Bond Terms – Negative Pledge Relating to Floating Charges
A customary practice in the credit market makes the provision of financing for a corporation contingent upon the creation of a floating charge on all of its assets in favor of the financier. In most instances, the bond terms relating to the lien also include a ”negative pledge” – a restrictive stipulation that prohibits a corporation from creating additional liens without receiving the financier’s prior written approval.
The moment that a corporation creates a floating charge that includes a negative pledge, does that make the corporation a captive of the financier for the purpose of obtaining additional financing?
Currently, there is no absolute certainty about the legal standing of a lien created by a corporation in favor of another entity that contravenes a negative pledge included in an earlier floating charge. The Israeli Companies Ordinance does not prohibit the creation of additional liens in favor of other entities, despite the existence of a negative pledge in favor of the financier. Yet, from a contractual perspective, at issue is a prima facie contractual breach of the bond terms that is detrimental to the fragile relationship between the corporation and the financier.
There are instances whereby courts in Israel ruled that those liens, despite their being created in contravention of a negative pledge, are void vis-à-vis the financier in favor of which the initial floating charge was created, but are valid vis-à-vis the creditor in favor of which the new lien was created.
However, there do not appear to be any contractual lawsuits filed by a financier against a borrower on the grounds that the borrower had acted in contravention of a negative pledge. It could be that the reason for this is that, as indicated above, the legal outcome is that the breach does not result in any “injured parties”: the financier holding the initial floating charge remains protected, the entity in favor of which the new lien was created (in contravention of the negative pledge) also remains protected, while the creditor cannot deny its obligations towards any of them. So what can a corporation do? One needs to keep a few things in mind. Firstly, notwithstanding the existence of a negative pledge in the bond, there is no obstacle to checking out the market and obtaining offers from a number of financiers. If necessary, a corporation can contact the financier in favor of which the initial floating charge was created and inform it of the intention of creating additional liens in favor of another financier. In any case, the receipt of offers from additional financiers may strengthen the corporation’s bargaining position vis-à-vis its financier. According to case law, a financier’s refusal to consent to the creation of additional liens in favor of others, when the financing terms offered by the competing financier are more favorable and the additional lien that the corporation is seeking to create is subordinated to the floating charge, may be deemed unreasonable and lacking bona fides.
One should also keep in mind that “floating charge” is not an abstract term with the mere mention of it in a bond being sufficient to encumber all of a corporation’s assets. The way the clauses are worded in bonds that define exactly which assets are included in the lien is of critical importance. On several occasions, courts in Israel have ruled in relation to a specific asset of a corporation, that that asset is not “caught in the net” of the floating charge. The negative pledge has no bearing on assets that are not included within the scope of the floating charge (even if this is due to sloppy wording in the bond), because those assets are not pledged in favor of the financier at all.
Barnea assists its clients obtain financing from financing institutions and represents them throughout all stages of the negotiations. You are invited to contact us to obtain legal counseling in this regard and on other matters.