Tomorrow, April 1, 2017, the Hague Convention on the Law Applicable to Certain Rights in Respect of Securities Held with an Intermediary (the "Convention") will take effect in the United States. On December 15, 2016, the United States became the third nation (after Mauritius and Switzerland) to ratify the Convention, thereby enabling the treaty to come into force. As noted in the explanatory report to the Convention, "[t]he need for conflict of law rules that reflect the reality of how securities are held, transferred and pledged today (i.e., by electronic book-entry through securities accounts) has become critical as a result of the growth, speed and volume of cross-border securities transactions, which have been made possible by technological advancements." Driving the adoption of the Convention were concerns regarding the uncertainties resulting from the application of traditional conflict of law rules to transactions involving securities held with intermediaries, and the adverse effect that those uncertainties could have on credit and liquidity – particularly during times of financial stress. Signed in 2006, the Convention creates a uniform choice of law regime that is intended to enhance the certainty and predictability of determining the choice of law applicable to transactions involving securities held with an intermediary, particularly on issues involving the perfection, priority and enforcement of security interests.
Choice of Law Principles
The primary rule of the Convention is that the governing law specified in the account agreement between the intermediary and the account holder, if any, shall control. This rule allows the parties to designate a governing law (the "Chosen Law") for those issues within the scope of the Convention that is different from the law which governs other aspects of the account agreement so long as the Chosen Law applies to all (not just some) of a set of seven enumerated issues. For the primary rule to apply, however, the intermediary must have an office in the country whose law has been chosen that is engaged in the business or regular activity of maintaining securities accounts in that country. In multi-state nations such as the United States and Canada, it is enough that the intermediary have a qualifying office in the country whose state law has been chosen to govern the transaction. For example, if the applicable account agreement designates New York law, the primary rule under the Convention will apply New York law so long as the intermediary has at least one office in the United States engaged in maintaining securities accounts; the physical office need not necessarily be in New York. The country whose law, or the state within the country whose law, has been chosen need not be a party to the Convention.
Fall Back Rules
The Convention provides three fall back rules that apply in the event that either the intermediary has no qualifying office or the applicable account agreement does not specify a Chosen Law. In sequence of priority, the fall back rules specify the Chosen Law as follows:
- The law of the country in which an office of the intermediary is located, if the account agreement "expressly and unambiguously" states that the account agreement was entered into through that particular office (Art. 5(1));
- The law of the jurisdiction of incorporation or organization of the intermediary on the date of the execution of an account agreement or, if no such agreement exists, the date the securities account was opened (Art. 5(2)); and
- The law of the jurisdiction in which the relevant intermediary has its principal place of business on the date of the execution of an account agreement or, if there is no such agreement, the date the securities account was opened (Art. 5(3)).
The Convention has no bearing on transactions involving only U.S. entities because it only applies to a choice between the laws of different nations. However, the Convention might be implicated simply as a result of the account holder, the issuer, the intermediary or perhaps an adverse secured claimant being located in another non-U.S. jurisdiction. Therefore, transacting parties should generally consider the possibility that the Convention may apply – if not at the outset, then at a later date, for example, if a foreign claimant asserts adverse rights.
To take advantage of the relative predictability afforded by the Convention, parties to significant cross-border transactions should consider ensuring that their transactions are subject to the primary rule, rather than the fall back rules - which depend on the location of the given intermediary or the account. To do so, they should designate in their account agreement their desired Chosen Law, either for all purposes or at least for all of the purposes set forth in Article 2(1) of the Convention and ensure that such choice meets the standards of the Convention. That designation may be effected through an amendment to the applicable account agreement. The parties may choose to use a control agreement between the intermediary, the account holder and the applicable secured party to expressly amend the account agreement. Since a secured party is typically not party to the account agreement itself, it will likely prohibit the account holder and/or intermediary from changing the Chosen Law without the prior written consent of the secured party. The parties should also memorialize the facts concerning the qualifying office that made the primary rule available.
The Convention applies to securities, including shares, bonds and other financial instruments or financial assets, but specifically excludes cash. Accordingly, the Convention does not alter the choice of law rules applicable to the attachment and perfection of security interests in cash held in a securities account or other types of collateral, which continue to be governed by the Uniform Commercial Code and its choice of law provisions.
If the Convention dictates that the law of a non-U.S. jurisdiction should apply, then the law of that jurisdiction will govern any perfection of a security interest, and therefore a customary UCC filing may be ineffective.