Choice-of-law rules for security interests in security entitlements in securities credited to security accounts will change on April 1, 2017 when the Hague Securities Convention comes into effect.

The choice-of-law rules for the perfection and priority of a security interest in security entitlements in securities credited to a securities account are set forth in Articles 8 and 9 of the Uniform Commercial Code (UCC), particularly UCC Sections 8-110 and 9-305.

But look out.

The Hague Securities Convention (Convention) will become effective in the United States on April 1, 2017. The Convention provides choice-of-law rules for the perfection and priority of a security interest in security entitlements in securities credited to a securities account that will preempt the choice-of-law rules in Articles 8 and 9 to a large extent. Although in most instances the outcome under the choice-of-law rules of the Convention will be the same as under Articles 8 and 9, there are some differences. These differences matter not only for new transactions but also for existing ones to which the Convention also will apply on its effective date.

This LawFlash provides some brief background on the Convention, explains the Convention’s choice-of-law rules applicable to a security interest in security entitlements in securities credited to a securities account, describes what steps secured parties may need to take now for existing secured transactions (and in planning for new ones), and indicates where additional information concerning the Convention is available.

Background

The Hague Conference on Private International Law promulgated the Convention in 2006. The only countries other than the United States to have adopted the Convention so far are Mauritius and Switzerland. Nevertheless, the Convention will become effective in the United States on April 1, 2017—even for secured transactions where there is no connection with Mauritius, Switzerland, or any country that adopts the Convention in the future.

The Convention provides choice-of-law rules for the perfection and priority of a security interest in “securities credited to a securities account.” That phrase is equivalent to a security interest under Articles 8 and 9 in “security entitlements” in securities credited to a securities account.  While the Convention’s definition of “securities” may be somewhat broader than the term “security” as defined in Article 8, a “security” as defined in Article 8 would seem to be included in the definition of “securities” under the Convention.

The Convention does not provide choice-of-law rules for the perfection or priority of a security interest in directly held securities or in commodity contracts or commodity accounts.

The Convention’s Choice-of-Law Rules

The Convention’s choice-of-law rules for the perfection and priority of a security interest in security entitlements in securities credited to a securities account are fairly straightforward. Perfection and priority will be determined by the substantive law of the jurisdiction whose law governs the account agreement between the securities intermediary and the entitlement holder. The account agreement may, however, provide that the issues governed by Article 2(1) of the Convention be determined by the law of a different jurisdiction. The Article 2(1) issues include the applicable law to determine the perfection and priority of a security interest in security entitlements in securities credited to a securities account.

There are two important qualifications to the Convention’s general choice-of-law rule. The first is that the chosen law in the account agreement, or the law otherwise specified in the account agreement to govern the Article 2(1) issues, must be that of a jurisdiction in which the securities intermediary has an office that deals in securities—whether or not the securities are the collateral in question. This is the so-called “Qualifying Office” test. The second qualification is that, for a “multi-unit” country like the United States, there are some special rules. If the chosen law is that of a US state, the Qualifying Office test is satisfied if the securities intermediary maintains an office in any US state. For example, if the account agreement is governed by New York law but the securities intermediary’s Illinois office is the only one that deals with securities, the Qualifying Office test is satisfied under the Convention.

In addition, given the status of the United States as a “multi-unit” country, if the chosen law is that of a US state and the Qualifying Office test is met, the Articles 8 and 9 choice-of-law rules will still be effective to operate within the United States (i.e., as long as the choice-of-law rules under Articles 8 and 9 of the state chosen under the Convention point to another US state). For example, if the account agreement is governed by Massachusetts law but the “securities intermediary’s jurisdiction” for purposes of the UCC is designated in the account agreement as New York, the perfection and priority of a security interest in security entitlements in securities credited to the account and for which the secured party claims “control” will be governed by New York substantive law after applying the choice-of-law rules of Articles 8 and 9 of the Massachusetts UCC. New York substantive law would govern perfection by control and priority even though the general choice-of-law rule of the Convention otherwise points to Massachusetts substantive law.

Likewise, if the account agreement is governed by New York law and the entitlement holder is a Delaware corporation and therefore viewed to be located in Delaware (as a “registered organization” under UCC Section 9-307(e)), Delaware substantive law would govern whether the security interest has been perfected by filing after applying the choice-of-law rules of Articles 8 and 9 of the New York UCC. Delaware substantive law would govern perfection by filing even though the general choice-of-law rule of the Convention otherwise points to New York substantive law.

Existing Secured Transactions

So, assuming that the Qualifying Office test is met, under what circumstances will the choice-of-law result under the Convention be different than under Articles 8 and 9 for existing transactions in which a security interest is granted in security entitlements in securities credited to a securities account?

Three situations come to mind:

1. Perfection is by control, but the chosen law in the account agreement is that of a non-UCC jurisdiction.

In this situation, it would be necessary for the secured party to obtain perfection and priority of the security interest under the substantive law of the jurisdiction whose law governs the account agreement, or to amend the agreement to specify that the law of a UCC jurisdiction will govern the issues referred to in Article 2(1) of the Convention. This is the case even if the account agreement refers to a UCC jurisdiction as the “securities intermediary’s jurisdiction.” Any reference to the “securities intermediary’s jurisdiction” will have no relevance under the Convention other than for choice-of-law purposes within UCC jurisdictions if the Convention itself points to the law of a UCC jurisdiction.

For example, if the account agreement is governed by English law but provides that New York is the “securities intermediary’s jurisdiction” for purposes of the UCC then—absent the account agreement being amended—perfection and priority of a security interest in security entitlements in securities credited to the securities account will be governed by English substantive law, even though under Articles 8 and 9, perfection and priority by control would be governed by New York substantive law.

2. Perfection is by filing, and the chosen law in the account agreement is that of a non-UCC jurisdiction.

It will be necessary for the secured party in this situation to perfect the security interest—whether by filing (if available) or otherwise—and obtain priority of the security interest under the substantive law of the non-UCC jurisdiction. This is the case even though the debtor is located (as determined under UCC Section 9-307) in a UCC jurisdiction.

For example, if the account agreement is governed by English law, the entitlement holder is a Delaware corporation, and perfection of the security interest is claimed by filing in Delaware, then, absent the account agreement being amended, perfection and priority of a security interest in security entitlements in securities credited to the securities account would be governed by English substantive law, even though under Articles 8 and 9, perfection by filing would be governed by Delaware substantive law.        

3. Perfection is by filing, the debtor is located (as determined under UCC Section 9-307) in a non-UCC jurisdiction, and the account agreement is governed by the law of a UCC jurisdiction.

In this case, it will be necessary for the secured party to perfect the security interest by filing and obtain priority under the substantive law of the chosen UCC jurisdiction. This is the case even though perfection and priority may have already been achieved under the substantive law of the foreign jurisdiction.

For example, if the account agreement is governed by New York law, the entitlement holder is located (as determined under UCC Section 9-307) in Ontario, Canada, and perfection of the security interest is claimed by a filing in Ontario, it would be necessary for the secured party to perfect its security interest under New York substantive law, presumably by the filing of a financing statement in New York. This is the case even though the filing of a financing statement in New York is not otherwise effective under Articles 8 and 9.

New Secured Transactions

For new transactions being planned now or entered into on or after April 1, 2017, a secured party will need to bear in mind the choice-of-law rules of the Convention. In addition, absent the secured party relying solely upon the governing law of the account agreement, it is advisable for the account agreement to contain a clause such as the following to satisfy both the UCC’s and the Convention’s choice-of-law rules:

The State of [X] is the securities intermediary’s jurisdiction for purposes of the Uniform Commercial Code, and the law in force in the State of [X] is applicable to all issues specified in Article 2(1) of the Hague Securities Convention.

Other Sources of Information on the Convention

There is much more that can be said about the Convention. It covers choice-of-law issues that go beyond security interests in security entitlements in securities credited to a securities account, and there are other nuances as well. The Convention itself and an explanatory report on the provisions of the Convention are available on the website of the Hague Conference on Private International Law. Furthermore, the Permanent Editorial Board for the Uniform Commercial Code has published a draft report on the Convention, which is available on the website of the American Law Institute.