In real estate contracts, the negative pledge agreement is sometimes a stand-alone document. The lender can record a negative pledge agreement with the real estate records in the county where the relevant property is situated. Hence, the application of negative pledge against the property becomes public knowledge since it is a part of the county records. Keep in mind, however, that a negative pledge does not convey any rights to the lender against the assets of the borrower.
Function of a Negative Pledge
A negative pledge is a promise the borrower makes to refrain from adding additional liens against specific or all of the assets of the borrower. Lenders typically insert a negative pledge clause in a loan contracts to keep borrowers from obtaining other loans with the same property as security. If the borrower violates the terms of the negative pledge agreement, the bank may construe the violation as an act of default and thus may initiate remedial action.
Purpose of Negative Pledge Agreements
Negative pledge agreements do not involve any pledging of assets; rather the pledge gives the lender “cause for action.” The lender can take action against the party signing the negative pledge because only he has a contractual obligation. This means that, in most cases, you will have no claim or any cause for redress against the third party who places liens on the borrower’s assets. Third parties are not bound by a negative pledge agreement between you and the borrower.
You may have recourse if a third party places liens on a borrower’s property for which you filed a negative pledge agreement with the county. In this scenario, you could claim “tortious interference,” which means that the third party knowingly interfered in your contract with the borrower.
While filing the agreement may not serve as actual notice to a third party, it lays a foundation for you to apply the tortious interference legal concept in your claim. This is because county records are public knowledge and a title search would thus reveal that there is a negative pledge associated to the property.
Negative pledge agreements do not guarantee claims against third parties and give nothing to the lender. These contracts are only promises that may be set aside in certain instances such as when the courts approve a borrower’s bankruptcy filing. Further, it can be difficult to determine if the third party had prior notice. If the negative pledge agreement is a clause in a contract and not publicly filed, a third party may have equal rights to the property should the debtor default.