What Is Bonded Stock and How Is It Used?

The term “bonded stock” has different interpretations. While it commonly refers to goods in a customs bonded warehouse, in the financial world, it takes on a distinct meaning. This article clarifies “bonded stock” as shares of a company’s equity held under specific restrictions. These restrictions typically arise when shares are pledged or held as security to guarantee an obligation or secure a financial arrangement.

Defining Bonded Stock

Bonded stock refers to shares of a company’s equity that are not freely transferable because they are held as security or collateral. These shares are placed under specific conditions to ensure a future obligation is met. Unlike a bond, which is a debt instrument, bonded stock still represents ownership in a company. A bond signifies a lending relationship, while stock signifies an ownership stake.

When shares are bonded, they are often either pledged as collateral for a loan or held in an escrow account. Pledged shares mean ownership remains with the shareholder, but they are given to a lender as security. If the borrower defaults, the lender can sell these shares to recover the outstanding amount. Escrowed shares are placed with a neutral third party, an escrow agent, until predefined conditions are satisfied.

Common Uses of Bonded Stock

Shares are frequently bonded to secure various financial arrangements and contractual obligations. One prevalent use is as collateral for loans, known as securities-backed loans or pledged-securities mortgages. Borrowers can leverage their investment portfolios, including stocks, to obtain credit lines, often at lower interest rates than unsecured loans, without having to sell their holdings. Lenders typically advance funds amounting to a percentage of the pledged shares’ value, such as 50% to 70%, depending on the type of security and the lender’s criteria.

Another common application involves using shares as performance guarantees, particularly in executive compensation plans. Companies may grant performance stock units (PSUs) or performance stock awards (PSAs) where the number of shares received depends on achieving specific company performance targets, like earnings per share or sales growth. These shares are often held in escrow and only vest, or become fully owned and transferable, once performance conditions and service periods are met.

Shares are also often held in escrow during mergers and acquisitions (M&A) to mitigate risks. A portion of the shares may be placed in escrow to cover potential liabilities, indemnification claims, or to ensure post-closing conditions are satisfied. This provides recourse for the buyer if the seller breaches an agreement or unforeseen issues arise. The escrow agent ensures shares are protected and released only upon fulfillment of contractual obligations.

Shareholder and Company Considerations

The bonded status of shares significantly impacts typical shareholder rights. While legal ownership of pledged shares may remain with the shareholder, their ability to freely trade or sell these shares is restricted. For escrowed shares, control is restricted by the escrow agreement, preventing premature sale or leveraging.

Shareholder rights such as voting and receiving dividends can also be affected. For pledged shares, the original shareholder generally retains voting rights and the right to receive dividends, unless specified in the loan agreement. For escrowed shares, voting rights and dividend entitlements depend on the specific terms of the escrow agreement. If the conditions for which the stock was bonded are not met, the consequences can be severe.

Failure to meet obligations secured by bonded stock can lead to forfeiture or seizure of the shares. In a loan scenario, if a borrower defaults, the lender can liquidate pledged shares to recover the debt. If conditions for escrowed shares are not fulfilled, the shares may be returned to the original issuer or used to compensate the aggrieved party. From the company’s perspective, managing bonded shares requires careful administrative oversight to track restricted shares and ensure compliance.