What if the seller demands a share pledge instead of a promissory note?

When a seller is paid over time, the buyer may owe a vendor take-back balance. A promissory note is the buyer’s promise to pay. A share pledge gives the seller a security interest in shares as backup if payment stops. The two do different jobs, so the first question is whether the seller wants the pledge in place of the note or alongside it. Confirm what obligation the pledge secures before agreeing to anything.

Investment property and control

Ontario’s Personal Property Security Act defines investment property as a security, whether certificated or uncertificated, a security entitlement, a securities account, or a futures contract or account, and gives “security” the meaning it has in the Securities Transfer Act, 2006. Ask your lawyer to confirm the pledged shares fall within that definition. A security interest in investment property may be perfected by control, under section 22.1. Other provinces have their own statutes, such as the Personal Property Security Acts of New Brunswick and Alberta, so ask your lawyer which one governs your shares.

Control and ranking

The same Ontario Act, in section 30.1(2), says a security interest of a secured party having control of investment property has priority over a security interest of a secured party that does not have control of it. Under that rule, a pledgee with control would rank ahead of a lender without control who only registered. If your bank also wants security over the same shares, ask whether the seller and the bank will set out ranking in writing; section 38 lets a secured party subordinate its security interest to any other security interest.

Terms to settle before you agree

• Which shares are pledged: the shares you are buying, your holding company’s shares, or both.
• Who votes the shares and receives dividends while the pledge stands.
• What counts as default, and what notice and cure period you get.
• How the seller may enforce, and whether you keep the right to pay out the balance early and take the shares back.
• Whether your senior lender permits the pledge at all.