to ensure that the negative pledge does not hamper its ability to run one’s business, as opposed to making efforts to suppress it. As a lender, however, it is important to understand why we have negative liabilities and their effectiveness and limitations to ensure that the benefits and risks in light of the broader circumstances of the transaction are factored into the terms of the transaction. ready.

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