Our post of December 9, 2014 introduced the proposed modifications to the Civil Code of Québec (Civil Code) in Bill 28 to permit, among other things, pledges over cash collateral. The proposed modifications were adopted in final form on April 21, 2015 and will come into force on January 1, 2016.
There were some important last-minute modifications to Bill 28 which clarify a number of rules:
- the consent required for a Québec counterparty to grant a pledge to a creditor that is also the debtor of the monetary claim need not be in writing;
- Control agreements also do not need to be in writing;
- A secured party will be able to obtain control of a financial account by becoming the account holder and this will give it priority over other secured creditors that may have control;
- the realization regime for these pledges will not require registration at the Québec central registry in any practical realization scenario; and
- the applicable Quebec conflict of laws rules have been clarified to harmonize them with those applicable under Article 9 of the Uniform Commercial Code (United States) (UCC).
In this post, we first set out the modifications to the Financial Administration Act (Québec) (FAA) with respect to the Québec government’s granting security on cash, securities and security entitlements. We then consider how Québec conflict of laws rules for cash collateral will interact with the conflict of laws provisions in other jurisdictions. We finish with some transitional considerations.
Financial Administration Act (Québec)
The Québec government is subject to the FAA. The FAA was modified by Bill 28 and the changes came into force on April 21, 2015.
One of the important modifications is to make it clear that the Québec government may include compensation or set-off in certain credit support documentation in relation to certain financial contracts and instruments. We believe that this clarification does not affect the ability of the Québec government to waive, in respect of other financial contracts and credit support documents, the application of the specific rules in the Civil Codewhich states that compensation may not be invoked against the State.
Counterparties may consider obtaining now valid first priority security over securities and security entitlements posted by the Québec government and, in respect of cash as Posted Collateral under the NY style credit annex, starting January 1, 2016. Counterparties may also wish to continue to use a UK transfer annex for cash or a NY style credit support annex modified to establish a debtor/creditor relationship for cash as Other Posted Support.
As of January 1, 2016, counterparties dealing with the Québec government will be reassured that they have the full panoply of credit support structures available for cash.
Conflict of Laws Rules
Fortunately, Bill 28 was modified before its adoption in a manner that harmonizes the Québec conflict of laws rules in respect of granting security on financial accounts and other cash collateral with the rules under Article 9 of the UCC in respect of deposit accounts. The rules are also very similar to the rules applicable to security entitlements. Essentially, the applicable parties may specifically set out in a juridical act (an agreement) which law applies to the validity, perfection and priority of such security. In a situation where a secured creditor is also the debtor of the relevant monetary claim, this can be done in the account agreement. For a tripartite relationship involving a control agreement, this choice may be made in the control agreement which can override what any account agreement provides. The rules also set out the means to determine the applicable law in the absence of a specific choice by the relevant parties.
It is important to know that even though Québec has adopted a conflict of laws regime very similar to the one in the US, care must be taken when doing the analysis for counterparties located in the common law provinces of Canada. An example follows.
- Assume that a Québec counterparty (i.e. a counterparty located in Québec) and an Ontario counterparty enter into an ISDA Master Agreement. The parties choose to use a New York style credit support annex and wish to elect cash as part of the collateral. The parties decide not to modify the CSA to provide for a debtor/creditor relationship in respect of cash.
- Under the applicable conflict of laws rules in the Province of Ontario (which would apply in a proceeding brought before an Ontario court), an Ontario court will disregard any contractual governing law provision and will apply the internal law of the Province of Ontario in order to determine the validity, perfection and priority of the security interest in cash posted by the Ontario counterparty. These rules will lead the Ontario court to apply the internal law of the Province of Québec in respect of the same issues for the security interest in cash posted by the Québec counterparty. To the extent that the Québec counterparty wants to ensure it has a perfected first-priority security on the cash which the Ontario counterparty posts, it would be essential for it to register a financial statement in the Province of Ontario and determine if there are any adverse entries after conducting the relevant searches. The fact that Québec has adopted conflict of laws rules which would allow the parties to choose the laws of a jurisdiction to govern the validity, perfection and priority of security on cash collateral under the credit support annex, is irrelevant for an Ontario court in respect of the security on cash granted by the Ontario counterparty.
- The situation would be very different where a US counterparty and a Québec counterparty execute similar documentation. For these counterparties, they would be able to choose the law applicable to the validity, perfection and priority in respect of security on cash collateral under the NY CSA. They should choose a jurisdiction which recognizes the intent of the parties to grant mutually first priority security over cash.
From the above, it is clear that the Québec legislator has adopted rules that will facilitate cash collateral between Québec counterparties and Québec and US counterparties. Should other Canadian provinces adopt rules similar to those in Québec and the US, the cash collateral landscape would be considerably improved.
We noted in our earlier piece that structures in place prior to the coming into force of the provisions would be able to benefit from those provisions immediately upon the coming into force. An example of the application of this rule may be useful.
- Assume that in October 2015 two Québec counterparties enter into an ISDA Master Agreement with a New York style credit support annex. Cash is chosen as part of the Posted Collateral. The CSA is not modified to establish a debtor/creditor relationship for cash and to consider this as Other Posted Support. Neither counterparty uses a custodian and Québec law is stated to govern the CSA.
- By virtue of the transitional rules, on January 1, 2016, any cash previously transferred by one counterparty to the other and not re-transferred will be subject to a valid first priority pledge by virtue of the control the counterparty exercises over it. Neither counterparty will need to do anything for this to occur.
The Québec legislator has shown that Québec is committed to facilitating the use of cash as collateral. The adopted provisions will do just that starting January 1, 2016.