New normalcy? – June 2021: Negative collaterals in commercial real estate financing – why do we need them? | Cadwalader, Wickersham & Taft LLP



Negative collaterals are contractual constructs widely used in many areas of finance – from simple mortgages to complex large-scale real estate finance transactions – and, as a result, are often accepted as the market standard for inclusion in financial documents. However, why do lenders insist on having them? Why are they necessary even with guaranteed financing, when the lender has the first security rank advantage? Why do lenders insist that they be included in the security documents, even if they are in the loan agreement? This article aims to provide a broader understanding of the existence and purpose of negative liens.

What is negative voice?

Negative collateral is an obligation provided by the borrower and, if applicable, the debtors not to create or authorize the existence of any collateral in respect of any of their assets. The generally accepted standard European market construction of a negative margin clause can be found in Article 22 (General obligations) a form of loan agreement for real estate financing signed by the Loan Market Association (“LMA”), which complements the condition that debtors “should not:

  • (i) sell, transfer or otherwise dispose of its assets under conditions under which they are leased or may be leased or reacquired by the debtor;
  • (ii) sell, transfer or otherwise dispose of its receivables with recourse;
  • (iii) enter into any arrangement whereby money or benefits from a bank or other account may be applied, set off or produced depending on the combination of accounts; or
  • (iv) enter into any other preferential agreements having similar effects,

in circumstances where an arrangement or transaction is entered into primarily as a method of increasing financial indebtedness or financing the acquisition of an asset.

Why are negative margins needed?

Negative collateral clauses are important in lending transactions. As with other negative conditions in the loan agreement, they are aimed at giving the lender control over the activities of the borrower, preventing him from creating collateral for his assets in favor of and maintaining any debt to other parties at the expense of the lender. creditors.

Thus, the negative collateral clause becomes even more important for an unsecured lender because, in the absence of collateral, the lender would be vulnerable to the risk of the borrower creating collateral in favor of another lender, placing it in front of the unsecured lender. insolvency of the borrower, which could lead to a reduction in the pool of assets available to unsecured lenders. Thus, the negative collateral clause will help the unsecured lender maintain its priority in the event of the borrower’s insolvency.

Why are secured lenders required negative collateral?

Most of the financial transactions with real estate in Europe are non-recourse, therefore the security group is fenced off. However, regardless of whether the creditor has first degree collateral, negative collateral should nevertheless be an important condition for secured creditors for both priority and practical reasons. For example, even if the lender has the advantage of a mortgage or fixed-value collateral, so any additional collateral provided by the borrower will be inferior to the original collateral (provided, of course, that it has been properly created and improved), the new lender may have an enforcement right that could hinder the position of the original creditor or hinder restructuring by refusing to agree to certain actions suggested by that original creditor.

In addition, in circumstances where the secured creditor has the advantage of providing a floating payment, under English law, such priority could be undermined by any subsequent security of the fixed payment, since the fixed payment will take precedence over the floating payment, even if such a floating payment was created earlier in time.

Why do lenders require that a negative collateral clause be reflected in both the loan agreement and the collateral agreements?

As noted earlier, the LMA form of a real estate finance loan agreement does contain negative collateral terms and is expected to remain as part of the loan agreement with any financing. However, the secured creditor may also require that a negative collateral agreement be included in the security documents.

The reason for this is that under the Companies Act 2006 (Amendment to Part 25) of the 2013 Regulation, almost all charges must now be filed, which means that the security right provided by the borrower to the secured lender, along with details of details of it, such as a negative bond agreement, can be entered into a public register that is viewable by all parties. A complete and complete copy of the title of protection must also be provided as part of the registration, with a copy of the agreement being publicly available upon request. This has significant implications for notifying subsequent creditors or potential creditors and significantly increases the likelihood that any subsequent creditor will receive a negative collateral notification.

The notification can potentially be received in two ways:

  • (i) Actual notice: if the new lender is informed of negative collateral, or as part of its due diligence, the lender checks the borrower’s accrual ledger at Companies House and identifies such negative collateral, then the new lender must have actual notice of this, and therefore will accept its security interest, taking into account any security that the original creditor may have; as well as
  • (ii) Constructive notice: If the new creditor has not received actual notice of negative collateral, it can be argued that constructive notice is imputed to third parties based on the registration of such collateral and the indication of negative collateral, resulting in it accepting collateral provided that that the original creditor might have it. It should be noted, however, that there is a debate over the registration of the collateral that automatically results in constructive notice, and therefore whether a party has a truly constructive notice will depend on the facts of the scenario in question.

The borrower should not object to the negative collateral clause appearing in both the loan agreement and the security document, but it is important for them and their attorney to ensure that the terms and conditions and obligations of the negative collateral clause in both the loan agreement and the title deeds are met. substantially duplicate each other.

What if there is existing collateral provided in favor of a third party lender?

Ultimately, the borrower must be able to effectively continue his business, and therefore there may be times when collateral will be required – for example, agreements to offset or offset credit balances, which are often routinely negotiated. borrower banking arrangements. Therefore, it is important for the borrower and his consultant to carefully consider the negative collateral clause in the broader context of the transaction and, if necessary, include exclusions and clauses, as default requirements under the LMA are limited to the following:

  • (i) collateral provided in connection with the transaction and financial documents (that is, collateral provided in favor of the lender);
  • (ii) security rights arising by law and in the course of ordinary trade; as well as
  • (iii) a security issued prior to the first draw.

If the borrower has any existing collateral, then the new lender will need to consider whether he is willing to allow such collateral to exist and remain in effect during the term of his loan. This is important because any such collateral could damage the position of the new lender. If the creditor agrees that the existing collateral will remain, such collateral would need to be explicitly excluded from the negative collateral clause as “permitted collateral”.

In addition, if the new lender also accepts collateral from the borrower, it may also wish to consider entering into a priority agreement or interlending agreement to manage the priorities of the security interest and enforcement rights. This will need to be negotiated between the borrower and competing lenders, so it will be negotiable at that time.

What if collateral was created in violation of negative collateral?

It should be recognized that a negative collateral agreement is ultimately just a contractual obligation, and therefore, in theory, the borrower can in practice provide collateral despite such a promise not to do so. Of course, a prudent borrower will and should abide by the terms of the negative collateral agreement he has agreed to, but in a situation where the borrower does create collateral in violation of his negative collateral, it is worth noting the consequences for the borrower, the original lender, and the new lender:

  • (i) Borrower: A breach of the negative collateral clause is likely to be a defaulting event on financial instruments, and will generally give rise to some fundamental power for the original lender.
  • (ii) Original lender: when the event of default has occurred and continues, the original lender will have the right to expedite the loan and, if the loan is secured, enforce its security, such as a mortgage on property. Alternatively, in particular for unsecured creditors, the possibility of obtaining an injunction against providing security to a new creditor could also be considered, and if the new creditor received a notice of negative collateral, then the original creditor could sue. against him in tort for inducement to breach a contract.
  • (iii) New lender: a key issue will be prioritized. Ultimately, the question of whether the collateral of the new creditor takes precedence over the collateral of the original creditor or vice versa depends on a number of factors and thus must be considered on a case-by-case basis, for example:
  1. the nature of security (eg, fixed fee has priority over floating);
  2. whether the security has been improved (security that has not been improved may not be valid); as well as
  3. whether the new creditor had a notice of negative collateral (if the new creditor received a notice of negative collateral, then its security interest is subject to security by the original creditor).

Final thoughts

Negative collateral clauses are a standard market convention in any real estate financing and therefore, as a borrower, the goal should be to negotiate the correct qualifications and exceptions to ensure that negative collateral does not interfere with his ability to run his business as opposed to attaching. efforts to remove it. However, as a lender, it is important to understand why we have negative collateral 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 loan.


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