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Perfecting Security Interests in Deposit Accounts, Securities Accounts and Other Investment Property

Establishing Control Under the UCC to Perfect Security Interests in Special Collateral Types

Today’s faculty features:

1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific THURSDAY, JULY 23, 2015

Sandra M. Rocks, Counsel, Cleary Gottlieb Steen & Hamilton, New York Edwin E. Smith, Partner, Morgan Lewis & Bockius LLP, New York Steven O. Weise, Partner, Proskauer Rose, Los Angeles

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Perfecting Security Interests in Deposit Accounts, Securities Accounts, and Other Investment Property

Sandra Rocks Cleary Gottlieb Steen & Hamilton LLP Edwin E. Smith Morgan, Lewis & Bockius LLP Steven O. Weise Proskauer Rose LLP

July 2015

6

Topics – UCC framework

• Choice of law
• Creation of security interest
• Perfection, effect of perfection or nonperfection,

and priority of security interest

• Secured party duties and exercise of remedies
• Comparison of security interests in deposit accounts

and security interests in securities accounts

• Legal opinions

7

Topics – control agreements

• Drafting and negotiating control agreements
• Deposit accounts
• Securities accounts / security entitlements
• Control agreement provisions
• Related to UCC provisions / requirements
• Commonly negotiated business terms
• Considerations in representing indenture trustees

and collateral agents

• Considerations in representing banks and securities

intermediaries

8

Exclusion from Article 9

• UCC § 9-109(d)(13) excludes from Article 9 a security

interest in a deposit account in a consumer transaction

• UCC § 9-102(a)(26) consumer transaction:
• individual as pledgor
• purpose of the borrowing
• size of transaction not relevant
• In excluded transactions, non-UCC law applies to

choice of law, creation, perfection, and priority of collateral assignment (common law ‘dominion and control’ and exclusion of debtor)

9

What is a ‘security’ – shares?

• ‘Security’: share or similar equity

interest issued by:

• Corporation/business trust/

statutory trust

• ‘Similar entity’

10

What is a ‘security’ – other interests?

• Not a ‘security’:
• Partnership interest
• LLC interest
• Series LLC interest?
• Exceptions to exclusion of LLC and partnership interests:
• Override exclusion by ‘opting in’ (UCC § 8-103)
• Held as a security entitlement
• Registered investment company / publicly traded
• Debt (if a ‘security’)
• Highland Capital Management LP v. Schneider (N.Y. 2007)
• 2010 Revisions – UCC § 8-102, Comment 13
• PEB Commentary

11

Deposit account v. securities account – does it matter?

• Requirements for control agreement
• Description of the account
• Choice of law
• Available perfection methods
• Protected purchaser / “takes free” rules
• Transaction excluded from Article 9
• Credit risk
• In re Gem Refrigerator Co., 512 B.R. 194

(Bankr. E.D. Pa. 2014)

12

What is an ‘account’?

• No definition in the UCC for the ‘account’

element of a ‘securities account’ or ‘deposit account’

• Reliance on the books and records of the

securities intermediary or bank, whether or not designated by it as an ‘account’

• Except, in the case of a deposit account, a

certificate of deposit that qualifies as an

• instrument. See UCC § 9-102(a)(29)

13

What is a ‘deposit account’?

• Debt of a bank to its customer
• Includes certificates of deposit (CDs) that are not

represented by an instrument

• Can include some certificated CDs (In re Perez (Bankr. D.

N.J. 2010))

• CDARS program
• CDs held in a securities account

 Not a deposit account  Monticello Banking Co. v. Flener (W.D. Ky. 2011) (CDARS

program creates security entitlements) [part of decision on collateral description issues discussed below]

14

What is a ‘securities account’/security ‘entitlement’?

• Custodial arrangement for holding customer assets
• Security entitlement – bundle of rights wit respect to asset

that a securities intermediary has agreed to hold for its customer and is a financial assets or securities intermediary has agreed to treat as a financial asset

• Credited or accepted for credit to the customer's

securities account

• Intermediary obligated to credit to the account
• Securities account – a collection of security entitlements
• May also include other rights of the customer against the

intermediary

15

In what ‘capacity’ is the bank or securities intermediary acting?

• Example:
• Bank is the depositary bank for Customer.
• Bank is also the agent on a syndicated loan facility to

Customer.

• Under a security agreement authenticated by Customer,

Customer has granted to Bank, as agent for the benefit of the syndicate lenders, a security interest in all of Customer’s customers deposit accounts maintained at Bank.

• Is a control agreement required for the Bank, as agent for

the benefit of the syndicate lenders, to have a security interest in the deposit accounts perfected by control?

• See Comment 1 to UCC § 9-104 (2010)

16

Treatment of ‘financial assets’

• Securities account
• ‘Financial assets’ other than securities. See UCC §

8-102(a)(9)(iii); Article 8, Prefatory Note, III.C.1.

‘Cash’

• Duty to maintain under UCC § 8-504.
• Question about ‘cash balance’ credited to a

securities account if no election to treat ‘cash’ as a financial asset.

Investment in U.S. treasuries or money market

shares

Use of deposit account

17

Choice of law – deposit account

• Local law of the bank’s jurisdiction governs

perfection, the effect of perfection or nonperfection, and priority of a security interest in a deposit account at that bank (UCC § 9-304)

• Bank’s jurisdiction is determined as provided in UCC

§ 9-304(b)

• Can select bank’s jurisdiction in the control

agreement

• If not in a control agreement, UCC § 9-304(b)

provides rules

• No ‘reasonable relationship’ requirement ((see

UCC § 1-301 (former UCC § 1-103)

18

Choice of law – securities

• Certificated security
• Local law of the jurisdiction where certificated security is

located governs perfection, the effect of perfection or nonperfection, + priority (UCC § 9-305(a)(1))

• Uncertificated Security
• Local law of the issuer’s jurisdiction (as specified in UCC

§ 8-110(d)) governs perfection, the effect of perfection

• r nonperfection, + priority (UCC § 9-305(a)(2))
• Perfection by filing
• Location of debtor (UCC § 9-305(c)(1))

19

Choice of law – securities account /security entitlement

• Local law of securities intermediary’s jurisdiction governs

perfection, the effect of perfection or nonperfection, and priority (UCC § 9-305(a)(3))

• Securities intermediary’s jurisdiction is determined as

provided in UCC § 8-110(e)

• Can establish by control agreement
• If not in a control agreement, UCC § 8-110(e) provides

rules

• Perfection by filing – location of debtor (UCC § 9-305(c)(1))
• Hague Securities Convention

20

Creation of security interest

• Usual requirements (UCC § 9-203):
• Debtor has rights in the collateral
• Value (UCC § 1-204 (Former UCC § 1-201(44)))
• Security agreement evidenced by an

authenticated record

• Legally sufficient description of collateral
• Exceptions to requirement for authenticated record

(UCC § 9-203(b)(3)(C) - (D))

• Control
• Possession of certificated security

21

Description or indication of investment property as collateral

• UCC § 9-108 description is sufficient, whether or not it is specific, if it

reasonably identifies what is described

• UCC § 9-108(b) examples of reasonable description

(including by UCC type)

• UCC § 9-108(d) description of a security entitlement, securities

account, or commodity account is sufficient if it describes:

 by those terms or as investment property, or  the underlying financial asset or commodity contract

• UCC § 9-108(e) consumer transaction rule
• Monticello Banking Co. v. Flener (W.D. Ky. 2010) (affirmed in unpublished
• pinion by 6th Circuit)
• Must use UCC § 9-108(d) language
• Decision widely criticized

22

Perfection and priority by ‘control’

• Control as a method of perfection
• Alternative to filing for securities,

security entitlement, and securities account as original collateral

• Only method of perfection for a

deposit account as original collateral

• Control as establishing non-temporal

priority over a security interest not perfected by control

23

Other benefits of control

• Requirement for protected

purchaser status

• Control allows secured party to

exercise remedies without court involvement

24

Security agreement v. control agreement

• Security agreement
• Between debtor and secured party
• Grants security interest and describes the collateral and secured
• bligations
• Specifies defaults and remedies (with loan agreement)
• Choice of law for creation of security interest
• Control agreement
• Among debtor, secured party and depositary bank / securities

intermediary where account is maintained

• Gives secured party right to direct the bank / securities intermediary

as to the account

• Deals with priority as between secured party and bank / intermediary
• Choice of law for perfection/priority/effect of perfection or

nonperfection of security interest

• Practice pointer: keep them separate

25

Meaning of ‘control’ – general

• Control means the ability of secured party to

direct transfer or disposition of funds / assets without further consent or action of debtor

• Control exists even if debtor retains right to

make substitutions, originate instructions or

• therwise deal with collateral (UCC §§ 9-

104(b), 8-106(f))

• Traditional ‘blocked’ account agreement may

not suffice

26

Control – certificated security

• UCC § 8-106(b) ‘purchaser’ (including a secured

party) has control of a certificated security in registered form if:

• Certificated security is ‘delivered’ to the

purchaser (possession) and

• Certificate is either:

Indorsed to the purchaser or in blank by an

effective indorsement or

Registered in the name of the purchaser

(upon original issue or registration of transfer by the issuer)

27

Control – uncertificated security

• UCC § 8-106(c) ‘purchaser’ (including a

secured party) has control of an uncertificated security if:

• Uncertificated security is ‘delivered’ to

the purchaser (registered in purchaser’s name) or

• Issuer has agreed that it will comply

with instructions originated by the purchaser without further consent by the registered owner

28

Control – securities account/ security entitlement

• UCC § 8-106(d) purchaser (including a secured party) has

control of security entitlement if:

• Purchaser becomes the entitlement holder
• Securities intermediary has agreed that it will comply

with entitlement orders originated by purchaser without further consent by entitlement holder or

• Another person has control of the security entitlement
• n behalf of purchaser or, having previously acquired

control of the security entitlement, acknowledges that it has control on behalf of purchaser

• UCC § 8-106(e) if security interest in a security entitlement is

granted by entitlement holder to entitlement holder’s own securities intermediary, securities intermediary has control

29

Control – deposit account

• UCC § 9-104(a) secured party has control of deposit

account if:

• Secured party is the bank with which the deposit

account is maintained

• Debtor, secured party and bank have agreed in

an authenticated record that bank will comply with instructions originated by secured party directing disposition of the funds in the deposit account without further consent by debtor or

• Secured party becomes the bank’s customer

with respect to the deposit account

30

Type of agreement

• Securities account
• Oral agreement? (see UCC § 8-113)
• Deposit account
• Authenticated record

31

Bank/intermediary’s rights

• Bank not required to:
• Enter into control agreement
• Confirm existence of control agreement (UCC § 9-

342)

• Securities intermediary not required to:
• Enter into control agreement
• Confirm existence of control agreement (UCC § 8-

106(g))

• Securities intermediary may not enter into control

agreement without consent of entitlement holder (UCC § 8-106(g))

32

Who are the parties?

• Securities account/security

entitlement

• Agreement of only the securities

intermediary?

• Deposit account
• Three-party agreement in a single

agreement?

33

Control – securities account / security entitlement

• Who is the securities intermediary?
• Referring and clearing brokers
• National Consumer Cooperative Bank v.

Morgan Stanley & Co. (M.D. Pa. 2010)

• Fifth Third Bank v. Lincoln Financial

Securities Corp. (WD Ky 2009)

• Practice pointer: If can’t determine who

is the intermediary, have all sign the control agreement

34

Key control agreement provision – deposit accounts

• ‘The bank agrees to comply with

instructions originated by the secured party, without the debtor’s further consent.’

35

Key control agreement provision – security entitlement/account

• ‘Intermediary agrees to comply with

all entitlement orders originated by secured party, without debtor’s further consent.’

36

Effect of other provisions on present ‘control’ – general

• Watch for provisions that amount to

a debtor ‘consent’ right

37

Effect of other provisions on present ‘control’ – conditions

• Example: The control agreement states

that the secured party may not give an entitlement order or instruction to the securities intermediary or bank unless the secured party certifies to the securities intermediary or bank that the debtor is in default.

• See Comment 7 to UCC § 8-106 and

Comment 3 to UCC § 9-104

38

Effect of other provisions on present ‘control’ – conditions

• Example: The control agreement

states that the junior secured party may not give an entitlement order or instruction to the securities intermediary or bank unless the senior secured party consents.

• See Comment 7 to UCC § 8-106

39

Effect of other provisions on present ‘control’ – debtor default

• Confirmation from debtor as to:
• Occurrence of a default
• Amount that can be withdrawn

40

Effect of other provisions on present ‘control’ – interpleader

• Contractual interpleader rights?
• Compare to statutory interpleader

rights

41

Effect of other provisions on present ‘control’ – termination

• Debtor’s right to terminate the

agreement before bank is required to act on secured party’s instructions

• Provide that upon termination by

debtor funds or financial assets transferred to secured party

42

Effect of other provisions on present ‘control’ – delays

• Delays before bank required to act?

43

Priority – general rules

• Perfection by control has priority over

perfection by other means

• First to obtain control has priority
• Depositary bank or securities

intermediary as secured party will have priority even if it obtains control later in time (See UCC §§ 9-327(3) and 9-328(3))

44

Other bank rights

• UCC § 9-340 depositary bank rights:
• Right of set off
• Right of recoupment

45

Subordination issues

• Fees and expenses of the securities

intermediary or bank

• Reversals of provisional credits/returned

items

• New advances by the securities

intermediary or bank

• Margin
• Indemnities from account holder

46

Control agreement: subordination

• ‘Bank/intermediary subordinates in

favor of secured party any security interest, lien or right of setoff or recoupment bank may now or in future have against the account.’

• Absent agreement to the contrary,

the bank or intermediary can exercise its subordinated remedies

47

Investment property: protected purchaser and ‘takes free’

• Applies to secured parties
• ‘Purchaser’/‘purchase’ (UCC § 1-201(b)(29), (30))
• UCC § 8-303(a) protected purchaser
• Gives value (UCC § 1-204 (Former UCC § 1-

201(44)))

• Does not have notice of any adverse claim to the

security (certificated or uncertificated)

• Obtains control of the security
• Analogous protection for securities accounts /

security entitlements

• UCC §§ 8-502, 8-503, 8-510

48

Deposit accounts: transferee of funds

• Transferee ‘takes free’ of security

interest in deposit account, unless transferee acts in ‘collusion’ with debtor to violate rights of secured party

• UCC § 9-332(b)

49

Deposit account control agreement: choice of law

• ‘The bank’s jurisdiction for purposes of Part 3 of

Article 9 of the UCC is [specify].’

• If this provision is not included, § 9-304(b)

determines applicable law

• Review for purposes of (i) selecting US

jurisdiction and (ii) law covered in perfection by control and control priority opinion

• Also amend choice of law provisions of the

account agreement and other agreements between bank and customer governing or relating to the account?

50

Securities account control agreement: choice of law

• ‘The intermediary’s jurisdiction for purposes of

Part 3 of Article 9 of the UCC is [specify].’

• If this provision is not included 8-110

determines applicable law

• Review for purposes of (i) selecting US

jurisdiction and (ii) law covered in perfection by control and control priority opinion

• Also amend choice of law provisions of the

account agreement and other agreements between intermediary and customer governing or relating to the account?

51

Control agreement: status of account

• ‘Intermediary maintains securities account [identify] for

debtor.’

• ‘All property credited to the account and all other rights of

debtor against Intermediary arising out of the account, including any free credit balances, will be treated as financial assets under Article 8 of the [jurisdiction] UCC.’

• Securities intermediaries that are banks often will not

agree to treat cash as a financial asset, unless they are acting through their trust department

• Confirming what is in the account or value of the account (or

not) (Fifth Third Bank v. Lincoln Financial Securities Corp. (WD Ky 2009))

• Monitoring account and transactions

52

Control agreement: other control agreements

• ‘Intermediary does not know of any adverse claim to

the account, except for claims and interests of [parties to the control agreement].’

• ‘Bank represents and warrants that no third party

has a right to give instructions with respect to the account.’

• ‘Bank will not agree with any third party that bank

will comply with instructions originated by the third party.’

• No third party has control (or priority) or will obtain

control

53

Control agreement: status and transfer issues

• Status of bank as a ‘bank’/securities

intermediary as a ‘securities intermediary’ for UCC purposes?

• Successor and renumbered

accounts

• Assignee or successor to secured

party

54

Control agreement: indemnity + duties

• Indemnification and expense

reimbursement of bank/securities intermediary

• Exculpation, standards of care
• Time in which bank / intermediary is

required to act on secured party instructions (‘outside time’)

55

Control agreement: miscellaneous

• Secured party access to statements,
• n-line info
• Monitoring of debtor activity re

account

• Notice of claims made by third

parties to account

56

Sweep investments

• Example:
• Secured party has a control agreement with depositary

bank and debtor over debtor’s deposit account maintained with bank

• Funds in the deposit account are swept each evening into

an investment vehicle maintained by bank and deposited to the deposit account the next morning with the

• vernight return.
• Does secured party have control over debtor’s interest in the

funds in the investment vehicle when the funds are in the investment vehicle rather than the deposit account?

• See ABA BLS Sweep Investment Form.

http://apps.americanbar.org/dch/committee.cfm?com=CL 710060

57

Repledge

• Securities account
• Right of secured party to repledge.

UCC § UCC 207(c)(3); but see UCC § 8- 504(a)

• Control during the period of repledge.

See UCC § 9-314(c)

• Deposit account
• Debtor/creditor relationship

58

Insolvency of the secured party

• ‘Pledgor access rights’
• ISDA IA Seg. working group project
• Automatic stay v. ‘safe harbors’
• Secured party as broker-dealer being

liquidated under SIPA

• Sec. Investor Prot. Corp. v. Lehman
• Bros. Inc., 433 B.R. 127 (Bankr. S.D.N.Y.

2010)

59

Insolvency of the securities intermediary or bank

• Broker dealer under SIPA
• Treatment of ‘cash’ and securities
• Federally insured bank under FDIA
• Treatment of securities
• Treatment of ‘cash’
• Allocation of credit risk between the

secured party and the debtor

60

Secured party remedies

• Without control of collateral secured party

may have difficulty effecting a transfer or liquidation of collateral or exercising other remedies following default

• UCC § 9-607 determines the rights between

secured party and debtor in the exercise of secured party remedies, but not the duties of an account debtor, bank or other person

• bligated on the collateral (Comments 6 and

7 to UCC § 9-607)

61

Legal Opinions

• Creation
• Perfection
• By filing
• By possession
• By control
• Control priority
• Protected purchaser (certificated or uncertificated

security) and ‘takes free’ (security entitlement / securities account)

• TriBar report

62

Control – Deposit Account

• In re Hawaiian Telecom Communications,
• Inc. (Bankr. D. Hawaii 2009)
• FTC v. Transcontinental Warranty, Inc.

(N.D. Ill. 2009)

• Full Throttle Films, Inc. v. National Mobile

Television, Inc. (Cal. App. 2010)

• In re Perez (Bankr. D. N.J. 2010)

63

Resources

• Model Deposit Accounts Control Agreement,

Inserts and Reports

• http://apps.americanbar.org/dch/committe

e.cfm?com=CL710060

• Securities Account Control Agreement
• Annotated agreement (included with

course materials)

• Legal Opinion Resource Center
• http://apps.americanbar.org/buslaw/tribar/

Thank You

Sandra Rocks Cleary Gottlieb Steen & Hamilton LLP srocks@cgsh.com Edwin E. Smith Morgan, Lewis & Bockius LLP edwin.smith@morganlewis.com Steven O. Weise Proskauer Rose LLP sweise@proskauer.com

64