The Securities Transfer Act, 2006 (the "STA") came into force in Ontario on January 1, 2007. The legislation is intended to be a first step towards the establishment of a uniform approach to the transfer and pledging of securities across Canada, with similar legislation to be introduced in the other Provinces over time. Currently, Alberta is the only other Province to have enacted similar legislation.
The provisions of the STA, and various related amendments to the Personal Property Security Act (Ontario) (the "PPSA") and Business Corporations Act (Ontario), will now require lenders to reconsider how they take security in shares and other securities and, in particular, in circumstances where the shares or securities in question are held indirectly by a borrower through an intermediary, such as a securities dealer or broker.
This Bulletin will attempt to briefly highlight certain key concepts of the STA relevant to lenders taking a security interest in securities. The legislation is relatively complex and, consequently, this Bulletin is not intended to be a detailed discussion or analysis of the STA. Feel free, however, to contact us should you have any questions or require further information.
Taking a Pledge of Securities
Under the new legislation, perfection of a lender’s security interest in "investment property" (which term is defined by the PPSA to include both directly and indirectly held securities) is now determined with reference to the concept of "control". Registration under the PPSA still perfects such security interests, but control is preferable because it takes priority over registration. "Control" under the STA is achieved differently, depending upon whether the securities are held directly (e.g., registered in the name of the pledgor as owner) or held indirectly (e.g., held by one or more intermediaries such as a clearing agency, broker, or custodian), and whether such securities are certificated or uncertificated.
(a) Directly Held Securities
To perfect a security interest in directly held certificated securities, not much will change from the existing practise. Lenders in this instance should continue to perfect their security interest by registering under the PPSA and, in addition, effect "control" over the shares pledged by taking possession of certificated securities, endorsed for transfer. The additional step of taking control over the securities will afford the lender a right in priority to that of another secured party that perfects its security interest only by registration under the PPSA. It is also possible to perfect a security interest in certificated securities by simple "delivery" – i.e., taking possession of an unendorsed certificate. However, this does not constitute "control" and so does not afford as high a degree of protection to the lender.
In the case of directly held uncertificated securities, lenders may continue to perfect their security interest by registration under the PPSA. However, in order to obtain a better ranking security interest in the securities, the lender will need to effect "control" over the securities by having the same transferred into its name or by entering into a control agreement with the issuer (see discussion below re: control agreements).
(b) Indirectly Held Securities
In the case of indirectly held securities (known as "security entitlements"), a lender may obtain "control" by: (i) becoming the entitlement holder (essentially having the lender noted on the records of the intermediary as the holder of the security entitlement), (ii) entering into a control agreement with the securities intermediary, or (iii) having a third party take control of the security entitlement on the lender’s behalf (using method (i) or (ii)).
(c) Conflict of Laws
The STA and PPSA also have new "conflict of laws" rules for determining where security interests must be perfected. Perfection by registration is still governed by the location of the debtor (e.g., its chief executive office). However, the jurisdiction governing perfection by control depends on the form of collateral. For certificated securities, it is the location of the certificate. For uncertificated securities, it is the jurisdiction of the issuer (determined by the statutory rules) and in the case of security entitlements, it is the securities intermediary’s jurisdiction, which is determined by a "waterfall" of tests set out in the STA.
Perfection of a security interest in uncertificated securities or security entitlements can be effected through an agreement whereby the issuer or the securities intermediary, respectively, agrees with the secured party to take instructions from the secured party without any further consent being required from the pledgor. The pledgor can still retain the right to deal with the securities, but usually the secured party will want to have exclusive control on and after the occurrence of an event of default. While the concept seems simple enough, as a practical matter, there are challenges to consider:
- First, there is no requirement for a securities intermediary to enter into a control agreement and, consequently, unless the pledgor can convince the securities intermediary to do so, this method of perfection may not be available to a lender.
- Second, unlike registrations effected under the PPSA, there is no public notice given of control agreements entered into. As noted below, the priority of security interests perfected by control agreements is determined by when the agreement was entered into. Consequently, an undisclosed control agreement could take priority over a lender’s security interest. As a result, lenders taking security over uncertificated or indirectly held securities will need to ensure that proper due diligence is conducted in order to confirm the existence of any control agreements and their terms.
Priority – In a "Nutshell"
In simplified form, with the introduction of the new legislation, priorities among secured parties with perfected security interests in the same investment property collateral are determined as follows:
- security interests perfected by control will rank in priority over security interests perfected only by registration under the PPSA or simple delivery.
- where two or more security interests are perfected by control, priority is determined according to the order in time that control was obtained.
- a securities intermediary has priority in the security entitlements it maintains over the security interests of other secured parties, unless it agrees otherwise.
The PPSA provides that if a security interest was perfected prior to January 1, 2007, that security interest will continue to be perfected so long as the prior method of the perfection would be sufficient to perfect the security interest under the new legislation. Where the old method of perfection would no longer be sufficient to perfect the security interest under the new legislation, the secured party will be given four months (commencing from January 1, 2007) within which to perfect its security interest in accordance with the new rules. In most cases, a security interest that was perfected prior to the STA coming into force will continue to remain perfected under the new legislation.
However, as noted above, perfection is not tantamount to priority. Given the introduction of the concept of control, lenders should now consider whether, depending upon the nature of the securities in question, any additional steps should be taken in order to better protect their interest in, and to obtain the requisite priority over, the securities to be pledged in their favour.
The foregoing provides only an overview. Readers are cautioned against making any decisions based on this material alone. Rather, a qualified lawyer should be consulted.
© Copyright 2007 McMillan Binch Mendelsohn LLP