With respect to a negative pledge, i.e., a covenant by the borrower not to convey or encumber specified real property during the term of the subject loan, the restatement (third) of property (mortgages) (“restatement”) (1997) § 3.5, Negative Covenant Does Not Create a Mortgage, states that:

In the absence of other evidence of intent to create a mortgage, a promise by a debtor to a creditor not to encumber or transfer an interest in real estate does not create a mortgage, equitable lien, or other security interest in that real estate.

 Despite the admonition of the restatement that generally negative pledges are not interests in real estate, they are still occasionally used in connection with certain types of real-estate-related transactions. But there are serious doubts about the value of a free-standing negative pledge.  A court is simply not likely to enforce such a pledge, since enforcing it would amount to a clear restraint on alienation.  It might be enforceable by way of damages, but the damages would be the amount of the debt, and the creditor can sue on the debt separately unless the loan is nonrecourse. It is also extremely unlikely that a court will treat the negative pledge as an "equitable mortgage" and let the lender foreclose it -- because if the lender wanted a mortgage, it should have used one. It also would be difficult to maintain a tortious-interference claim against a third party who places a lien on the property subject to a negative pledge, because the third party would need to have actual notice of the pledge and the recording of a negative pledge does not create any type of lien on assets or guarantee the success of a claim against the third party.

 A negative pledge therefore would seem to have virtually no value by itself as a legal document. It does not transform an unsecured debt into secured debt, provides no lien or security to the creditor, and does not provide for foreclosure of the debt. In fact, whether the creditor has any satisfactory remedy at all for breach of a negative covenant is unclear. A negative pledge also does not constitute a security interest if a bankruptcy proceeding is filed by or against the debtor, and will be treated as just another unsecured claim in terms of priority.

 It is true that due-on-sale provisions in mortgage documents permit the lender to elect to accelerate the debt if the borrower conveys or encumbers the property without the lender's consent, but this is done in the context of, and as part of, a clause in the recorded mortgage itself.  A due-on-sale clause is not a direct restraint on the sale of the property.  The lender has the option to call the loan as a result of a violation of the covenant, but there is no automatic default.  A negative pledge, on the other hand, is an express prohibition on the sale of the property and is clearly is a direct, as opposed to an indirect, restraint on alienation.

 A negative pledge was utilized in New York by some lenders in the 1980s as an attempt to avoid recording a mortgage and paying the state's mortgage-recording tax. But a regulation issued by the New York State Tax Commission in 1995 clearly indicated that a negative pledge is the equivalent of recording a mortgage and, therefore, is taxable.

Article 9 of the Uniform Commercial Code may also have some relevance with respect to negative pledges. See Ernest A. Goetz and Kenneth A. Hoffman, The Negative Pledge, available at http://www.certilmanbalin.com/reference/article_detail/192/the-negative-pledge (2010). The authors state as follows:

Generally, revised [in 2001] Article 9 has done away with all county filings, except for filings against fixtures and timber. Thus, an attempt to make a county UCC filing indexed to specific real property in support of a Specific Negative Pledge likely should be rejected by the county filing office, since such a filing is not against fixtures or timber. Filings at the state level may still be made, however, most title companies performing real property searches routinely search county real property records but would not customarily check state UCC filings. Therefore, the efficacy of a Specific Negative Pledge filed at the state level and providing notice may be questioned for this reason.

With respect to a title insurer’s ability to insure the holder of a negative pledge against a violation by the borrower when there is an existing loan on the real property, see Titan Management, L.P. v. First American Title Insurance Co, 2006 WL 3732995 (N.J. Super. Ct. App. Div., Dec 20, 2006), certification denied, 190 N.J. 849 (Table, 2007). In this case (which is the only reported case to deal with the title-insurance issues raised in connection with negative pledges), the plaintiff argued that the title company should have listed the negative pledge as an exception to its title report and commitment for title insurance, but instead omitted the negative pledge as an exception, conditioned on receipt of an indemnification agreement from the lender’s principal and his corporations. The plaintiff alleged that the title company was negligent in concluding that the negative pledge was not a matter that affected title to the property.

The Appellate Court held that there was no conspiracy or fraud on the part of the title company, and that there was no negligence because it had no duty to a third party, as opposed to its professional duty to its client. The Appellate Court also relied on the testimony of the title company’s representative as to why no exception was placed in the title policy for the Agreement, i.e.: 1) the statement in the Agreement that it was not a mortgage; 2) the offer of indemnity agreements from the lender’s principal and corporations; and 3) the totality of the facts that enabled the title company to decide that it would be willing to assume the risk. The Appellate Court therefore ruled that the title company was under no duty to demand that the recorded Agreement be released as a condition to insuring the refinancing of the mortgage loan.