Wednesday 23 April 2014

Basic concept of Negative Lien or Negative Pledge

There is no legal definition of 'negative lien'. Lien is the right to retain goods of a 
borrower or pledgor for the debt. Negative Lien is used in banking parlance for a 
borrower to undertake not to create any charge on his property without the consent 
of the lender. 

The borrower may sometime be having non-encumbered assets which are not 
charged to the bank as security. The borrower is thus free to deal with these assets 
and may even sell them if he so desires. To restrict this right of the borrower, bank 
may sometimes request him to give an undertaking to the effect that he will neither 
create any encumbrance on these assets nor sell them without the previous 
permission of the bank so long as the advance continues.
This type of an 
undertaking obtained by the bank is known as 'Negative Lien'. Negative lien is in the 
form of a personal assurance or undertaking which has binding effect but confers no 
right on the bank to proceed against the property itself and thus creates no 
encumbrance or charge on the property. 
The case of Knott v. Shepherdstown Manufacturing Co. 5 S.E. 266 (W. Va. 1888) may 

be examined at this juncture to help bring some clarity to the issue. It was held in Knott that Negative Pledgee’s remedies are purely contractual and that the 
covenant confers no right in the property. The Court held, 
“Of course the agreement’s negative pledge covenant creates no lien on or 
pledge of any property. It is simply negative; an agreement not to do a 
particular thing. The creation of a lien is an affirmative act, and the intention 
to do such act cannot be implied from an express negative. It seems to me 
that both of these clauses of the obligation that is, the negative pledge 
covenant and a covenant to keep the property insured are simply personal 
covenants, for the breach of which the remedy must be sought in a court of 
law. ” 

The generally accepted view as mentioned before is that the negative pledge does 
not create a proprietary or security interest and is therefore not registrable. [Tracy 
Hobbs, The Negative Pledge: A Brief Guide, 8(7) J.I.B.L.269(1993)] 

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