In secured financing transactions, cash is a popular and useful form of collateral. It is fully liquid, readily available and transferrable, and its value is always known. A debtor holding cash in a deposit account may wish or be required to use it as collateral for obligations such as loans, repurchases and derivative transactions. In order to maintain a perfected security interest in this cash collateral, a lender or agent will need to adhere to the applicable methods of perfection as set forth under the applicable provincial personal property security legislation (the “PPSA”). For the reasons outlined below, cash collateral can at times create uncertainty when it comes to perfection.
Methods of Perfection
Generally speaking, the PPSA provides for perfection against collateral by, among other means, “registration”, “control” and “possession or repossession” and the nature of the collateral influences the method of perfection. In most provincial PPSAs, perfection of a security interest in cash collateral (or “money” or “accounts” as it is sometimes referred to in the PPSA) can be perfected by registering a financing statement or by possession or repossession. In Canada, registration is typically the method which is used and relied upon for perfection purposes.
This can sometimes render the use of cash, a liquid form of collateral, impractical from a credit support perspective. Perfection by registration can create uncertainty, including the following issues:
- Priority rules relating to security interests perfected by registration are less straight forward, meaning that legal opinions containing a priority opinion may not always be clear; and
- The registration process, while relatively straightforward, can be time consuming and costly if estoppel letters or other types of no-interest or priority agreements are required.
Calls have been made in recent years for a systematic change which would provide legal certainty for secured parties holding cash as collateral. Under the PPSA, “investment property” – which include securities accounts – can be perfected by control. Control over the securities can be obtained by way of physical possession of the certificates representing the securities (in the case of certified securities) or the execution of a “control agreement” in the case of uncertificated securities.
The U.S. Example
Article 9 of the Uniform Commercial Code (the “UCC”) provides for perfection of the cash deposit accounts of a debtor by “control”. In the U.S., each state has adopted Article 9 of the UCC with minor variations. Control of a deposit account will be obtained if (i) the secured party is the bank with which the deposit account is maintained; (ii) the debtor, secured party, and the bank enter into a control agreement; or (iii) the deposit account is in the name of the secured party. This means that if the secured party is a bank which also holds the debtor’s cash deposit accounts, it’s security interest will automatically be perfected as it controls those accounts. In cross-border lending transactions we often see deposit account control agreements used, however a control agreement is only necessary to perfect where the secured party is not the same entity as the bank holding the debtor’s cash deposit accounts. Nonetheless, unlike the current PPSA system registration or other formalities under the U.S. framework are not required to perfect the security interest. This has resulted in a competitive disadvantage for Canada, as secured lenders and swap counterparties have increasingly chosen to escape the Canadian PPSA regime and take their business across the border.
Proposed Changes to the PPSA
In 2012, the Ontario Bar Association proposed amendments to the PPSA which would follow the U.S. example, recommending that the PPSA provide for perfection by control of security interests in cash collateral accounts. The recommendation includes a proposal which would create a type of collateral known as a financial account that would permit perfection by control and provide that a secured party with control of such collateral has priority over another that does not have control. In a 2015 panel led by the Ontario Ministry of Government and Consumer Services, it was similarly recommended that the PPSA be amended to facilitate the use of cash as effective and reliable collateral which could be done in two ways: (i) firstly, by allowing security interests in deposit accounts to be perfected by “control”; and (ii) providing that when so perfected, the security interests have clear and certain priority over competing interests.
Uncertainty can be created by a perfection system where financing statements or possession is required in order to perfect a security interest in cash collateral. Under the changes which have been put forward by various stakeholder groups, a secured party who controls the account would have priority over any other party which does not have control. If the proposed amendments are adopted, the UCC and PPSA regimes would align to create a much-needed consistency in cross-border transactions.
The author would like to thank Nazish Mirza, summer student, for her assistance in preparing this legal update.
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