No new liens: Overview, definition, and example
What is "no new liens"?
The "no new liens" provision is a clause commonly found in contracts, particularly in financing or loan agreements, that prohibits a borrower or seller from placing any new liens or encumbrances on their assets without the consent of the lender or other relevant party. A lien is a legal claim or right against assets that serves as security for the repayment of a debt. The "no new liens" clause is intended to protect the existing creditors by ensuring that the borrower or seller does not increase the amount of outstanding secured debt against their assets, which could potentially reduce the value or priority of the current creditor's claim in case of default.
Why is "no new liens" important?
The "no new liens" clause is important because it helps protect the interests of the current creditor or party by ensuring that no additional claims are placed on the borrower’s or seller’s assets, which could impair the creditor's ability to recover their loan in the event of non-payment or liquidation. It preserves the priority of the existing debt and prevents the borrower from taking on additional financial obligations that could jeopardize the ability to repay the current loan. Without this provision, the borrower could further encumber their assets with additional liens, increasing the risk for the creditor and potentially diminishing their recovery in case of default.
Understanding "no new liens" through an example
For example, a company takes out a loan from a bank, and the loan agreement includes a "no new liens" clause. This means the company is prohibited from using its assets as collateral for any new loans or credit lines unless the bank, as the existing creditor, provides approval. If the company decides to apply for another loan in the future, it cannot pledge its assets as security for the new loan without the bank's consent, which protects the bank’s interest in the event of a default.
In another example, a business owner sells their company to a buyer and agrees to a "no new liens" clause as part of the sale agreement. The clause ensures that after the sale, the seller will not place new liens on the company’s assets that would reduce the value of the assets being transferred to the buyer. This helps the buyer secure the value of the assets they are purchasing without the risk of any new claims arising that could affect their ownership.
An example of a "no new liens" clause
Here’s how a "no new liens" clause might appear in a loan agreement:
“The Borrower agrees that, without the prior written consent of the Lender, the Borrower will not create, incur, or permit any lien, mortgage, or other encumbrance on any of the Borrower’s assets, whether real or personal, that would be senior or pari passu to the Lender’s lien under this Agreement.”
Conclusion
The "no new liens" clause is an essential tool in protecting creditors and ensuring that the value of the collateral backing a loan or transaction remains secure. By preventing the creation of new liens or encumbrances on assets, this provision helps preserve the priority of existing creditors' claims and reduces the risk of financial instability or default. It is a key clause in financing agreements, mergers, and acquisitions, helping to safeguard the interests of all parties involved.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.