Blue-chip stocks can be attractive collateral for a loan because these securities are liquid and the company whose stocks are pledged has generally enjoyed consistent growth and earnings. A lender whose security is certificated stock, i.e., stock in paper form evidencing the borrower’s ownership of the stock, should take physical possession of the stock certificates from its borrower to properly perfect its security interest. Furthermore, a lender’s physical possession of a certificated security should allow it to prevail against any competing claims of creditors in the same stock. Of course, most secured lenders are well aware of the good reasons for obtaining possession of certificated securities that serve as collateral for a loan.
But secured lenders may be less aware of their rights when a borrower (or someone else) contacts the stock issuer or transfer agent and obtains re-issued shares of the same stock evidenced by the certificate in the lender’s possession. It may be reasonable to assume that a borrower who obtains re-issued shares of certificated stock that has already been pledged to a secured lender is a bad actor. Indeed, the issuer or transfer agent will likely require the person requesting the re-issuance of shares to certify that the certificated stock is not subject to a security interest as a condition of re-issuance. Even so, there are situations where the person seeking re-issuance does so without knowledge of the secured lender’s interest and therefore incorrectly (but unknowingly) certifies that the shares are not subject to any such interest.
Consider a scenario where the shareowner delivers a stock certificate to a lender as collateral for a loan properly made by the lender to a third party, e.g., a business owned by the shareowner. Then the shareowner dies. The executor of the deceased shareowner’s estate may obtain, provided he or she posts an adequate bond, re-issuance of the pledged shares without knowing that the decedent had previously pledged the certificate evidencing the same shares to a lender as collateral. Assume that the executor then sells the shares and uses the proceeds to pay obligations of the decedent. In such a scenario, what is the effect of the stock sale on the secured lender’s interest in the certificate evidencing the same shares of stock that were sold by the executor? Luckily for the secured lender in this case, the certificated security is valid and remains unaffected by the re-issuance of the same stock represented by the certificate held by the secured lender and sold by the executor.
Thus, even though an issuer may contend that the certificate held by the secured lender was replaced by a new certificate as a result of the re-issuance requested by the executor, the issuer must still recognize the original certificate that the deceased borrower-shareowner delivered to the lender as collateral for the loan. As between the secured lender and the stock issuer, the law places the risk of loss with the issuer because the issuer is in the best position to assure that the securities were properly re-issued. Therefore, under the scenario described, the secured lender has the right to demand that the issuer transfer registration of the original certificate to the lender and the lender may then liquidate the shares and apply to the proceeds to the balance of the loan.
All is not lost for the issuer, however; it can pursue claims against the executor who obtained the re-issued shares and can make a claim on the bond posted by the executor in connection with the re-issuance of the shares at issue.
Christopher Markus is a Northern Kentucky attorney practicing at Dressman Benzinger LaVelle psc.
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