Negative Pledge

Czech Republic: Prohibiting the encumbrance or divestment of assets may improve the position of lenders, but can also cause problems for borrowers

In contrast to the legal arrangement that was in force until 31 December 2013, under which negative pledges had only limited applicability and were effective only among the parties to the given contract, the new Civil Code introduces the new concept of “negative pledge” – a ban on encumbrance or divestment which may newly be established with effects vis-a-vis third parties (i.e., in the form of a right in rem). The “ban on encumbrance” is to be understood as a restriction that disallows the creation of a pledge title to the given asset, whereas the “ban on divestment” represents a ban on selling the asset or, under a more stringent interpretation of the new provisions, also a ban on any other form of disposal of the asset (i.e., in the case of real property, also a ban on leasing and renting).

Negative pledges may only ever be created for a limited period of time, which must moreover be “reasonable”. Also, the negative pledge must be justified by a specific interest, deserving of legal protection, on the part of the beneficiary of the negative pledge.

Principally, negative pledges have effects only among the parties. However, a negative pledge that is made part of the public record (e.g. by being entered in the cadaster in the case of real property, or by being entered in the Commercial Register in the case of shares or ownership interest) is also effective vis-a-vis third parties, i.e., third parties cannot validly acquire the ownership title or a pledge title to the asset which is encumbered by the negative pledge.

This institution reflects the latest trends in bank financing and doubtlessly represents a practical way for lenders to attain additional comfort. However, borrowers will greet this new concept with considerably less enthusiasm, as it may substantially complicate their access to refinancing loans offered by competing banks. For the purposes of refinancing by such other bank, the negative pledge would first have to be deleted from the public record, which presupposes the consent – i.e., a display of constructive assistance – of the original lender.

Anna Suchá, Lawyer


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