Negative Pledge Clause

A “negative pledge clause” basically says that, if we have an unsecured loan from one lender, we can’t turn around and take out a secured loan from someone else if it would have a negative impact on the first lender.

To illustrate how this works, let’s talk grass. No, not that kind of grass—we’re talking lawns. Synthetic lawns, to be precise. Think: California. Water is a scarce resource, and is really expensive. So instead of putting in real grass lawns, which require regular watering, a lot of people have opted to put in fake grass. All the beauty, none of the maintenance. And our company, Fake Grass, Inc., is here to make homeowners’ synthetic lawn dreams come true. Our business is doing so well that we’ve decided to expand into Nevada, and to do this, we’ve taken out an unsecured loan for $3 million so we can build a new facility and hire more staff.

Before that loan is paid off, however, we decide we’d also like to expand into Arizona. This means we’ll need another loan. Because we’ve got a negative pledge clause in our original loan docs, though, we can’t get another loan if it means we might end up defaulting or otherwise causing financial harm to the lender on our first loan. We’ve got to have enough assets to cover both loan amounts, just in case the fake grass industry goes south, or in case our new Nevada venture doesn’t work out. And even if we do manage to secure another loan, our first priority in terms of payments needs to be the first lender.