An ESOP Loan and Pledge Agreement is a legal contract between the employee and the company whereby the employee pledges the stocks options due to him for the purpose of taking a loan. The employee has to pay interest on the loan taken by him or her.
This is a tripartite agreement between a lender, borrower, and a trustee. It is the responsibility of the trustee to ensure that the loan is repaid on time. The lender is the company, the borrower is the employee and the trustee is a bank or financial institution. The employee stock options are restored once the loan along with interest has been paid in full by the employee.
When Do You Need ESOP Loan and Pledge Agreement
An ESOP Loan and Pledge Agreement is required when an employee requires a loan and wants to pledge the stock options exercised by them. The purpose of ESOP Loan and Pledge Agreement is for the employee to use the stock options given to them by the company as collateral against a loan. The employee is able to get a loan easily as the lender is the company and does not require to sell the stock options.
The company provides the loan to the employee or borrower as they are assured return of the principal and interest. Once the loan and accrued interest are paid in full, the employee stock options are reinstated. It is a convenient way to get a loan for eligible employees as taking loans from banks and other financial institutions would be time-consuming.
Inclusions in ESOP Loan and Pledge Agreement
Since an ESOP Loan and Pledge Agreement is a tripartite agreement between the lender, borrower, and trustee, it is hence important that their names, as well as the relationship between them, be clearly mentioned.
The ESOP Loan Agreement must include the effective date of the agreement, the percentage of shares being pledged, principal amount, interest, duration of the loan, the effective interest rate of the loan, the pledge, representations and warranties of the pledgor, eligible collateral, delivery, event of default, payment in full, no waiver, binding effect, no assignment or delegation, governing law, notices, security, use of proceeds of the loan, indemnification, interpretation, construction and prepayment clauses.
The governing law relates to the state in which the agreement is being made and the agreement should be in compliance with these laws. The penalties in the event of default should be clearly mentioned.
How to Draft ESOP Loan and Pledge Agreement
The following points should be kept in mind while drafting an ESOP Loan and Pledge Agreement:
- The names of the parties to the agreement as well as their relationship must be mentioned clearly
- The number and percentage of shares being pledged by the employee should be stated
- The compliance with the relevant laws of the state under whose jurisdiction the agreement is being made
- The total loan amount which includes the principal and the outstanding interest should be mentioned
- Details of the repayment schedule should be stated in the agreement
- The rights and obligations of the borrower also need to be mentioned
- The lender’s right in event of default must be clearly stated
- The conditions which lead to default should be stated along with the penalty
- The rights and responsibilities of the trustee must be mentioned
- A clause regarding the prepayment of the loan, mentioning penalties, if any
Benefits of ESOP Loan and Pledge Agreement
The benefits which accrue on having an ESOP Loan and Pledge Agreement are:
- The employee is provided a hassle-free loan from the employer with better terms and conditions compared to the bank
- The employee is merely pledging his or her stock options and not selling them. When the employee repays the loan, then the stock options are restored
- The employer has no risk when it comes to providing the loan as they have the stock options as collateral
Consequences of not having an ESOP Loan and Pledge Agreement
The following are the consequences of not having an ESOP Loan and Pledge Agreement:
- The employer will have a difficult time realizing the principal amount of the loan, not to mention the principal
- There will be a negative impact on the relationship between the employee and the employer. This could lead to either termination of employment or resignation by the employee
- The facility of pledging stock options would be withdrawn
Key terms of ESOP Loan and Pledge Agreement
The key terms of ESOP Loan and Pledge Agreement are:
- Purpose of the pledge: The purpose of pledging the stock options by the borrower should be clearly stated including the number of stocks options being pledged
- Payment schedule: The payment schedule of the borrower should be clearly mentioned including the total amount of the loan, the duration of the loan as well as the effective rate of interest.
- Collateral: The pledged shares including the rights that accrue to such shares
- ESOP: The Employee Stock Option Plan of the company
- Event of default: The event that is defined in the agreement
- Liabilities: This relates to all the obligations of the pledgor to the pledgee
- Pledged shares: Shares of common stock of the company against which the loan is being taken
- Delivery: The responsibility of the pledgor to deliver the shares to the pledgee
Download ESOP Loan and Pledge Agreement
If your employee decides to pledge their stock options to take a loan, then a ESOP Loan and Pledge Agreement is advisable.
You can download a sample ESOP Loan and Pledge Agreement here.
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