With the adoption of An Act Respecting the Transfer of Securities and the Establishment of Security Entitlements (the “Québec STA”), Québec has now joined Ontario, British Columbia, Alberta and Newfoundland in implementing legislation largely identical to that in force in the United States. The Québec STA creates new legislation and amends the Civil Code of Québec in an effort to provide certainty to the rules that govern the transfer of securities and the taking of security interests in them. The aim of this article is not to provide a comprehensive analysis of the Québec STA. Our objective instead is to provide a general understanding of the Québec STA and an awareness of the impact it will have on current commercial practices. As a general observation, it should be noted that the Québec STA is very similar to its Ontario counterpart and uses the same concepts and terminology. Thus, if one is familiar with the intricacies of the Ontario legislation, the mechanics of the Québec STA will be easily grasped.
Objective of the Québec STA
The Québec STA is designed to better reflect the manner in which securities and interests in securities are held and transferred in the modern economy. The Québec STA provides for two different systems: the “direct holding” and “indirect holding” systems. In the direct holding system, the security holder deals directly with the issuer. Under this system, securities that are represented by physical certificates receive the benefit of the Québec STA.
In the indirect system, securities are held and traded through securities intermediaries who keep records of the transactions as book-entries. The issue of debtor acting as agent for the secured party is defeated because once the securities are recorded on the books of the securities intermediary, the rights of the secured party and the debtor in the securities is replaced by rights in their favour against the securities intermediary, not against the securities themselves.
Scope of the Québec STA
The Québec STA applies to “securities” and a more broadly defined class of “financial assets” which include (a) securities and other investments traded on financial markets, (b) property held by a securities intermediary for a third party in a securities account and (c) any credit balance in a securities account.
The Québec STA also creates a new type of asset called a “security entitlement”, which applies to the indirect holding system and consists of the bundle of rights belonging to an investor in an asset held for the investor’s account by a securities intermediary.
Of note is the particular status of partnership units. The Québec STA explicitly states that partnership interests are not to be considered “securities” unless the issuer specifically elects in its constating documents that the partnership interests are “securities” within the meaning of the Québec STA. Consequently, partnership (including limited partnership) interests will only be governed by the Québec STA if the terms of the governing partnership arrangement expressly stipulate that they are “securities.” Any purchaser or person who proposes to acquire or to take a secured lien or hypothec on partnership interests, should insist that the partnership/limited partnership opt into the Québec STA because of the significant benefits to purchasers and lienholders conferred on them by it.
The Notion of Control
Central to the Québec STA is the concept of “control” of a security to determine priority between competing interests. Control may be achieved in different ways depending on whether the security is traded in the direct system or indirect system.
In the direct system, gaining “control” is similar to the rules which applied prior to the enactment of the Québec STA. In other words, a purchaser or secured party would gain control of a certificated security if the certificate evidencing the security is physically delivered to the purchaser or secured party.
If the security is certificated in the direct holding system, a purchaser or secured party may gain control through delivery of the certificate. Where the security is uncertificated, a purchaser or secured party may gain control either by (a) becoming the registered holder of the security on the books and records of the issuer or (b) having someone else become the registered holder on behalf of the purchaser or secured party.
In the indirect holding system, the purchaser or secured party can gain control of the securities either by entering into a “control agreement” with the securities intermediary or by having the securities recorded in its name with the securities intermediary. Under the control agreement alternative, the intermediary agrees to comply with orders that are originated by the purchaser or secured party without regard to the wishes, direction or consent of the owner of the securities. Under the registration alternative, the purchaser or secured party becomes an “entitlement holder” of the securities.
As noted previously, the Québec STA creates a set of new priority rules which may be summarized as follows: (a) control has priority over non-control (as an example, hypothecs published through control, e.g. through delivery, will have priority over those published otherwise than by control, e.g. through registration) and (b) multiple security interests published by control rank in accordance with their respective time of publication.
Without getting into too much detail the reader should know that there are certain exceptions to these rules when dealing with security entitlements. For example, the person who gains control by becoming the entitlement holder has priority over all other parties and a securities intermediary who holds a movable hypothec over security entitlements in an account that he maintains has priority over all other parties.
The above exception is intended to facilitate immediate and orderly trading in securities. The securities intermediary may transfer any securities under its control without the transferee having any duty to enquire as to the title and authority of the securities intermediary. The owner, purchaser or secured party who has opened the securities account where the securities are registered, or entered into a control agreement, only has claims against the securities intermediary for breach of its obligations to them. The securities account holder has no claims against the person to whom the securities intermediary transferred the securities, even where the transfer was made in error or on purpose by the securities intermediary. Parties in any such chain of title who knowingly participate in fraudulent transfers are accountable, but the first transferee who innocently purchases (virtually no duty to enquire) takes title free of adverse claims.
Conflict of Law
The Québec STA creates a set of conflict rules to clarify which jurisdiction may govern validity, perfection and priority of a security interest in securities depending on whether transactions occur in the direct or indirect systems and whether they involve certificated or uncertificated securities. Generally, when dealing with certificated securities, the laws of the jurisdiction where such securities are located at the time the security interest is granted will govern. In the case of certificated securities, the Québec STA will govern if the certificates are delivered to the secured party or its agent at a place in Québec. The laws of the jurisdiction of the issuer will govern uncertificated securities (direct system). The laws of the jurisdiction of the securities intermediary will govern securities entitlements (indirect system). The Québec STA provides various rules to determine the jurisdiction of the issuer or the intermediary, as applicable.
The Québec STA provides for a one year transition period that expires on December 31, 2009. This is of special importance for secured parties who hold movable hypothecs or pledges of securities.
If hypothecs over securities or security entitlements have not been published in accordance with the Québec STA, secured parties must take steps to ensure that their hypothecs are adequately published on or before December 31, 2009. This could entail, for example, entering into a control agreement with a securities intermediary or an issuer, as applicable. Corrective measures need not be taken in every instance. For example, pledges of securities, where securities were physically delivered to the secured party, will generally remain perfected provided such delivery was effected in accordance with the Québec STA.
Actions to be taken
We encourage readers to review transactions where they may have acquired an interest in securities issued by a Québec entity or hypothecated by a Québec debtor to see if the transactions comply with the Québec STA and to determine if any corrective measures are required before December 31, 2009.