What is a negative pledge clause?
A negative pledge clause protects bondholders’ investments. It prevents a bond issuer from taking on future debt, which may result in paying off the current debt.
This clause is one of the ways for bondholders to protect/guard their investment. By including a negative pledge clause in a bond agreement, the bondholders prevent the company to raise any further debt in the future which would risk their rights of priority claims on the Company’s assets. The bondholders of the current bond issue prevent the company from issuing any further debt in the future which would jeopardize their current priority claim on the company’s assets.
Including this clause in a bond agreement increases the safety of the bond issue from the point of view of the investors. And therefore often allows the bond issuer to borrow funds at a rather lower rate of interest.
This is also called “covenants of equal coverage”.
