Forthcoming changes in legislation regarding transfers of securities will result in significant changes to the law regarding pledges of shares under the Personal Property Security Acts of Ontario and Alberta (referred to below as the "PPSA"), and probably changes to similar legislation in other provinces.
New Regime: Securities Transfer Acts
The Securities Transfer Act, 2006 (Ontario) and the Securities Transfer Act (Alberta) (collectively referred to below as the "STA") each received Royal Assent in May 2006 and will come into force on proclamation. It is expected that proclamation will occur in early 2007. These Acts are based on the Uniform Securities Transfer Act developed by the Canadian Securities Administrators’ USTA Task Force as a joint project with the Uniform Law Conference of Canada. They introduce a new regime that is intended to bring Canadian law regarding transfers of securities up to date by better reflecting market practices that have moved away from the issuance of certificates for publicly-traded securities to various book entry systems.1 It is hoped that similar legislation will be adopted quickly in other provinces, including Quebec.2
The PPSA amendments introduce several new concepts, many by reference to the definitions or concepts in the STA. These include the following:
(a) "financial assets" is an STA term that includes certificated or uncertificated securities and may include credit balances and other property held in a securities account;
(b) "securities accounts" is an STA term for accounts in which financial assets are held by "securities intermediaries" (a clearing house or a person such as a broker, bank or trust company that maintains such accounts) for "entitlement holders" (those who hold securities entitlements);
(c) "securities entitlements" is an STA term for rights arising from book entry credits of financial assets made by securities intermediaries in securities accounts; and
(d) "investment property" is the PPSA term that is the subject matter of most of the new PPSA provisions and includes securities, security entitlements, security accounts, futures contracts and futures accounts.
The PPSA amendments include changes in the conflicts of law rules relating to investment property. For example, new Ontario and Alberta sections 7.1 provide that the validity, perfection and priority of a security interest in investment property shall be governed by the law, at the time the security interest attaches, (i) of the jurisdiction where the certificate is located if the collateral is a certificated security, (ii) of the issuer’s jurisdiction if the collateral is an uncertificated security and (iii) of the securities intermediary’s jurisdiction if the collateral is a security entitlement or a securities account. Item (i) addresses questions that arise under existing law about whether a certificated security is located where the certificate is physically located or where the issuer is located. Item (iii) incorporates STA provisions that allow the securities intermediary and entitlement holder to contractually determine which law applies.
The PPSA amendments include special rules for attachment and perfection of security interests in investment property. Under amended Ontario section 22 and Alberta section 24, the concept of taking "delivery" of a certificated security will replace the concept of taking "possession" of securities as a method of perfection, although possession remains an important element of delivery. Taking "control" is a key method of perfecting a security interest in investment property generally.
Control is generally determined in accordance with the STA. In the case of a certificated security, it involves endorsement as well as possession of the certificate, except for a bearer certificate. In the case of a securities entitlement, it involves having the entitlement "re-registered" in the name of the secured party or entering into a control agreement with the securities intermediary.
Control agreements have been used in the United States for some time. Using a control account would, for example, allow a lender to obtain security over a securities account maintained by the lender’s customer with a broker. The lender, broker and customer would enter into an agreement concerning the account. The agreement would typically allow the customer to receive income from the account before the lender takes control. It would typically allow the customer to direct trading in the account, although the lender would probably want some limits to reduce the risk of the account being depleted. The key to a control agreement is that the securities intermediary (broker in this example) must agree to comply with orders of the secured party (lender) without the further consent of the entitlement holder (customer). That is, the broker must agree to, for example, turn over the contents of the account to the lender if required by the lender, without further reference to the customer. A control agreement is not, however, a substitute for a security agreement, which will continue to be entered into separately between the lender and customer to grant the required security interest. The control agreement is a method of perfecting the security interest. As before, the lender will also typically file a financing statement under the PPSA naming the customer as debtor.
The STA provides that a securities intermediary may not enter into a control agreement without the consent of the entitlement holder and is not required to do so even if the entitlement holder requests .
The PPSA amendments introduce special priority rules for security interests in investment property. A security interest perfected by control takes priority over one not perfected by control. A security interest held by a securities intermediary in a securities entitlement or securities account maintained with it has priority over a conflicting security interest held by another secured party.
The amendments to the PPSA made as part of the STA are not limited to matters relating to the STA. There are a few unrelated changes. For example, section 11(3) of the current Ontario PPSA regarding attachment of security interests in crops, fish, timber etc. has been deleted.
Finally, the STA contains rules regarding seizure of a security or securities entitlement under the Execution Act (Ontario) and the Civil Enforcement Act (Alberta), as applicable.
In summary, the amendments to the PPSA will result in significant changes and improvements to the law regarding pledges of securities and should greatly facilitate pledging securities held through brokerage accounts, especially if all parties are not located in the same jurisdiction. For example, if a person wishing to pledge securities held in an Ontario brokerage account resides in Mexico, the PPSA currently requires Mexican law to apply in some circumstances, thereby creating difficulties because Mexico does not have a personal property security regime like the PPSA. Under the amended PPSA, the parties will be able to agree that Ontario law applies.
In preparation for the PPSA amendments becoming effective, lenders should, among other things, consider their requirements for control agreements that they will wish to obtain from brokerages in order to perfect pledges of shares held in brokerage accounts.
1. These comments are not intended to cover all of the changes introduced by the STA.Rather, they are limited to the consequential amendments to the PPSA and, even in that area, are by no means exhaustive.
2. A 2004 consultation paper on the Uniform Securities Transfer Act, as well as proposed amendments to the Alberta and Ontario PPSAs, can be found in the Hot Topics section of the Ontario Securities Commission website at www.osc.gov.on.ca. The paper on proposed amendments to the Ontario PPSA contains a detailed commentary on the new priority rules relating to security interests in securities etc.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
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