On April 1, 2017, the Hague Convention on the Law Applicable to Certain Rights in Respect of Securities Held with an Intermediary (the “Convention”) became effective in the United States. While Canada has not yet ratified the Convention, it is important for Canadian financing practitioners to become familiar with the new rules thereunder.
The Convention’s primary objective is to provide for a uniform set of rules applicable to the determination of the law governing the perfection and priority of security interests encumbering security entitlements held in a securities account by a securities intermediary1. While the Convention supersedes the conflict of laws rules of the Uniform Commercial Code (“UCC”), it has no effect on the substantive law that will apply once the choice of law determination has been made2.
UCC Conflict of Laws Rules Applicable Before the Convention3
Before April 1, 2017, the conflict of laws rules applicable to the perfection, the effect of perfection, and the priority of a security interest in security entitlements were determined by Articles 8 and 9 of the UCC. Under such rules, the “local law of the securities intermediary’s jurisdiction” governed the perfection, the effect of perfection and the priority of a security interest encumbering security entitlements4. However, the “local law of the jurisdiction in which the debtor is located”5 governed the perfection by filing of such security interest6.
In most cases, the securities intermediary’s jurisdiction7 is expressly set out in the agreement8 governing the securities account entered into between the entitlement holder and the securities intermediary.
Conflict of Laws Rules Provided by the Convention
Under the Convention, the relationship between an account holder and its securities intermediary is the determining factor. The objective is to give effect to the express agreement of the parties to an Account Agreement regarding the law governing the issues dealt with by the Convention. Unlike the twofold approach of Articles 8 and 9, the law determined by the Convention will govern the perfection, the effect of perfection as well as the priority of the security interests encumbering security entitlements held by a securities intermediary.
Under the Convention’s primary rule9, the applicable law is the governing law of the Account Agreement, unless the parties have expressly chosen another law to apply to the specific issues governed by the Convention (which includes the perfection, effect of perfection and priority of security interests)10.
In order for the Convention’s primary rule to apply, the securities intermediary must have an office that deals in securities or engages in the activity of maintaining securities accounts11 in the selected jurisdiction (the “Qualifying Office Requirement”).
If the primary rule does not find application, the following three fall-back rules would apply, and the applicable law would be:
- the law of the jurisdiction of the office through which the securities intermediary entered into the Account Agreement12, if the securities intermediary otherwise complies with the Qualifying Office Requirement; or
- if paragraph (i) does not apply, the law of the jurisdiction of incorporation or organization of the securities intermediary; or
- if the law applicable is not determined under either paragraph (i) or (ii) above, the law in which the securities intermediary has its place of business (or if the securities intermediary has more than one place of business, its chief executive office).
Finally, the Convention provides for transitional rules that are only applicable if the securities intermediary meets the Qualifying Office Requirement at the time the Account Agreement was entered into.
Practical Examples of the Impact of the Convention on Cross-Borders Transactions
Generally speaking, Canadian conflict of laws rules on security interests in security entitlements provide for a regime that mirrors Articles 8 and 9 of the UCC. Such rules are set forth in the applicable Personal Property Security Act and Securities Transfer Act13 in most provinces other than Quebec, where the Civil Code of Québec14 applies.
While the Convention aims to simplify the determination of the law applicable to investment securities, the following three examples illustrate the impact of the application of the conflict of laws rules of the Convention on cross-borders secured lending transactions15.
In all of the foregoing examples, unless the Account Agreement is amended to fall within the scope of the primary rule, a secured party would want to perfect its security interest in the State of New York to ensure that same remains validly perfected.
Key Distinctions Between the Rules of Articles 8 and 9 and those of the Convention
Under the Convention, “securities” are specifically defined to exclude “cash”16 held in a securities account. Further, the Convention does not deal with security interests encumbering directly held securities (i.e. not held through a securities intermediary). Accordingly, the conflict of laws rules of Articles 8 and 9 of the UCC continue to apply to both instances.
The Convention’s primary objective is to simplify cross-borders transactions by providing certainty and predictability regarding the law applicable to holding and transferring of securities held by an intermediary.
While the modification to the conflict of laws rules does not constitute a major upheaval in the Canadian legislative scheme, practitioners involved in taking a security interest over security entitlements with a nexus to the US should ensure that the application of the Convention will not detract from the outcome that was expected before the implementation of the Convention. To avoid having to rely on the fall-back rules, parties to an Account Agreement may want to amend same to fall within the scope of the primary rule, bearing in mind the Qualifying Office Requirement.
In the future, considering that a secured party does not typically enter into the Account Agreement, it will want the parties thereto to covenant not to amend the governing law of same without notice to (or written consent of) the secured party. As indicated above, an amendment to the governing law of an Account Agreement could have a material impact on the perfection, effect of perfection and priority of the secured parties’ security interest.
The Uniform Law Conference of Canada (ULCC) will no doubt take into account United States’ adoption of the Convention when it will hold its annual meeting in August 2017. Since Canada participated in the negotiation of the Convention more than ten years ago, and given the overall similarities of its secured lending laws and those of the United States, it is expected that Canada will ratify the Convention in the near future.