Lenders who take security interests in securities accounts are familiar with the rules of Articles 8 and 9 of the Uniform Commercial Code that identify the governing jurisdiction for these transactions. Commencing April 1, 2017, those lenders and their counsel may also have to consult the Hague Convention on the Law Applicable to Certain Rights in Respect of Securities Held with an Intermediary (the “Convention”).[1] While lenders involved in cross-border transactions will definitely need to factor the Convention into their thinking, a lender that believes it is only involved in U.S. financings will also need to understand the rules of the Convention.
The Convention
Drafting of the Convention was suggested as early as 2000, as being necessary to provide clear international conflicts of laws rules to determine the law applicable to interests in securities (including transfers as well as security interests) that were held by a securities intermediary. The Convention was finally promulgated in 2003 but did not become effective until April 1, 2017.[2] While the Convention addresses issues between nations (referred to as “States” in the Convention) it may also affect selection of the applicable state of the United States (referred to as “territorial unit of a Multi-unit State”) in certain instances. An obvious cross-border transaction, such as one involving a foreign entity as debtor, will be subject to the Convention. However, as the Explanatory Report notes, the Convention applies to all situations that relate in any way to more than one country, such as deriving “from one of the parties, from a governing law clause, or from any other element.”[3] Those parties could include the debtor, the secured party, the intermediary, the issuer of any security entitlement, or an adverse claimant.[4] Thus, since a securities account may include securities entitlements of a foreign issuer, or since an adverse claimant may arise from a foreign jurisdiction, lenders and their counsel may decide that it is prudent to assume that the conflicts of laws rules of both the Convention and the Uniform Commercial Code may apply in their transactions.
Perfection of Security Interests in Securities Held by a Securities Intermediary; UCC Rules
Under Section 9-106 and Section 8-106 a secured party may perfect a security interest in securities held by a securities intermediary (such as a broker) by control. In addition, the lender may perfect by filing a financing statement pursuant to Section 9-312, although a secured party that perfects by control has priority over a secured party that does not have control.
Section 9-305(a) currently provides the choice of law rules to determine which U.S. state’s law governs perfection and priority of securities that are held in a securities account. That provides that the local law of the securities intermediary as specified in Section 8.110(e) governs that question. However, the applicable state for filing a financing statement remains the state in which the debtor is located under Section 9-305(c).
Effect of the Convention on UCC Rules
Now lenders may have to look outside of UCC Articles 8 and 9 in order to determine which state will govern whether control has been established, whether a financing statement was filed in the proper jurisdiction, whether a secured party has priority over other claimants, and other issues in connection with the creation and enforcement of security interests in securities held by intermediaries. While the Convention only establishes choice of law rules and does not attempt to impose substantive provisions on the contract between the parties, the choice of law can be extremely important in establishing the rights of the secured party.
The primary rule of the Convention, as noted in its Article 4, is that the law chosen by the parties to govern as reflected in their account agreement will be applicable. While this is not unlike the rule of Section 8.110, Article 4 requires that the intermediary have an office in the chosen country that monitors or administers certain actions with respect to the securities account and requires that the account agreement itself (not some later or ancillary document) select the laws of the particular jurisdiction to govern the transaction. Those additional steps are not currently the rule of Section 8.110. If the securities intermediary does not have the requisite contact with the country, or if the parties did not select the law of a particular jurisdiction in the account agreement, Article 5 provides a number of “fall back rules” to determine which jurisdiction would govern the relationship.
As a result of the rules of the Convention, the ability to rely upon the “jurisdiction of the intermediary” as is typically provided in an account control agreement under the Uniform Commercial Code will no longer suffice for that determination. Due to the additional requirements of Article 4 it is possible that the law chosen by the account owner and the intermediary would not be effective. It is also possible that the account agreement that is to govern the choice of law is difficult to locate, may have been amended multiple times, or may have selected different jurisdictions from time to time. Lenders will not want to default to the fall-back rules of Article 5 of the Convention. While the rules on perfection by control are sufficiently uniform among the various states that the effectiveness of control will likely not be adversely affected, the possible application of a different jurisdiction than would govern under the Uniform Commercial Code adds a layer of complexity for opinion givers and opinion recipients. Now both the Convention and the Uniform Commercial Code may need to be consulted to determine whether loan closing opinions covering all applicable jurisdictions have been received. Opinion givers may be concerned that the laws of their respective jurisdictions that may have governed control prior to April 1 will no longer be the applicable laws.[5] Lenders and their counsel may require amendments to account agreements and other curative agreements from both the debtor and the securities intermediary to reduce the uncertainties surrounding these issues.
[1] The complete title of the Hague Convention is “36. Convention on the Law Applicable to Certain Rights in Respect of Securities Held with an Intermediary”. The text of the Hague Convention is available at https://www.hcch.net/en/instruments/conventions/full-text/?cid=72.
[2] The history of the Convention as well as an extensive review of its applications is available in an Explanatory Report which may be obtained at https://www.hcch.net/en/publications-and-studies/details4/?pid=2955 (the “Explanatory Report”).
[3] Explanatory Report at 60.
[4] Explanatory report at 54, 60.
[5] The Permanent Editorial Board of the UCC is preparing a PEB Commentary to alert practitioners of this issue. A 2013 draft of the PEB commentary is available at https://www.ali.org/permanent-editorial-board-ucc/. A more recent draft is being circulated but has not yet been posted for public comment.
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