Generally, a stock option is treated as exercised at the time
the grantee, usually an employee of the grantor/employer, pays the
strike price and takes possession of the stock, whether actually or
constructively. Sometimes when an employee cannot afford to pay the
strike price, the employer will assist the employee by granting him
or her a loan to cover the cost. Normally, this is not a problem,
but when the loan is a "non-recourse loan" it can have
unintended tax consequences.
Under a non-recourse loan, the employer's only collateral is
the underlying shares subject to the stock option. This means that
if the employee defaults on the loan, the employer can only take
back the shares but cannot go after the employee for anything
beyond the shares. This is significant because it means if the
stock value drops below the loan value, the employee would
presumably purposely default on the loan since there would be no
incentive to pay off a loan only to receive shares of a
