Lesson 6 of 20 · 6 min
Term six: the lender may sell pledged securities
The remedy for a shortfall is a sale the lender executes, choosing what goes and when.
The sixth term is the remedy. If cover is not restored, the lender may sell pledged securities to restore it. This is the clause that converts everything else in this track from paperwork into consequence.
Three specifics of the clause matter, and they are usually stated plainly once you look for them. The lender selects which securities to sell. The lender selects the timing and the order. And the lender is generally not obliged to obtain any particular price, only to act in a commercially reasonable manner, which is a much weaker standard than getting a good outcome.
Combine that with the forced-sale multiple from Track 1 lesson 9 and the shape of the outcome is determined. At a 70 percent threshold each dollar of shortfall requires selling 3.33 dollars of collateral, because the sale reduces the numerator and the denominator together. The lender is solving for a restored ratio, so it will sell what is most liquid and most easily valued — which is typically your best and most marketable holdings rather than the ones you would part with.
The tax consequence from Track 1 lesson 18 attaches here too. Lot selection is not yours, so a long-held low-basis position can be liquidated in a down market, realising a large gain at the worst moment, with the resulting tax bill a fresh cash need for someone whose liquid assets are pledged.
The remedy clause is short and it is the whole mechanism. Everything else in the agreement describes when it may be used.
Key terms
- Right of sale
- The lender's contractual authority to sell pledged securities to restore cover. Includes selection of which positions and when.
- Commercially reasonable
- The usual standard governing how a lender must conduct a sale. It requires reasonable process, not a favourable price.
- Liquidation preference by liquidity
- The tendency for the most marketable holdings to be sold first, because they restore the ratio fastest.
Worked example
Who chooses what, in one shortfall
Collateral value $420,000, balance $310,000, threshold 70%. Holdings: $250,000 broad fund, $120,000 long-held single stock at a low basis, $50,000 recent purchase near cost.
- Permitted balance
- $294,000
- Shortfall
- $16,000
- Collateral to sell at 3.33×
- $53,333
- Position you might have chosen
- The recent purchase, $50,000 near cost
- Position most likely sold
- The broad fund, or the low-basis stock
- Who decides
- The lender
A $16,000 shortfall becomes a $53,333 sale, and the choice of which $53,333 belongs to the party solving for the ratio.
Check yourself
A $16,000 shortfall at a 70% threshold requires selling $53,333 of collateral. Why so much, and who picks the positions?
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Educational only. Nothing in this lesson is investment, legal or tax advice, or a recommendation to enter into any transaction. Figures are illustrative and computed from the inputs stated in the lesson.