In February 2012, the Ontario Bar Association, Personal Property Security Law Subcommittee, submitted a proposal to both the Ministry of Consumer Services and the Ministry of Finance (the “Proposal”) to recommend changes to Ontario’s Personal Property Security Act 1 (the “PPSA” or the “Act”). The proposed amendments would bring the PPSA more in line with Article 9 of the United States Uniform Commercial Code (the “UCC”) by allowing a secured party to perfect its security interest in a debtor’s cash collateral by “control” as an alternative to by registration.
Currently the PPSA provides that registration perfects a security interest in any type of collateral. The Act also allows for perfection by possession of a security interest in money, but only while it is actually held as collateral by the secured party, or on the secured party’s behalf by a person other than the debtor or the debtor’s agent. When the Securities Transfer Act, 2006 2 (the “STA”) was proclaimed in force, a secured party became able to perfect a security interest in a certificated security by taking possession of it. More importantly, with the proclamation of the STA, the PPSA was amended to enable a security interest in investment property to be perfected by “control.” Section 1(2) of the PPSA was concurrently revised to define the concept of control and integrate this concept with the types of investment property described in the STA.
The recommended changes to the PPSA in the Proposal would allow a security interest in cash collateral to be perfected by control, using similar concepts to the concepts in the STA and PPSA with which we have become familiar. The rationale for the Proposal, in addition to bringing the PPSA more in line with the UCC and facilitating cross-border transactions, is to provide certainty of priority in security interests in cash collateral.
The proposed amendments to the PPSA are significant and extensive as they address all aspects of this new type of security interest and its attachment and perfection. This paper will focus on the amendments which create the new class of collateral, address perfection by control, provide for priority and enforcement and codify set-off. The cash collateral that will be primarily considered is a deposit account maintained in a financial institution.
- New class of collateral
Although the Proposal contains a number of additional definitions and amendments to existing definitions, there are two significant new definitions, the first being the “financial account” and the second being the “financial institution.” A financial account will be excluded from the current definition of account and will also exclude from its definition, a consumer account. A financial account is defined as a deposit account at a financial institution or a monetary obligation owed by a financial institution to any person in respect of funds held in the financial institution as security, whether securing an obligation to that financial institution or to another person. The definition of financial institution is very broad and includes any type of financial entity that would receive funds, including banks, trust companies, credit unions, insurance companies, pension funds, mutual funds and government organizations that receive cash collateral. As a result, any monies deposited into a bank account or any letter of credit provided to a financial institution would be a financial account.
- Amendment to concept of control
As noted above, control was a concept added to the Act in 2006 to enable implementation of the provisions of the STA and address control of investment property. The Proposal contemplates adding to the definition in subsection 1(2), provisions to deal with control of a financial account. The amendments propose three means of obtaining control of a financial account:
- if the secured party is the financial institution that is obligated to the customer under the financial account, the secured party (i.e. financial institution) will automatically have control.
- if the secured party, customer and the financial institution wherein the customer maintains a financial account, enter into an agreement ( a “control agreement”) which provides that the financial institution will comply with instructions originated from the secured party directing disposition of funds from the account without further consent of the customer, then the secured party will have control.
- if the secured party is the customer with respect to the financial account, then the customer has control.
Based upon the foregoing, if a customer of a financial institution wants to provide security in a bank account or in a letter of credit to a secured party, if the financial institution is willing3, the three parties enter into a control agreement which sets out the respective responsibilities of the parties. This control agreement would be similar to the control agreements currently being used for investment property.
To obtain perfection, the Act requires both attachment and perfection. The Proposal contemplates a new clause to be added to subsection 11(2) of the PPSA, which sets out when a security interest attaches to collateral. The three criteria for attachment remain, with an amendment to add a new reference to a security agreement. So, value must still be given, the debtor must still have rights in the collateral, but, pursuant to the addition of a clause (e), where the collateral is a financial account, the debtor must have signed a security agreement, the secured party has control under subsection 1(2) pursuant to the security agreement and the security agreement contains: (i) a description of the financial account sufficient to enable it to be identified, or (ii) a description of the financial account that describes it as such. So for a secured party to have a security interest in the financial account, there will have to be a control agreement entered into among the customer, secured party and financial institution and this control agreement will have to describe the collateral either by reference to the monies transferred to the financial institution or by reference to the account itself.
An addition to section 22.1 of the PPSA will provide that a security interest in a financial account may be perfected by control of the financial account under subsection 1(2). As a result, in addition to registration, control will be added to the Act as a means to perfect a security interest in a financial account.
By an amendment to section 30.1 of the Act, priority rules will be included for security interests in financial accounts. Subsection 30.1(2) will provide that a security interest of a secured party having control of a financial account will have priority over a security interest of a secured party that does not have control. As well, additions to this section 30.1 set out priorities for security interests in financial accounts, depending upon how control was obtained.
- Conflict of laws
As the Proposal will add a new class of collateral, it will be necessary to determine what law will govern the location of the debtor and what law will govern the location of the security interest in this new class of collateral (i.e. the financial account).
An addition to clause (a) of subsection (5) to section 7.1 will provide that the law of the jurisdiction in which the debtor is located will govern perfection of a security interest in a financial account by registration.
As noted above, since the Proposal sets out how to take control in financial accounts, there is a need to determine the location of the security interest in the financial account. In a manner similar to the STA provisions for determining the location of the securities intermediary, proposed additions to section 7.1 will address the validity of a security interest in a financial account. Briefly, the validity of a security interest in a financial account will be governed by the law, at the time the security interest attaches, of the jurisdiction of the financial institution. Similarly, perfection, the effect of perfection or non-perfection, and the priority of a security interest in a financial account will be governed by the law of the jurisdiction of the financial institution. There are a number of rules for determining the law of the financial institution’s jurisdiction, but the one that will be most used will likely be “the jurisdiction expressly provided for in the agreement is the financial institution’s jurisdiction.”
In addition to the foregoing, and bearing in mind that subsection 8(1)currently provides that (a) procedural issues in enforcement of the rights of a secured party against collateral are governed by the law of the jurisdiction in which the enforcement rights are exercised and (b) substantive issues are governed by the proper law of the contract between the debtor and secured party, a new clause (c) will be added to subsection 8(1) by the Proposal. This new clause will provide that other than the rights in (a) and (b), the rights and duties of a secured party with respect to collateral in its possession or control and any rights or obligations arising from a breach of any such rights, will be governed by the proper law of the contract between the debtor and secured party. Again, this will likely be the control agreement.
The Proposal contains some provisions that clarify current practices in respect of a financial account when a customer defaults. Firstly, the amendments contemplate that unless the financial institution otherwise agrees in writing, that its rights and duties with respect to a financial account will not be terminated, suspended or modified by any of the (a) creation, attachment or perfection of the security interest in the account, (b) the financial institution’s knowledge of the security interest, or (c) the receipt by the financial institution of instructions from the secured party. Secondly, an amendment will provide that upon an event of default, the secured party will be entitled to apply the balance of the financial account to the obligation secured by that collateral. A right of set-off against the financial account to satisfy an obligation owed to the secured party will be specifically set out. Moreover, where the collateral is a financial account, no notice to the debtor will be required under the PPSA before the secured party may take action.
These proposed amendments codify what many financial institutions are currently doing when a debtor defaults and the financial institution has security over the account. However, the Proposal amendments will allow a third party secured party to direct the financial institution in respect of the disposition of the balance in the financial account.
The Proposal provisions will allow a security interest in cash collateral to be perfected by means of control, which will simplify and provide certainty with this type of collateral. As well, the PPSA would again be more closely aligned with the UCC, which will facilitate cross border security transactions. For financial institutions, a number of issues are clarified and they know, with certainty, that if their only security is in respect of an account that is an obligation of that financial institution, that their security interest in that account has priority over a conflicting security interest in the financial account held by a third party…and this is without having to effect a registration in respect of that financial account. We will be monitoring this Proposal to see how it is addressed by the Ministries to whom it has been presented.