How to pledge shares of stock

A stockholder may wish to raise money for personal or business use. For this purpose, he may obtain a loan from a lender. To secure payment of the loan, the lender may require the borrower to pledge personal properties (such as shares of stock) owned by the borrower.

A pledge is an agreement by which the borrower delivers to the lender (or a third person agreed upon by the parties) personal properties for the purpose of securing the fulfillment of an obligation (such as repayment of a loan), with the understanding that when the obligation is fulfilled (or in case of a loan, when the borrower pays the loan), the thing delivered is returned by the lender to the borrower. The person who gives the pledge is called a pledgor, while the person in whose favor the pledge is given is called the pledgee.

The basic steps in creating a pledge over shares of stock are:

1.     Negotiation, execution and notarization of the pledge agreement (often called a deed of pledge);

2.     Delivery of the thing pledged to the pledgee (or an authorized third person);

3.     Payment of the documentary stamp (DST) tax on the pledge and the filing of the appropriate return with the Bureau of Internal Revenue (BIR).

Let’s discuss each of those steps:

1.     Pledge agreement

The basic pledge agreement will contain the following:

(a)     the name and other personal details (e.g., civil status, citizenship, address, etc.) of the pledgor and the pledgee;

(b)     a description of the shares of stock being pledged (including the number of shares pledged, the par value of shares, the class of shares (if applicable) and the relevant stock certificate numbers);

(c)     a provision that the pledgor creates a pledge over the shares of stock;

(d)     representations and warranties of the pledgor (e.g., that the pledgor is the legal and beneficial owner of the shares, that the shares of stock are free from liens and encumbrances, etc.); and

(e)     the date of the pledge.

Some notes:

(a)      To create a pledge, the pledgor must be the absolute owner of the thing pledged (Civil Code, art. 2085). In other words, a person does not have the power to create a pledge over property he does not own. Of course, this does not preclude the pledgor from pledging his personal property through a duly authorized agent.

It is not necessary that the pledgor is also the borrower. A third party may pledge shares of stock owned by him to secure the loan obligation of the borrower (Civil Code, sec. 2085).

(b)     The pledgor must have free disposal of the property pledged, and in the absence thereof, that he is legally authorized to do so (Civil Code, art. 2085). In this regard, a corporation has the power to pledge shares owned by it (Corporation Code, sec. 36[7]; see Corporation Code, sec. 40).

(c)     Under the Civil Code, a “pledge shall not take effect against third persons if a description of the thing pledged and the date of the pledge do not appear in a public instrument.” (Civil Code, art. 2096). In general, contracts are binding only upon the parties to the contract (and their successors-in-interest). However, certain contracts (such as a pledge agreement) can be binding upon third parties. For example, a person who buys pledged shares must recognize the pledge over the shares. In order that a pledge may be binding upon third persons, the Civil Code requires that the pledge agreement must appear in a public instrument (e.g., notarized) and must contain a description of the thing pledged and the date of the pledge.

2.     Delivery of the property pledged

In order to create a pledge, the thing pledged must be placed in the possession of the pledgee or a third party agreed upon by the pledgor and the pledgee. With respect to shares of stock, this generally means that the stock certificates representing the shares pledged must be delivered to the pledgee (or an authorized third party)(see Civil Code, sec. 2094). A pledge is not created without delivery of the thing pledged.

Some notes:

(a)     With the consent of the pledgee, the pledgor can sell the shares of stock pledged. However, the pledge remains and the stock certificates remain in the possession of the pledgee. The buyer can acquire ownership of the shares of stock subject to the pledge (Civil Code, art. 2097).

(b)     The pledgee cannot deposit the thing pledged with a third person, unless there was an agreement between the parties that the pledgee can do so (Civil Code, art. 2100).

(c)     Unless the parties agree otherwise, the pledge extends to the interest and earnings of the right pledged (Civil Code, sec. 2102). Thus, in case of shares of stock, the pledge extends to dividends received on the pledged shares of stock (unless the parties agree otherwise). In this regard, the stock certificates covering the stock dividends must also be delivered to the pledgee (or the authorized third person). The parties can execute a pledge supplement to cover the stock dividends. Note that this is not a new pledge but simply a supplement to the existing pledge agreement for the purpose of covering additional properties that are originally intended to be covered by the pledge agreement.

(d)     In case of pledged shares in stock corporations, the pledgor has the right to attend and vote at meetings of stockholders, unless the pledgee is expressly given by the pledgor such right in writing which is recorded on the appropriate corporate books (Corporation Code, sec. 55).

3.     DST

A pledge is subject to DST at following rate:

(a)      when the amount secured does not exceed five thousand pesos (P5,000), twenty pesos (P20.00);

(b)      on each five thousand pesos (P5,000), or fractional part thereof in excess of five thousand pesos (P5,000), of the amount secured, an additional tax of ten pesos (P10.00)(Tax Code, sec. 195).

Under the Tax Code, the DST may be paid either by the borrower or the lender (see Tax Code, sec. 173). In practice, the borrower assumes payment of DST. The DST must be paid (and the corresponding DST return filed) not later than the 5th day of the month following the date of the transaction. For example, if the pledge agreement was executed during the month of June, the DST must be paid not later than July 5.

Non-payment of the DST does not make the pledge agreement invalid. However, if DST is not paid, the pledge agreement cannot be used in evidence in any court until the DST due is paid (Tax Code, sec. 201). Thus, it is in the interest of lenders to ensure that the DST due is paid.

(Note: This is part of a series of “How To” articles. These articles intend to give the reader a general overview of the legal aspects of doing certain things and they will not contain all details regarding the proposed action. There may be changes to applicable laws and regulations after the article is posted. You should consult your lawyer if you wish to take a particular action. See Disclaimer page for additional disclaimers.)