An equity pledge agreement enables a promoter to raise finance and avail loans by pledging his/her shares to a third party lender. A pledge agreement can be in the form of a standard template, maintained by companies, or can be a tailor-made document. Clauses must be in compliance with the applicable law. One must be thorough with corporate law principles before one sets out to draft this agreement.
What is the Equity Pledge Agreement?
Equity is an interest in the company held in the form of shares. An equity pledge agreement or a share pledge agreement, as it is otherwise called contract between the equity holder and a third party to pledge the shares in lieu of money. This is typically done to raise finance for the company. Such finance may be used for fresh acquisitions, meeting the needs of working capital, etc. An equity pledge agreement is typically a tripartite agreement, that is, it is between three parties: The lender, borrower, and the pledgor. The pledgor is typically the promoter of the company, the lender is a bank/financial institution, and the borrower is the company.
Purpose of the Equity Pledge Agreement
Such contracts are typically entered into in order to raise funds for companies by their promoters. It is a safer method for meeting financing needs than selling the equity interest altogether. It also helps in recording the terms and conditions of a share pledge transaction in a simple and effective manner. It enables the promoters to raise money without losing control over their company. A share pledge agreement is required by the lender, the borrower, and the pledgor. It is to be noted that a pledgor and a borrower may not be the same persons or entities.
Inclusions in Equity Pledge Agreement
An equity pledge agreement, like any other contract requires some basic inclusions. One of the first things that need to be taken into account is the names of parties. This becomes important in this context, as this is a tripartite agreement. The effective date, the date of invocation, the conditions for redemption, jurisdiction, choice of law, limitation of liability, indemnity, etc. are some other clauses that need to be included in an equity pledge agreement.
Key terms of the Equity Pledge Agreement
The following key terms need to be included in a contract for pledging of shares:
- Purpose of the pledge: A clause clearly stating the purpose behind the pledge should be included in the contract. It is important that the number of shares and the percentage it constitutes get clearly reflected in the agreement.
- Representations: Some major representations in such an agreement are:
- Condition of the pledged shares
- Corporate approval
- Legal compliance
- No encumbrance
- Good title
- Invocation of the pledge: The event which would trigger the invocation of the pledge by the lender should be mentioned in the contract. For example, “The lender shall send an advance notice 15 days prior to invoking the pledge”. Default events may be negotiated.
- Timeline for redemption: The timeline for the redemption of shares by the borrower should also be mentioned in the agreement. This may be negotiated.
Drafting an Equity Pledge Agreement
The following guidelines may be followed for drafting an effective share pledge contract:
- Include the names and relationships of the three parties involved very clearly.
- Default events for invocation should be mentioned properly
- A standard draft with specifics of the facts and circumstances should be kept handy by the companies.
- The number of shares being pledged should be mentioned clearly. This should also reflect the percentage of the total equity share capital.
- The termination events and the timeline for redemption should be included in the contract.
- The language should be simple, crisp, and clear.
- Reference to compliance with applicable laws should also be there.
- The percentage of equity should also be included in the agreement.
- This is an agreement with potential for negotiation; hence every clause should be negotiated properly before being included.
- The remedies included in the contract should be as wide as possible. A provision for injunctive relief should also be provided.
Equity Pledge Agreement Benefits
The advantages of a share pledge contract are the following:
- It provides a good ground to the promoters to raise finance for certain activities of the company.
- It clearly mentions the rights and obligations of all the three parties and hence avoids future disputes.
- It takes care of all exigencies and provides a proper schedule and timeline for redemption and invocation of pledge.
- The fact that certain representations and warranties will be mentioned in the agreement would provide security and assurance to the lender.
- It is an easy way for the company to expand and grow.
- A pledge does not result in complete sale till the time no default occurs. Hence, there is no external interference from the investor.
A share pledge agreement is the bible document that governs the relationship between the pledgor, borrower, and the lender. Being a tripartite agreement, its construction and drafting requires special attention. Negotiations too occur on a multi-party basis. A violation of the same would entail the invocation of the dispute resolution clause. The arbitration may be a preferred method. One may also resort to injunctive remedies in the event an interim relief is required.
Sample for Equity Pledge Agreement
A sample of the agreement can be downloaded from below.
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