Before You Sell That Asset: Understanding Disposal Restrictions in Loan Deals

Introduction

Let’s revisit Tunde, a Nigerian entrepreneur with a rapidly expanding manufacturing business in Lagos. His factory floor is bustling, with trucks waiting to deliver goods to distributors across the southwest. Business is thriving, but growth brings its own challenges. He plans to expand to Ibadan and Kaduna, and to scale further, he secured financing from a local Nigerian bank. A few months later, rising costs compel him to reassess his asset base. To relieve the pressure, he decides to sell some equipment that has outlived its usefulness. It seems simple enough: sell what’s no longer needed, free up cash, and focus on the business. However, in corporate finance, disposals of assets are rarely that straightforward.

Whether the loan is secured or unsecured, the ability to dispose of assets is rarely entirely at the borrower’s discretion. For secured loans, lenders go further by embedding protections into the security documents that restrict the disposal of fixed assets unless they give their explicit consent. The logic is clear: those assets, in the event of enforcement, form part of the lenders’ recovery pool if things go wrong. Unsecured facilities adopt a more lenient stance, but restrictions still exist. Since unsecured lenders lack security, the borrower has more flexibility to deal with their assets. Even so, unsecured lenders usually impose a monetary limit for disposals within a financial year. They may also require that proceeds from disposals be used to prepay part of the loan or reinvested in replacement assets. The principle remains the same in both cases. Lenders want to ensure that the borrower’s asset base, the true foundation of its repayment capacity, is not quietly eroded over time.

Let us examine the nuances. What does this clause actually mean? Who does it bind? Why does it matter? And what exceptions typically apply?

The Clause - What Does It Actually Say?

A typical Loan Market Association provision reads:

• “No Obligor shall [(and the Company shall ensure that no other member of the Group will)], enter into a single transaction or a series of transactions (whether related or not) and whether voluntary or involuntary to sell, lease, transfer or otherwise dispose of any asset.”

Initially, it appears like an outright ban. However, the thinking is more nuanced. Lenders are not trying to be obstructive; they aim to be protective. Why? Major disposals, even when carried out at fair value, often signal a shift in the borrower’s business direction, a sign of cash flow stress, or a decline in its ability to generate income. The goal is therefore not just to preserve value but also to prevent asset stripping. Asset stripping occurs when a business gradually sells off revenue-generating assets to meet short-term liquidity needs. Lenders provide funding on the expectation that the business will continue operating and generating cash. Anything that undermines that assumption naturally attracts their attention.

What Counts as an Asset?

This is where things get a little tricky. The LMA definition of “asset” is intentionally broad. It goes well beyond fixed assets like machinery or real estate. It covers cash, receivables, intellectual property, and even future income streams. Routine matters such as the sale of finished goods, the collection of receivables, or intra-group transfers of funds can be caught if the clause is not properly drafted. For borrowers, this breadth is important to understand. Without negotiation, the clause could restrict transactions that were never meant to be restricted. Take Tunde’s business again. His production line includes automated machines, forklifts, and packaging robots that are critical to operations. Selling any of these without consent would almost certainly fall under the clause. But selling scrap metal, damaged pallets, or obsolete parts should not. These are disposals made in the ordinary course of business, not strategic divestments. That’s why borrowers often push to narrow the definition of an Asset. As we would learn in this article, Tunde could introduce materiality thresholds, thereby limiting the clause to disposals of only “material assets” or those that would have a Material Adverse Effect on his company’s operations. That way, the restriction focuses on meaningful disposals and not day-to-day operational activity.

Who’s Bound by the Restriction?

This is where negotiations become delicate. The question is simple: who should this restriction actually bind? In most LMA-style agreements, the clause naturally applies to the Obligors. That is, the Borrower and its Guarantors (which might include parent/sister companies or subsidiaries providing cross-guarantees). But lenders sometimes try to extend the clause to the entire group, including companies that have not given guarantees or taken on any obligations under the loan.

Borrowers like Tunde usually push back. He naturally questions that: If the lenders have no direct claim against those non-Obligor group companies, why should those companies be bound by the disposal restriction? Tunde would rather see the restriction apply only to the Obligors or, in some cases, only to the Borrower. And his reasons are straightforward:

• It can create the risk of an unnecessary cross-default. If a non Obligor company sells an asset in a way that breaches the clause, the Borrower could face an Event of Default even though it had nothing to do with the breach.
• Tunde may not have full control over all companies in the group, especially if the group includes joint ventures, partnerships, or minority interests. He cannot guarantee compliance where he does not have control.
• Companies need some flexibility to reorganise, restructure, sell, or acquire subsidiaries as business needs evolve. A group-wide restriction can make this unnecessarily burdensome.

It would also interest you that the Lender’s perspective isn’t without merit. A few arguments tend to surface:

• One argument is that subsidiaries of Obligors contribute to the financial strength of their parent, which ultimately supports the Borrower’s creditworthiness. If that logic is taken to its full conclusion, you might expect those subsidiaries to become Obligors themselves. But that is not always possible. In some jurisdictions, local laws on upstream guarantees or financial assistance make it difficult, or even impossible, for certain subsidiaries to guarantee group-level debt. (We’d treat financial assistance under another article.)
• Another argument could be that if the lenders have a share charge over the Borrower’s subsidiaries, the value of that security depends on the value of the subsidiaries. Significant disposals by those subsidiaries can reduce the value of the security package. Extending the restriction ensures that lenders don’t face an erosion of collateral value without consent.
• Lenders may also seek to restrict subsidiaries of Obligors from incurring debt to avoid structural subordination, where the lender’s credit position is weakened by new debt raised at a lower level in the corporate chain.
• Extending the restriction can also serve as a basic control mechanism to preserve the transparency of the group’s asset base as presented during due diligence. Since subsidiaries that are not obligors fall outside the reporting and general covenant framework of the loan agreement, extending the disposal restriction across the group ensures that material movements in non-obligor companies cannot occur unnoticed.

The key takeaway for a borrower like Tunde is simple. Any attempt to extend the no-disposals clause beyond the Obligors requires careful thought. It must be tied to the credit rationale and negotiated in a way that balances lender concerns with practical business flexibility.

What exceptions exist?

In practice, borrowers like Tunde usually seek several carve-outs that allow them to trade and operate normally. Without these, a business could barely function. So, what exceptions are there to this seemingly absolute prohibition?

• Ordinary Course of Business - The first and most common exception permits disposals made as part of regular business operations. This enables Tunde’s company to continue its core activities, such as selling finished goods, rotating stock, disposing of worn-out parts, or replacing components that can no longer support production. Without this carve-out, his business would come to a complete standstill. Many lenders accept this exception without much resistance, but they typically require such disposals to be at market value and on an arm’s length basis. Why? Because these requirements protect value. Consider Tunde's business again. His enterprise is expanding, lenders have backed him, and everyone is betting on the strength of the assets within his group. If one of his subsidiaries quietly sells an asset at a discount or transfers it to a related party on very generous terms, the lenders might not notice the leak immediately. But from a credit perspective, such moves gradually erode the value that underpins their funding. Therefore, protections exist to ensure nothing moves out of the group without proper visibility or scrutiny.
• The ordinary-course exception also interacts with the type and characterisation of security held by the lender. Where assets are charged to the lender, the ability of an Obligor to sell them freely may determine whether the security is characterised as a fixed charge or a floating charge. Typically, a fixed charge requires the lender’s consent before any sale; a floating charge allows the borrower to deal with the assets in the ordinary course. If the goal is to maintain a fixed charge, the disposal clause must be drafted carefully to prevent any unintended right to sell those assets.
• Exchange of Assets - The second exception involves assets exchanged for other assets of comparable or superior type, value, and quality (excluding an exchange of a Non-Cash Asset for Cash). Tunde might want to modify this so he can dispose of an asset for cash, provided the cash is reinvested within a reasonable period into an asset that would qualify under this subclause. However, lenders need to be cautious here. Why? Because allowing Tunde to convert income-generating assets into cash freely increases the risk of value drifting out of the business. Cash is fluid, harder to track, and doesn’t offer the same credit comfort as tangible operating assets. Therefore, even when agreeing to this exception, lenders usually require safeguards to keep the value supporting the loan within Tunde’s group.
• Disposal of Obsolete or Redundant Assets: Borrowers are generally permitted to dispose of assets that no longer serve any economic purpose, such as outdated machinery, unused vehicles, or equipment that has reached the end of its useful life. Lenders tend to be comfortable with this, as such assets contribute little to the borrower’s repayment ability. However, this exception typically applies only to tangible assets, excluding shares or intellectual property.
• Intragroup Disposals: Disposals within a group require caution from lenders. While transferring assets between entities for tax, operational, or efficiency reasons is typical, there is a concern about structural subordination. If Tunde’s company sells an asset to a subsidiary that is not an Obligor, the lender’s claim on that asset may be weakened. Hence, lenders often restrict intragroup disposals to transfers to entities offering the same guarantees and security as the original Obligor. If a secured asset is transferred, the acquiring company may need to grant equivalent security to the lender before proceeding, ensuring the security package remains intact.
• Disposals where proceeds prepay the loan: An additional exception involves disposals where proceeds are used to reduce the existing debt. From the lender’s perspective, this is a practical trade-off since selling an asset and using the proceeds to pay down debt balances the loan’s risk.
• Licensing of Intellectual Property and Similar Rights: Borrowers may license intellectual property rights as part of normal business on arm’s length terms. Lenders usually accept this, but remain vigilant for assets that may seem low-value but are crucial to the business model. If losing certain rights could cause significant operational issues, lenders sometimes impose specific consent requirements or thresholds.

Consequences

As discussed in my earlier articles, breaching the disposal restriction (just like negative pledges) generally constitutes an Event of Default. Once triggered, the lender may accelerate the loan, demand immediate repayment, or enforce its security if available. The threat of acceleration alone often prompts a borrower to negotiate. Lenders may then seek enhanced security, tighter covenants, or restructure facility terms. If they learn beforehand that a borrower might breach the clause, they can seek an injunction to prevent the disposal or join the recipient of the asset or security.

Final Notes:

For secured facilities, drafting permitted disposal clauses requires extra care. If too permissive, a fixed charge might be reclassified as a floating charge, weakening the lender’s priority. The list of permitted disposals must align with the security’s intended nature.

This piece is for information only and should not be taken as legal advice. If you want to read more, ask questions, or share thoughts, you can reach me at toluadetimehin@gmail.com