The negative deposit clause ensures that the borrower`s assets remain in arre with them and are available to meet the requirements of unsecured creditors in the event of insolvency. Insolvency is a state of financial emergency, while bankruptcy is a legal procedure. Negative collateral is a provision of the contract that prohibits the debtor, in a contract, from creating security interests on certain assets. The contractual provision is intended to protect unsecured creditors by ensuring that debtors can only use unsured assets as collateral. Because a negative deposit clause enhances the security of a bond issue, it often allows issuers to borrow funds at a slightly lower rate. This lower interest rate benefits the issuer, creating a win-win situation for both issuers and the bondholder. In the case of real estate mortgages, many loan contracts contain terminology that prevents the borrower from using the mortgage property as collateral against a new loan, except in the event of refinancing. Subsequently, XYZ intends to borrow $2 million from Bank B. Bank B wants XYZ to secure $1 million of plant assets as collateral for the loan. Since XYZ has a negative pledge clause in its loan agreement with Bank A, XYZ cannot mortgage the $1 million security, as this would reduce the security of Bank A. XYZ could choose to mortgage bank B of other assets, ask Bank B for an unsecured loan if it has no other guarantees to provide, or try to renegotiate its hedging contract with Bank A. Consider a scenario in which a company lends $1 million to a bank and the bank needs all $500,000 of the company`s assets to be used as collateral for the loan. The Bank wants to protect its interests; Therefore, there will be a negative deposit clause.
A negative deposit clause also limits the likelihood that a particular asset will be mortgaged more than once, which prevents conflicts in which the lender is entitled to the asset when the borrower is late in payment. The negative mortgage clause reduces the risk to bondholders by limiting the activities in which the issuer may participate. Most of the time, this means that the issuer does not use the same assets to secure another debt commitment.