This is a form of security usually given by blue chip companies. There is no formal charge over company's assets, but rather a written undertaking by the borrowing company that it will not charge any of its assets to any other lender without the bank's consent.
Advantages of Negative pledge to the bank
i. It can be easily taken
ii. It is not expensive to perfect.
iii. If the borrower's external financing is much lower than the worth of its assets, the risk is reduced since there will be enough for all the creditors.
iv. The higher the repayments, the lower the lender's risk.
v. If the terms and conditions of the security are complied with, the borrower's penchant to borrow and pick up debts is reduced.
vi. The higher the borrower's hidden /secret reserve, the stronger the security.
Disadvantages/risks to the bank
i. It is a weak security.
ii. The security does not attach any specific assets.
iii. In the event of the borrower's liquidation, the unattached assets could be seized and disposed off by the liquidator.
iv. In effect of winding up of the company, the bank can only prove as an unsecured creditor.
v. If the company's unattached assets are insufficient to cover it's liabilities, the bank might be unable to recover its total exposure.
vi. Any legal charge subsequently created by the borrower in regard to the existing negative pledge takes precedence over the bank's security.
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