Panel Recommends Update to Ontario's PPSA: Perfection of Security Interests in Cash Collateral by Control

By and Rebecca CochraneSteve Vasilevski

Introduction

In June 2015, an expert panel (the “Panel”), convened by the Minister of Government and Consumer Services, delivered its Priority Findings & Recommendations Report (the “Report”), assessing Ontario’s business laws. The Report presents a broad range of recommendations for legislation in Ontario, aimed at positioning the province as a jurisdiction of choice for business. One of the focal points of the Report is the Personal Property Security Act (the “PPSA”), Ontario’s legislation regulating the creation and perfection of security interests in personal property. The Report asserts that Ontario has missed an opportunity to better facilitate commercial activity in the province by not updating the PPSA in certain ways. One of the Report’s main recommendations is that Ontario amend the PPSA to better facilitate the use of cash collateral. The Report does not make its own specific recommendations on the issue, but rather looks toward how other jurisdictions address the creation and perfection of security interests in cash collateral, as well as proposals brought forward by the Ontario Bar Association (“OBA”) as starting points for a potential update of the PPSA in relation to cash collateral. 

This legal update focuses on such “starting points” in a discussion of cash collateral in Ontario, as follows:

I. Cash Collateral and the Current State of the Law

a. Cash Collateral in Ontario

b. Cash Collateral in Other Jurisdictions

II. Perfection by Control in Ontario

a. Proposed Amendments by the Ontario Bar Association

b. Changes to Legislation in Ontario

III. Conclusion

I. Cash Collateral and the Current State of the Law

a. Cash Collateral in Ontario

In the past decade, cash has become an increasingly popular form of collateral for a wide range of secured obligations. A debtor that holds cash in a deposit or financial account may wish to use it as collateral for obligations ranging from loans to repurchase and derivatives transactions. A secured party that wishes to maintain a first priority security interest in cash collateral will need to “perfect” its security interest under the PPSA.

The PPSA provides for perfection by, among other means, “registration”, “control” and “possession or repossession”, depending on the nature of the collateral. In Ontario, “cash” is considered an “intangible” or “account”, and a security interest in these forms of collateral can be perfected only by registration of a financing statement under the PPSA. The registration process, however, is time consuming and costly, as it involves searching for prior registrations and, where required, obtaining estoppel letters and subordinations from prior creditors of the debtor in order to ensure the intended priority of a security interest vis-à-vis such other creditors.

The concept of “control” provides an alternative means of perfecting security interests in certain types of personal property collateral, namely “investment property” (e.g., certificated and uncertificated securities, security entitlements and securities accounts). For instance, if common shares in the capital of a company are pledged as collateral security to a lender for a loan, control over those securities is achieved by way of (i) in the case of certificated securities, physical possession of the certificates representing those shares, or (ii) in the case of uncertificated securities (i.e., securities held in an account with a securities intermediary, such as CDS), execution of a “control agreement” between the secured lender and the securities intermediary. The PPSA specifies that the security interest of a secured party that perfects a security interest in a debtor’s investment property by way of control has priority over the security interest of a secured party that does not have control of the investment property (including, presumably, a secured party that has a prior registered financing statement against the same debtor). If the perfection and priority of security interests in cash collateral received similar treatment, then the need to conduct searches and negotiate intercreditor arrangements with prior creditors would largely fall away.

b. Cash Collateral in Other Jurisdictions

The Panel points toward the treatment of cash collateral in other jurisdictions, particularly the United States, for possible solutions to the limited options for perfecting interests in cash collateral in Ontario. 

In the United States, the perfection of interests in cash collateral is regulated by Revised Article 9 of the Uniform Commercial Code (the “UCC”). Under the UCC, cash held in an account to be used as collateral falls under the definition of a “deposit account”. A security interest over this type of collateral may be perfected by means of control under the UCC. Control over a deposit account will be obtained if:

(i)     the secured party is the bank with which the deposit account is maintained;

(ii)   the debtor, secured party, and the bank enter into a control agreement whereby the secured party may direct disposition of the funds without further consent by the debtor; or

(iii)  the deposit account is in the name of the secured party.

Revised Article 9 of the UCC also provides priority for the secured party that has established control over those secured parties that have not established control.

Quebec is the only jurisdiction in Canada that allows for perfection of interests in cash collateral by control. In 2014, the province introduced amendments to the Civil Code of Québec to mirror Revised Article 9 of the UCC and allow for control as a method of perfection for interests in cash collateral.

II. Perfection by Control in Ontario

a. Proposed Amendments by the Ontario Bar Association

In addition to endorsing the methods of regulating cash collateral in the United States and Quebec, the Report also commends the proposed amendments to the PPSA brought forward by the OBA in February of 2012 (the “Proposed Amendments”).

The rationale behind the Proposed Amendments echoes the findings of the Report – namely, the OBA found that Ontario could better facilitate the use of cash collateral if the PPSA were updated to allow for interests in cash collateral to be perfected by control in addition to registration.

The fundamentals of the Proposed Amendments are similar to Revised Article 9 of the UCC, though they differ in certain respects. Under the Proposed Amendments, a new class of collateral would be created, known as a “financial account”. “Financial account” is broadly defined under the Proposed Amendments to include any form of deposit account maintained by a financial institution, mirroring the UCC’s definition of “deposit account”. However, the Proposed Amendment’s definition of “financial account” goes further than the UCC by also encompassing any other monetary obligation of a financial institution to a debtor in respect of funds held or received by that financial institution as security for an obligation, whether or not in the form of a deposit account. The definition of “financial institution” is also more broadly defined under the Proposed Amendments than that of “bank” under the UCC. Under the Proposed Amendments, “financial institution” covers every type of participant in financial markets that regularly receives cash collateral, including banks, loan companies, trust companies, insurance companies, and clearing and settlement agencies. Thus, the Proposed Amendments go further than the UCC in order to create a more flexible concept of cash collateral that encompasses monetary obligations not necessarily in an identifiable deposit account with a bank. 

The Proposed Amendments would allow a security interest in a financial account to be perfected by registration or by control. Control over a financial account would be established under the Proposed Amendments in the same way control is established over a deposit account under the UCC, that is: (i) if the secured party is the financial institution maintaining the financial account; (ii) if the secured party, the debtor, and the third-party financial institution enter into a control agreement; or (iii) if the funds are transferred to a financial account of the secured party. The Proposed Amendments would also confer priority on the secured party that first obtains and continues to maintain control over a financial account.  While this clearly adds efficiency and certainty where cash collateral is the primary credit backstop to a transaction, it results in more paper heavy transactions where an “all assets” filing is contemplated.  Where previously a lender taking an “all assets” filing could perform searches, register, and have comfort as to their enforcement priority, the “all assets” lender will now need to also take a control agreement to ensure their priority with respect to the debtor’s cash – more paper, more negotiation and more cost, at least in the short term as financial institutions put processes in place to make this fairly routine. 

b. Changes to Legislation in Ontario

In the Proposed Amendments, the OBA emphasized the need for Ontario to update the PPSA as quickly as possible in order to meet the needs of the business community and to better support the use of cash collateral. In the Government of Ontario’s 2012 and 2013 budgets, the province announced its intention to allow for security interests in cash collateral to be perfected by control, even outlining changes that reflected the Proposed Amendments. However, the comments on this issue by the Government were sparse, and the intentions expressed in the 2012 and 2013 budgets were not reiterated in the following years. The Report notes that there have been numerous proposals to amend the PPSA over the years, including the Proposed Amendments, but that Ontario has largely failed to implement them.

On October 8, 2015, the Ministry of Government and Consumer Services announced that it will create a new advisory council whose role will be to further review Ontario’s corporate and commercial laws and make recommendations on reforms.  The Ministry also announced that certain amendments will be made to the PPSA, among other pieces of corporate and commercial legislation, by the end of this year to reduce complexity and business costs.  The details of the changes to the PPSA and whether they will concern the use of cash collateral has not yet been announced.

Conclusion 

Cash in isolation, and separate from an “all assets” security package, is becoming an increasingly popular form of collateral, and allowing for its perfection in a timely and cost-effective manner would be helpful in transactions where cash collateral is either the only collateral or the primary collateral. If the PPSA is amended to bring the Proposed Amendments into force, in circumstances where the entirety of the debtor’s personal property forms the collateral package (such as in many “mainstream” bank loans) lenders will need to consider going beyond the current approach of taking an “all assets” general security agreement and filing in the appropriate jurisdictions.  Instead, if the Proposed Amendments are brought into force, as in the U.S., account control agreements will likely become a common consideration in all standard secured lending transactions.    

This update is intended as a summary only and should not be regarded or relied upon as advice to any specific client or regarding any specific situation.

If you would like further information regarding the issues discussed in this update or if you wish to discuss any aspect of this commentary, please feel free to contact us.