Cash is king
The most common liquid asset is cash as it is easily valued and transferred. Cash collateral is the predominant form of collateral used in financial transactions including securities lending, repurchase transactions and over-the-counter derivatives and is used to secure a debtor’s obligations to a secured party. The International Swaps and Derivatives Association has estimated that cash amounts for over 80% of collateral used in derivative transactions. Recognizing the importance and predominance of cash collateral, on February 6, 2012 the Cash Collateral Working Group of the Personal Property Security Law Subcommittee of the Ontario Bar Association recommended changes to the Personal Property Security Act (Ontario) (the “PPSA”).
If adopted, the proposed amendments will create a new class of collateral – a “financial account” – and enable a secured party to perfect a security interest in the financial account by control, using similar means for perfection of investment property under the Securities Transfer Act (Ontario) (the “STA”). “Financial account” is broadly defined to include any form of deposit account maintained by a financial institution, and any other monetary obligation of a financial institution in respect of funds held or received by it as security for an obligation. “Financial institution” is also broadly defined to include every type of participant in financial markets that regularly receives cash collateral. At present, a secured party can only perfect its security interest in cash collateral by registration under the PPSA.
Article 9 and the PPSA
Article 9 of the Uniform Commercial Code (the “UCC”) allows a secured party to perfect its security interest in a debtor’s deposit accounts by control. In the event that the secured party is the financial institution with which the debtor maintains the deposit account, the secured party will have automatic perfection in and control over the account. A control agreement will not be required. A control agreement is also not necessary where the deposit account is in the name of the secured party. Alternatively, the parties enter into a control agreement with the bank that maintains the debtor’s deposit account, setting out the terms and conditions of the secured party’s rights to and control of the deposit accounts of the debtor.
Under the UCC, a first priority security interest over cash in a deposit account is possible by control, however the current PPSA regime does not provide for this. In Ontario, registration is required to perfect the security interest in cash and searches must be performed to ascertain prior creditors for which waivers and subordinations may be required. Given the nature of transactions in the capital markets, this is often a time consuming and costly task. Further, priority is uncertain when registering a security interest in cash collateral under the PPSA’s complex priority rules. Legal opinions cannot be delivered as to priority of security interests in the cash collateral or where such a security interest needs to be perfected. In cross-border transactions, the PPSA conflict of laws rules and Article 9 of the UCC often result in uncertainty as to the jurisdiction governing the validity, perfection and effect of perfection of the security interest in cash collateral. Adopting the Article 9 model is expected to address the issues with the current registration regime in Ontario for perfecting cash collateral.
A made in Canada solution
The proposed amendments are somewhat similar to the approach taken with deposit accounts under the UCC but deviate in certain respects, such as the broad definition of financial accounts. The definition of a financial institution is also broader than that of a “bank” as defined in Article 9. The purpose of the recommended changes to the PPSA is to facilitate the use of cash as collateral for loans and other secured obligations. Currently, under the PPSA cash falls under the definition of an “intangible” or “account”. In order to perfect its security interest under the current PPSA regime, a secured party would have to perfect by registration even though its remedy would be set-off rather than a sale or foreclosure, and notwithstanding the issues noted above.
“Financial account” is a wider class of collateral than the deposit account collateral under the UCC. Similar to the UCC, consumer accounts are excluded from the definition of a financial account. Attachment is expected to occur in the normal course but the proposed amendments provide for perfection by registration (as already provided under the current PPSA regime) and perfection by control. The definition of control is similar to that used in the context of control of a securities and a futures account. The proposed amendments provide for three means of obtaining control of a financial account:
Under the proposed amendments, a secured party that has control over the financial account will have priority over one that does not have control. In the circumstance that the financial account is an obligation of a financial institution which is itself the secured party, that financial institution will have priority over a conflicting security interest of any other party, other than a secured party which gains control by becoming the financial institution’s customer.
Where it comes to conflict of laws, the proposed amendments provide that, as to validity, perfection and priority matters, these matters will be governed by the law of the financial institution’s jurisdiction, consistent with the approach under Article 9.
The proposed amendments will harmonize the PPSA with Article 9 of the UCC (ideally resulting in uniformity in security documentation and perfection methods used in cross-border transactions) and provide consistency with the treatment of investment property under the STA.