STIKEMAN ELLIOTT MEMORANDUM OF LAW FOR THE

Transcription

STIKEMAN ELLIOTT
MEMORANDUM OF LAW FOR THE INTERNATIONAL SWAPS AND
DERIVATIVES ASSOCIATION, INC. AND THE FUTURES INDUSTRY
ASSOCIATION
on the
Enforceability of the Liquidation, Setoff, Netting and Credit Support Provisions of
Certain Futures Account Agreements and a Cleared Derivatives Addendum upon a
Customer's Default or Insolvency, and Enforceability of Certain Offset Provisions
Applicable Prior to a Customer's Default or Insolvency
Ontario Law, Quebec Law and Canadian Federal Law
October 9, 2013
STIKEMAN ELLIOTT LLP
5300 Commerce Court West, 199 Bay Street, Toronto, Canada M5L 1B9
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TABLE OF CONTENTS
INTRODUCTION AND BASIC ASSUMPTIONS
PART 1I.
INTRODUCTION
II. ASSUMPTIONS FOR COVERED BASE AGREEMENTS AND CDA
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3
FURTHER ASSUMPTIONS AND OPINIONS
PART 2 I.
NETTING UNDER A COVERED BASE AGREEMENT AND CDA
II. NETTING FOR MULTIBRANCH PARTIES
III. COLLATERAL UNDER A COVERED BASE AGREEMENT AND CDA
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APPENDIX A - CERTAIN DERIVATIVES TRANSACTIONS
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APPENDIX B - CERTAIN COUNTERPARTY TYPES
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APPENDIX C - APPLICATION OF INSOLVENCY REGIMES
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APPENDIX D - DESCRIPTION OF CANADIAN INSOLVENCY REGIMES
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APPENDIX E - DEFINITION OF ELIGIBLE FINANCIAL CONTRACT
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APPENDIX F - PENSION ENTITY WINDING-UP
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APPENDIX G - INSOLVENCY PROCEEDING STAYS
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APPENDIX H - SUMMARY OF CONFLICT OF LAWS RULES
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TO:
International Swaps and Derivatives Association, Inc. (ISDA) and
the Futures Industry Association (FIA)
RE:
Enforceability of the Liquidation, Setoff, Netting and Credit
Support Provisions of Certain Futures Account Agreements and a
Cleared Derivatives Addendum upon a Customer's Default or
Insolvency, and Enforceability of Certain Offset Provisions
Applicable Prior to a Customer's Default or Insolvency
DATE:
October 9, 2013
PART 1 -
INTRODUCTION AND BASIC ASSUMPTIONS
I. Introduction
This legal opinion (this opinion) examines the treatment under the laws of the
Provinces of Ontario and Quebec and the federal laws of Canada of the
liquidation, set-off, netting and credit support provisions of:
(A)
certain Covered Base Agreements (as defined below), entered into by an
entity that is registered with the United States Commodity Futures Trading
Commission (the CFTC) as a futures commission merchant and is a member of
one or more CFTC-registered derivatives clearing organizations (FCM) (each
such FCM, a Clearing Member) and such Clearing Member's Covered Customer
(as defined below), setting forth the right of such Clearing Member, upon the
occurrence of an event giving rise to any right of such Clearing Member to
liquidate all Futures Transactions (as defined below), to liquidate such
transactions and to determine amounts owing with respect to them, to exercise
remedies in respect of Futures Payment Rights (as defined below) and rights of
netting and setoff with respect to obligations arising from Futures Transactions
and to apply Futures Credit Support (as defined below) transferred by a Covered
Customer in connection with such Futures Transactions; and
(B)
an addendum for Cleared Derivatives Transactions (a CDA), entered into
by a Clearing Member and such Clearing Member's Covered Customer, setting
forth the right of such Clearing Member, upon the occurrence of an event giving
rise to any right of such Clearing Member to liquidate either (i) all Cleared
Derivatives Transactions (as defined below)or (ii) any Cleared Derivatives
Transactions affected by a Tax Liquidation Event (as defined in the form of
Cleared Derivatives Addendum published by the FIA and ISDA), under a
Covered Base Agreement, to liquidate such transactions and to determine
amounts owing with respect to such transactions, to exercise remedies in respect
of Cleared Derivatives Payment Rights (as defined below) and rights of netting
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and setoff with respect to obligations arising from Cleared Derivatives
Transactions, to apply Cleared Derivatives Credit Support (as defined below)
transferred by a Covered Customer in connection with such transactions and to
offset obligations arising from Cleared Derivatives Transactions against Cleared
Derivatives Credit Support transferred to the Covered Customer. 1
This opinion addresses only the laws of the Province of Ontario, the Province of
Quebec and the federal laws of Canada that apply in these Provinces as of the
date of this opinion. 2
The Canadian insolvency laws addressed in this opinion are the Bankruptcy and
Insolvency Act (Canada) (BIA) 3 (both with respect to bankruptcy (BIA
Bankruptcy) and restructuring proposals (BIA Proposal)), the Winding-up and
Restructuring Act (Canada) (WURA) 4, the Canada Deposit Insurance Corporation Act
(Canada) (CDIC Act)5, the Companies' Creditors Arrangement Act (Canada)
(CCAA) 6, and national court administered receivership under the BIA
(Receivership) (together Insolvency Laws). These Insolvency Laws and
proceedings under them are generally the only federal insolvency laws and
proceedings that apply to Canadian entities.? This memorandum also considers
the application of the Payment Clearing and Settlement Act (Canada) 8 (PCSA) to
the termination and close-out netting provisions of the Agreement. Where this
opinion addresses Canadian insolvency proceedings it refers to proceedings
under these Insolvency Laws.
This opinion does not address or constitute advice with respect to compliance with, or the effects of
(including any unenforceability as a result of a failure to comply with), any other body of law or regulation
other than as explicitly set forth in this opinion, including but not limited to (i) any Canadian federal or
provincial commodities, securities or derivatives laws, rules or regulations, (ii) the rules and regulations of
any self-regulatory organization, exchange or clearing organization of which a Clearing Member may be a
member, (iii) Canadian federal or provincial tax laws, rules or regulations, (iv) laws applicable to
individuals, including but not limited to those related to capacity, competency, marriage, divorce or death
or (v) any laws, regulations, or insolvency proceedings not governed by Ontario, Quebec or Canadian
federal law. In addition, this opinion does not address or constitute advice with respect to bankruptcy,
insolvency or insurance matters other than those expressly addressed in it.
2 There are some very material differences in the laws of the different provinces as they apply to the subjects
discussed in this opinion. Therefore, in considering these issues in any case where a party might be
potentially litigating in another Canadian jurisdiction, or where the private international law rules would
direct you to that jurisdiction, specific advice should be sought.
3 S.C. 1992, c.27 as amended, including by S.C. 2007, c.36.
4 R.S.C. 1985, c.W-11, as amended by S.C. 1996, c.6, ss.133-161.
5 R.S.C. 1985, c.C-3, as amended.
6 R.S.C. 1985, c.C-36.
7 There are proceedings in various corporate statutes that provide for (1) a restructuring of a company at the
shareholder and sometimes at a creditor level, or (2) a winding-up of a company. Occasionally these
proceedings can involve insolvent corporations. Although they are not strictly insolvency proceedings, they
are also discussed in this memorandum because of their potential application to an insolvent entity.
8 S.C. 1996, c.6.
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The chart at Appendix C illustrates in chart form which insolvency proceedings
apply to the Covered Customer types addressed in this opinion. Appendix D
provides a description of each insolvency proceeding.
IL Assumptions For Covered Base Agreements and CDA
Our opinion is based on the following assumptions:
(a)
Covered Base Agreements
(i)
Pursuant to a futures customer account agreement (a Covered Base
Agreement) entered into between a Clearing Member and a customer
located in Ontario or Quebec that is an entity type specified on Appendix
B as being covered by this opinion (a Covered Customer), the Clearing
Member agrees to carry one or more accounts on behalf of that Covered
Customer (each, an Account) and to execute, carry and clear transactions
for the purchase or sale of commodities for future delivery on, or subject
to the rules of derivatives clearing organization (a DCO) registered as
such under the United States Commodity Exchange Act (the CEA) or
traded on, or subject to the rules of, a board of trade outside the United
States (such contracts executed on a contract market designated pursuant
to Section 5 of the CEA and cleared by a U.S.-registered DCO, "U.S.
Futures, such as contracted, traded on or subject to the rules of, a board of
trade outside the United States, an options thereon, "Foreign Futures"
and, collectively Futures) and/or options on U.S. Futures subject to Part
33 of the rules of the CFTC (such contracts, Options, and collectively with
Futures, Futures Transactions). With respect to Foreign Futures, the
Clearing Member acts for the Covered Customer by carrying Foreign
Futures on the Covered Customer's behalf with, and guaranteeing the
Covered Customer's performance to, clearing members ("Foreign
Clearing Members") of the relevant foreign clearinghouses, which Foreign
Clearing Members may frequently be affiliates of the Clearing Member,
and the Foreign Clearing Members will, in turn, enter into back-to-back
futures transactions cleared by foreign clearinghouses.
(ii)
Each Covered Base Agreement is governed by New York law and is legal,
valid and binding and enforceable in accordance with its terms under
New York law. Each party has the capacity to enter into each Covered
Base Agreement and has properly authorized, executed and delivered the
Covered Base Agreement.
(iii)
Pursuant to a Covered Base Agreement, the Covered Customer agrees to
transfer, as applicable, initial margin and variation margin payments as
the Clearing Member may require in respect of the Covered Customer's
Futures Transactions. Also, pursuant to the Covered Base Agreement, the
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Covered Customer grants a security interest to the Clearing Member in all
of the Covered Customer's rights in the following property, whether at
the time of the grant or thereafter existing:
(A) "Futures Credit Support" including:
(1) with respect to U.S. Futures and Options, its Account and
all assets credited thereto, including assets held by a
DCO, as well as other property of the Covered Customer
held in respect of Futures Transactions by or for the
Clearing Member, the DCO or any agent acting for the
Clearing Member, the DCO or the Covered Customer;
(2) with respect to Foreign Futures, its Account and all assets
credited thereto, including assets held by a Foreign
Clearing Member or foreign clearinghouse, as well as
other property of the Covered Customer held in respect
of Futures Transactions by or for, or for the Account and
due from the Clearing Member, any Foreign Clearing
Member, any foreign clearinghouse or others, or any
agent action for the Clearing Member, any Foreign
Clearing Member, any foreign clearinghouse or others;
and
(B)
"Futures Payment Rights", including:
(1) with respect to U.S. Futures and Options, its Futures
Transactions and all rights to payment thereunder
(whether constituting obligations of the Clearing
Member or a DCO);
(2) with respect to Foreign Futures, its Futures Transactions
and all rights to payment thereunder (whether
constituting obligations of the Clearing Member, a
Foreign Clearing Member or a foreign clearinghouse).
The security interest secures all obligations of the Covered Customer to
the Clearing Member under the Covered Base Agreement.
(iv) A Covered Base Agreement contains one or more events of default
(whether or not described therein as "events of default") (each, an Event of
Default) the effect of which is to give the Clearing Member the right to
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liquidate the Futures Transactions held in the Covered Customer's
Account (Futures Liquidation Rights). Among such Events of Default are
defaults predicated on (A) a Covered Customer's filing under applicable
bankruptcy or similar insolvency laws, (B) the filing of a petition for the
commencement of involuntary proceedings in respect of the Covered
Customer under applicable bankruptcy or similar insolvency laws which
filing results in a judgment of insolvency or bankruptcy or an order for
relief and (C) the appointment in respect of the Covered Customer or
substantially all of its assets of an administrator, conservator, receiver or
similar official, including the possession and control of the property of the
Covered Customer by such an official pursuant to seizure orders.. The
terms of the Covered Base Agreement provide the Clearing Member with
the right as a secured party to exercise remedies in respect of Futures
Payment Rights and to net and set off amounts owing under Futures
Transactions on account of their liquidation and termination (collectively,
Futures Netting Rights).
(v)
The Covered Base Agreement includes a provision the effect of which is to
permit the Clearing Member, upon the occurrence of an Event of Default
in respect of a Covered Customer, to dispose of or realize on all Futures
Credit Support posted by the Covered Customer to the Clearing Member
in respect of Futures Transactions and net or apply the foregoing or the
liquidation value thereof to any obligations the Covered Customer owes
to the Clearing Member under the Covered Base Agreement. We refer to
the foregoing collectively as Futures Credit Support Rights.
A futures account agreement that does not alone satisfy the above requirements
is nevertheless a "Covered Base Agreement" to the extent it is paired with a CDA
that supplies any of the otherwise unsatisfied requirements.
(b) The CDA
(i)
In addition to entering into a Covered Base Agreement with the Covered
Customer, the Clearing Member and the Covered Customer execute a
CDA. The CDA supplements a Covered Base Agreement with respect to,
among other things, the liquidation, set-off and netting of "Cleared
Derivatives Transactions" carried in the Covered Customer's account
holding Cleared Derivatives Transactions (the Cleared Derivatives
Account), as well as the application of collateral related to those Cleared
Derivatives Transactions. "Cleared Derivatives Transactions" are swaps,
forwards, options, or similar transactions (but excluding Futures
Transactions executed on or subject to the rules of a U.S. designated
contract market or on a foreign board of trade and subject to regulation in
that jurisdiction) that are (a) entered into by a Covered Customer in the
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over-the-counter market, or (b) executed or traded by such Covered
Customer on or subject to the rules or protocols of any multilateral or
other trading facility, system or platform, including any communication
network or auction facility permitted under applicable law or any
designated contract market and, in either case, subsequently submitted to
and accepted for clearing by a DCO and subject to the CFTC's Part 22
rules. To the extent that a security-based swap is, in accordance with
applicable law, carried by an FCM in a cleared swaps customer account
(as defined in the CFTC's Part 22 rules), such security-based swap
constitutes a Cleared Derivatives Transaction. A list of example types of
Cleared Derivatives Transactions appears in Appendix A.
(ii)
Each CDA is governed by New York law and is legal, valid and binding
and enforceable in accordance with its term under New York law. Each
party has the capacity to enter into each CDA and has properly
authorized, executed and delivered the CDA.
(iii) Pursuant to a CDA, Cleared Derivatives Transactions become
incorporated into the related Covered Base Agreement, which
incorporation is accomplished by considering references to "Contracts,"
"Futures," "Futures Contracts" and similar terms in such Covered Base
Agreement to include references to the Cleared Derivatives Transactions.
Through this incorporation, the Covered Customer grants a security
interest to the Clearing Member in all of the Covered Customer's rights in
the following property, whether at the time of the grant or thereafter
existing:
(A)
its Cleared Derivatives Account and all assets
credited thereto, including assets held by a DCO, and (2)
other property of the Covered Customer held in respect of
Cleared Derivatives Transactions by or for the Clearing
Member, the DCO and any agent acting for the Clearing
Member, the DCO or the Covered Customer (collectively,
Cleared Derivatives Credit Support); and
(B)
its Cleared Derivatives Transactions and all rights to
payment thereunder (whether constitution obligations of the
Clearing Member or a DCO) (collectively, Cleared
Derivatives Payment Rights).
(iv) Pursuant to the CDA, following the occurrence of an Event of Default, the
Clearing Member is entitled to set off or apply any margin transferred to
the Covered Customer under Cleared Derivatives Transactions (Customer
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Received Margin) against obligations to the Covered Customer under the
CDA.
(v)
The Clearing Member is entitled, upon the occurrence of an Event of
Default, to designate a date and thereupon cause the liquidation of a
Covered Customer's Cleared Derivatives Transactions (such rights, the
Cleared Derivatives Liquidation Rights). The Clearing Member is
entitled to exercise its remedies as a secured party in respect of Cleared
Derivatives Payment Rights and to net amounts owing in respect of
liquidated Cleared Derivatives Transactions.
(vi)
Upon the liquidation of a Covered Customer's Cleared Derivatives
Transactions, the CDA provides the Clearing Member with rights to (a)
dispose of or realize on all Cleared Derivatives Credit Support posted by
the Covered Customer to the Clearing Member in respect of Cleared
Derivatives Transactions and set off or apply the foregoing or the
liquidation value thereof to any obligations the Covered Customer owes
to Clearing Member under the CDA and (b) apply the value of any
Customer Received Margin against any obligations owed to the Covered
Customer under the CDA (such rights, the Cleared Derivatives Credit
Support Rights).
The FIA-ISDA Cleared Derivatives Addendum in the foreign published jointly
by the FIA and ISDA satisfies the above requirements.
A CDA that does not alone satisfy the above requirements is nevertheless a
"CDA" to the extent it is paired with a Covered Base Agreement that supplies
any of the otherwise unsatisfied requirements. In addition, a single document
that satisfies the above requirements for a Covered Base Agreement and a CDA
is both a "Covered Base Agreement" and a "CDA."
Any reference to a "Question" in this memorandum refers to a Question in the
same section of the memorandum unless otherwise indicated.
PART 2 - FURTHER ASSUMPTIONS AND OPINIONS
I. Netting Under a Covered Base Agreement and CDA
A. Assumptions
1.
On the basis of the terms and conditions of a Covered Base Agreement
and CDA and other relevant factors, and acting in a manner consistent
with the intentions stated in the Covered Base Agreement and CDA, the
parties over time enter into a number of Futures Transactions and Cleared
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Derivatives Transactions (Covered Transactions) that are intended to be
governed by the Covered Base Agreement and CDA. The Covered
Transactions entered into include any or all of the transactions described
in Appendix A.
2.
Some of the Covered Transactions provide for an exchange of cash by
both parties and others provide for the physical delivery of shares, bonds
or commodities in exchange for cash.
3.
After entering into these Covered Transactions and prior to the maturity
thereof, the Covered Customer, which is organized in Canada, becomes
the subject of a voluntary or involuntary case under the insolvency laws of
Canada and, subsequent to the commencement of the insolvency, either
the Covered Customer or an insolvency official seeks to assume the
profitable Covered Transactions for the Covered Customer and reject the
unprofitable Covered Transactions for the Covered Customer or
otherwise prevent the exercise of close-out rights by the Clearing Member.
B. Issues
1. Are the provisions of the Covered Base Agreement and CDA
permitting the Clearing Member to terminate all the Covered
Transactions upon the insolvency of the Covered Customer
enforceable under the laws of Ontario and Quebec?
The provisions of the Covered Base Agreement and CDA permitting the Clearing
Member to terminate all the Covered Transactions upon the insolvency of the
Covered Customer are enforceable under the laws of these jurisdictions, subject
to the following provisos and qualifications.
Provisos
Proviso 1 - Covered Transactions Must be EFCs Between the Parties
In the context of an insolvency proceeding, the above opinion applies to Covered
Transactions as long as they are "eligible financial contracts" between the
Clearing Member and the Covered Customer as defined under the relevant
Insolvency Law.
Under certain Insolvency Laws (namely CCAA, BIA Proposal, WURA, CDIC
Act, Receivership), either automatically or by court order, the non-insolvent
party may not exercise a right to terminate any contract or accelerate obligations
under a contract by reason of the insolvency of the other party or commencement
of the insolvency proceeding with respect to it.
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Under certain of these insolvency proceedings (CCAA, BIA Proposal and
WURA) there is a safe-harbour provision that permits a party to rely on
contractual termination rights in an eligible financial contract notwithstanding
the automatic or any court ordered stay (the EFC safe-harbour). Mutuality of
obligations is a requirement for relying on the EFC safe-harbour. Mutuality exists
between the DCO and the Covered Customer through the agency of the Clearing
Member so as to permit reliance by the DCO (or its agent) on the EFC safeharbour with respect to the Covered Transactions that have been novated to the
DCO.
Futures Transactions are eligible financial contracts as they are expressly covered
by the definition ("a derivative agreement [which includes a futures agreement
or an option] that ... trades on a futures or options exchange or board, or other
regulated market").
Cleared Derivatives Transactions would be eligible financial contracts assuming
they met the general criteria for being an eligible financial contract, which
definition is set out in Appendix E. Any of the Cleared Derivatives Transaction
types set out in Appendix A are potentially eligible financial contracts. The
definition is very general. Cleared Derivatives Transactions that are "derivatives
agreements that are the subject of recurrent dealings in the derivatives markets or
in the over-the-counter securities or commodities markets" are eligible financial
contracts. A transaction which is sufficiently standardized to be cleared would be
subject of recurrent dealings in such markets.
The definition of "derivative agreement" encompasses the concept of a
"financial" agreement. We believe that the intention of the definition is not to
require evidence in individual cases that transactions have a "financial" element
in the particular context if the transaction is one of the listed types of contracts,
such as a swap, future, option, spot or forward, and if it relates to an underlying
interest that is specifically listed. In other words, such contracts should be, by
definition, "financial" agreements. This approach to the definition meets the
purpose of the legislation, which is to provide certain and express protection for
termination, netting and collateral enforcement rights for the types of contracts
that are the subject of recurrent dealings in derivatives, securities and
commodities markets.
If this interpretation is not correct, then we believe that Transactions that provide
for cash settlement or Transactions that involve an element of financial risk
management or speculation would be found to be "financial" agreements. Also,
if the analysis of the Ontario Court of Appeal in Re Androscoggin Energy LLC 9 is
9
(2005), 8 C.B.R. (5th) 11.
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applied, the presence of termination and netting rights is a key indication of the
financial nature of the contract.
Covered Derivatives Transactions of the types listed in Appendix A would in our
view meet the criteria for an eligible financial contract.
The CDA and Covered Base Agreement are eligible financial contracts to the
extent that the Covered Transactions are themselves eligible financial contracts
as an eligible financial contract includes a master agreement in so far as it is in
respect of, among others, a derivative agreement.
Also included in the definition is "an indemnity or reimbursement obligation
with respect to the liabilities under" such an agreement. To the extent that the
Covered Customer has an obligation to indemnify the Clearing Member with
respect to the Clearing Member's liability to the DCO for the Covered
Customer's Covered Transactions novated to the DCO, that indemnity obligation
is itself a safe-harboured transaction and, consequently, the right to accelerate the
obligation is covered by the EFC safe-harbour. 10 We are assuming that the proper
interpretation of the CDA and any Covered Base Agreement under the relevant
governing law would recognize that the nature of the Customer's obligations to
the Clearing Member is to indemnify the Clearing Member for its obligations to
the DCO. Consequently, although mutuality of obligations is a requirement for
reliance on the EFC safe-harbour, the required mutuality exists between the
Clearing Member and the Covered Customer in this respect even though it may
not exist between the Clearing Member and the Covered Customer with respect
to the Cleared Derivative Transaction itself or to Covered Transactions that have
been novated to the DCO.
Although there is no express statutory safe-harbour, there is a practice in
Receivership proceedings of providing the same exemption for eligible financial
concerts as part of the court order.
There is also an EFC safe-harbour in the CDIC Act (which applies to CDIC
insured deposit taking institutions), but it subject to certain additional
qualifications and provisos where a bridge institution is to be incorporated (see
below).
The measurement of that liability may be determined by a calculation of gains and losses determined
through the Clearing Member entering into Close-out Transactions, Risk-Reducing Transactions and
Mitigation Transactions that are entered into in order to liquidate Cleared Derivatives Transactions and
which themselves give rise to a liability of the Clearing Member to the DCO. As noted below, however,
there may be impediments to entering into such Transactions as agent of an insolvent Customer directly for
the account of the Customer.
10
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A more detailed description of the treatment of termination rights in insolvency
proceedings is set out in the following paragraphs.
BIABankruptcy
In our view, the provision allowing the Clearing Member to terminate would be
enforceable against a trustee in bankruptcy under the BIA. 11 There is no statutory
provision that provides for a stay on termination rights in a BIA bankruptcy
procedure. Consequently, the principle that the trustee in bankruptcy obtains no
greater rights under a contract than had the insolvent party will operate. In fact,
the trustee in bankruptcy may have fewer rights. As stated in a Canadian
bankruptcy text:
... But when bankruptcy occurs the rights of the trustee are
not in all respects the same as those of the debtor before
his bankruptcy or insolvency. The rights which the trustee
acquires are only those rights which remain in the
insolvent party. The trustee's rights are not those of the
party if it had not become insolvent. 12
So where a contract contains a clause to the effect that rights are terminated or
obligations accelerated upon insolvency, the trustee in bankruptcy will,
assuming all contractual preconditions to termination are met, be subject to that
contractual provision. 13
On the same basis, a contractual right to rescind contracts that may be settled by
physical delivery is also enforceable provided that title has not passed to the
Customer.
The BIA provides for an automatic stay of "proceedings" for the recovery of
claims that are provable in the liquidation upon the commencement of a
liquidation proceeding. 14 The automatic stay of proceedings provided for in the
BIA does not, in our view, prevent the termination of Covered Transactions by
the Clearing Member. We have three reasons for this view. First, the purpose of
liquidation proceedings is for all creditors to value their claims and seek redress
There is now an exception to this principle for contracts with individuals. There is an automatic stay on
termination or acceleration in that case, although subject to a safe-harbour for eligible financial contracts
(BIA, s.84.2).
12 Duncan, Bankruptcy in Canada, at 329-330.
13 See Re Diamond Truck Co. Ltd., [1942] 3 D.L.R. 738, at 743 (Que. C.A.); Re Durnford Elk Shoes Ltd. (1916), 11
O.W.N. 59 (C.A.) lv. to app. refd. 11 O.W.N. 105; Laing Construction Equipment Limited v. Casson (1975), 19
C.B.R. (N.S.) 89 (B.C.C.A.); Garrett v. Richardson & Sons Ltd., [1942] 2 D.L.R. 182 (Ont. C.A.); Merrill Lynch
Royal Securities Ltd. v. Blum (1983), 23 B.L.R. 260 (Ont. H.C.J.); Fridman, The Law of Contract 2nd ed. (Toronto:
Carswell, 1986) at 515-516.
14 BIA, s.69.3(1).
11
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for those claims solely within the insolvency proceedings. The termination and
close-out netting mechanisms are simply mechanisms to value claims of or
against the Clearing Member. There is no intention that the insolvent party will
continue in business following the proceedings and therefore, no purpose would
be served by preventing the Clearing Member from terminating and valuing its
claim. Secondly, the case law supports the right of contracting parties to
terminate agreements after the commencement of insolvency proceedings.
Thirdly, it would be surprising if the court were to prevent termination in the
liquidation context, when it is clearly permitted by the BIA in the reorganization
context.
Also, where the PCSA applies (see Proviso 2 below), the Clearing Member will
also be able to rely on the express statutory termination right included in section
13 as described below.
BIA Proposal
The BIA proposal provisions expressly address the issue of termination of
derivatives transactions. 15 The BIA provides that the filing of a proposal or notice
of intention to file a proposal to effect a creditor reorganization prevents a party
from terminating contracts or accelerating obligations under contracts for the
reason only that the other party (1) is insolvent, or (2) has filed a proposal or
notice of intention to file a proposa1. 16 A party is permitted to terminate contracts
by reason of any other default, either before or after the filing of the proposal or
notice. Eligible financial contracts, however, are expressly exempted from the
provision preventing termination because of insolvency or the filing of a
proposal or notice of intention to file a proposa1. 17
In summary, the right of the Clearing Member to terminate all Covered
Transactions is not adversely affected by the filing of a proposal or notice of
intention to file a proposal to effect a creditor reorganization under the BIA.
CCAA
The CCAA expressly recognizes the right of a party to terminate eligible financial
contracts pursuant to the terms of a master agreement. Section 34(1) provides for
BIA, s.65.1.
BIA, s.65.1(1).
17 BIA, s.65.1(7).
15
16
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an automatic stay on terminating or accelerating contracts by reason only that
proceedings are commenced under the Act or that the company is insolvent.
Section 34(7) provides an exemption from that automatic stay for eligible
financial contracts:
34. (1) No person may terminate or amend, or claim an accelerated
payment or forfeiture of the term under, any agreement, including a
security agreement, with a debtor company by reason only that
proceedings commenced under this Act or that the company is insolvent.
(7) Subsection (1) does not apply
(a) in respect of an eligible financial contract; or
(b) to prevent a member of the Canadian Payments Association from
ceasing to act as a clearing agent or group clearer for a company in
accordance with the Canadian Payments Act and the by-laws and rules of
that Association.
WURA
Under the WURA there is express recognition of the right to terminate eligible
financial contracts. 18
22.1 (1) Nothing in this Act or an order made under this
Act prevents or prohibits the following actions from being
taken in accordance with the provisions of an eligible
financial contract:
(a) the termination of the contract;
Where the PCSA applies, however, the Clearing Member will also be able to rely
on the express statutory termination right included in section 13 as described
below.
If the Covered Transactions have been transferred to a new bridge institution or
CDIC has guaranteed the payment obligations under them under the procedures
18
WURA, s.22.1.
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in the CDIC Act, the Clearing Member will not be able to rely on the WURA safeharbour if the defaulting financial institution is made subject to a WURA order. 19
Receivership
A court order appointing a receiver and manager will often prevent the
termination of contracts. This type of order is generally intended to prevent
utilities and other suppliers from terminating their arrangements with the debtor
in a way which would prejudice the receiver and manager's opportunities to sell
the business as a going concern. In theory, the order preventing termination may
be drafted widely enough to capture any type of agreement. We believe that,
even if an original order was drafted so widely as to capture Covered
Transactions, a court would amend this order to exclude them upon a motion by
the Clearing Member. A court administered receivership is, in essence, a
liquidation proceeding, not a creditor reorganization proceeding, and
consequently, a court would be reluctant to allow a situation that differs so
markedly from that under either the BIA, CCAA or WURA. It is our view that
the risk of a court order in a receivership preventing the termination is minimal.
We would expect that, at most, there might be a period of delay until the court
can hear and determine the Clearing Member's motion to exclude it from the
general stay that might be granted by the order. Current practice in Ontario is to
exempt eligible financial contracts from such a stay.
Where the PCSA applies, the Clearing Member will also be able to rely on the
express statutory termination right included in section 13 as described below.
Voluntary Wind-up of Trusts
If the Covered Customer is in the form of a trust and is voluntarily winding-up,
then there is no applicable stay with respect to the termination rights.
Proviso 2 - Application of Payment Clearing and Settlement Act
If the EFC safe-harbour does not apply, then the Clearing Member may
nevertheless be able to rely on certain provisions of the PCSA, which provides an
additional stay exemption. This stay exemption 20 applies "[d]espite anything in
any law relating to bankruptcy or insolvency or any order of a court made in
respect of an administration of a reorganization, arrangement or receivership
involving insolvency". This PCSA exemption applies to allow a party to a
"netting agreement" to terminate the agreement. A "netting agreement" is
defined as:
19 CDIC Act, s.39.18(2).
20 PCSA, s.13.
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"netting agreement" means an agreement between
two or more financial institutions, between the Bank
[of Canada] and one or more financial institutions or
between a participant 21 and a customer to which the
participant provides clearing services that is
(a) an eligible financial contract; or
(b) an agreement that provides for the netting or setoff or compensation of present or future obligations to
make payments against the present or future rights to
receive payments. [emphasis added]
A Clearing Member for a DCO clearing futures, options on futures, or other
over-the-counter derivatives transactions would be a "participant". There is no
requirement for purposes of this provision that the DCO be licensed in this
jurisdiction. Consequently termination rights in an eligible financial contract
between a Clearing Member and a Covered Customer are protected by this
provision. This means, for example, that this express safe-harbour would apply
in Receivership (where there is no express safe-harbour).
Further, termination rights in any other agreement between a participant and
customer that provides for the netting or set-off or compensation 22 of present or
future payment obligations is a netting agreement even if the obligations do not
relate to an eligible financial contract. Because the Covered Base Agreement and
CDA are agreements that provide for such netting and set-off of obligations
between the Clearing Member and the Covered Customer, they would be an
A "participant" means a member of a clearing house or a party to an arrangement that establishes a
clearing and settlement system (PCSA, s.2). A"clearing house" means "a corporation, association,
partnership, agency or other entity that provides clearing or settlement services for a clearing and settlement
system. It includes a securities and derivatives clearing house, as defined in subsection 13.1(3) [which means
any designated DCOs], but does not include a stock exchange or the Bank [of Canada]". (PCSA, s.2). A
"clearing and settlement system" means a system or arrangement for the clearing or settlement of payment
obligations or payment messages in which:
(a) there are at least three participants, at least one of which is a Canadian participant and at least
one of which has its head office in a jurisdiction other than the jurisdiction where the head office of
the clearing house is located;
(b) clearing or settlement is all or partly in Canadian dollars; and
(c) except in the case of a system or arrangement for the clearing or settlement of derivatives
contracts, the payment obligations that arise from clearing within the system or arrangement are
ultimately settled through adjustments to the account or accounts of one or more of the
participants at the Bank.
For greater certainty, it includes a system or arrangement for the clearing or settlement of securities
transactions, derivatives contracts, foreign exchange transactions or other transactions if the system or
arrangement also clears or settles payment obligations arising from those transactions.
22 "compensation" is the Quebec law equivalent of set-off.
21
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eligible financial contract even if the mutual obligations netted are not
themselves derivatives agreements between the parties.
Qualification 1 - Agency Relationship
In order to close out the transactions and determine the indemnity obligation of
the Covered Customer to the Clearing Member, it is contemplated that the
Clearing Member could enter into Offsetting Transactions or Risk-Reducing
Transactions as agent and for the account of the Covered Customer.
With respect to BIA proceedings, Quebec law provides that the agency
relationship would be automatically revoked by the commencement of a
"bankruptcy" proceeding, but it does not define bankruptcy proceeding so it
could include not only proceedings under bankruptcy legislation but also other
insolvency proceedings. 23 However, under Quebec law, whether such an agency
relationship is irrevocable inside or outside of insolvency proceedings is
determined by the governing law of the agency relationship and hence this
automatic revocation would only apply if the agency relationship was governed
by Quebec law. The agency relationship may be revocable by the insolvency
representative if under its governing law it is not irrevocable. Consequently, for a
Quebec Counterparty where the agency relationship is governed by Quebec law
or whether it is not an irrevocable agency relationship under its governing law, it
may be necessary to adopt a method of liquidating the Covered Transactions
with the DCO in a manner that does not require entering into Transactions for
the account of the Covered Customer.
Under Ontario law, there is only very limited case law on the agency issue. An
agency relationship that is expressed to be irrevocable, is granted for
consideration, and is coupled with an interest cannot be revoked by the
principal. This type of agency relationship will also survive the commencement
of insolvency proceedings. 24 There is some support in Canadian common law
case law for the position that an agency relationship that is for the protection of
the agent would be considered to be coupled with an interest. 25 In other words,
it is not necessarily the case that the agency power relates specifically to property
over which the agent has rights (such as a security interest or option). This case
law would support in our view the irrevocability of the Clearing Member's right
to enter into Offsetting Transactions or Risk-Reducing Transactions as agent of
the Covered Customer. However, it is not a definitive body of case law. Also, it
Art. 2175 Civil Code of Quebec. It is silent with respect to other insolvency proceedings.
Cameron Harvey and Darcy MacPherson, Agency Law Primer, 4th ed (Toronto: Carswell, 2009).
25 Wilkinson v. Young, [1972] O.J. No. 1707, 25 D.L. R. (3d) 275 (Ont. H.C.J.); Mitchell v. Sykes [1883] O.J. No.
266 at para 21, 4 O.R. 501, Klymas v. Burkholder, [1976] O.J. No. 1625 at para 27; Lear v. Klapstein [2000] 7
WWR 736 at para 40 to 42, 79 Alta LR (3d) 335.
23
24
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may also be the case that an Ontario court would consider the issue of whether
or not the agency relationship is irrevocable to be governed by the law of the
agency relationship and not Ontario law. Consequently, with respect to an
Ontario Customer, if under the governing law of the Covered Base Agreement or
CDA the agency relationship is revocable, it may be necessary to adopt a method
of liquidating the Covered Transactions with the DCO in a manner that does not
require entering into Transactions for the account of the Covered Customer.
Further, given the limited case authority on this point in Ontario, this may also
be a prudent course of action for any Customer potentially subject to insolvency
proceedings in Ontario.
Qualification 2 - CDIC Act Bridge Institution
If the Covered Customer is a deposit taking institution whose deposits are
insured by the Canadian Deposit Insurance Corporation, then there is a
possibility of a stay preventing termination of the Covered Transactions by the
Clearing Member.
Where CDIC obtains a vesting order under the CDIC Act 26, the Act imposes a
number of different limitations on the rights that can be exercised against the
institution, including that no person may terminate or amend any agreement
with the institution or claim an accelerated payment only because of (1) the
institution's insolvency, (2) the making of the order, or (3) a default before the
order was made in any performance of obligations under the agreement. 27
Subject to the bridge institution provisions discussed below, the CDIC Act
provides that these provisions do not prevent termination in accordance with
their terms of "eligible financial contracts". 28
The CDIC Act EFC safe-harbour provides for an exception to its effectiveness
where an order to incorporate a bridge institution is made. 29
The CDIC Act permits CDIC to assign all of the eligible financial contracts
between a member institution that is subject to a receivership order under the
CDIC Act and its counterparty to a bridge institution. A bridge institution is an
institution of the same type as the insolvent member institution (e.g. a bank)
CDIC Act, s.39.15.
CDIC Act, s.39.15(1)(d). Note that the CDIC Act differs from section 65.1(1) of the BIA in that under the
CDIC Act a prior default, such as a payment default, cannot provide grounds for termination once an order
is made, whereas under the BIA the pre-proceeding defaults can be relied on. The Governor in Council
(essentially the federal cabinet), in making the order, has the power to provide that these provisions do not
apply to the institution, but no such order has been made (s.39.15(1))
28 CDIC Act, s.39.15(4).
29 S.C. 2009, c. 2, s. 245(7).
26
27
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incorporated by a Cabinet order. The shares of a bridge institution would be
owned by CDIC. 30 CDIC is required, to provide the financial assistance that a
bridge institution needs in order to discharge its obligations as they become due.
Where an order directing the incorporation of a bridge institution is made, there
is (1) an automatic temporary stay that prevents reliance on the EFC safe-harbour
and (2) the possibility of a permanent stay where the Agreement is assumed by a
bridge institution or CDIC guarantees the payment obligations under the
Agreement. These stays take precedence over the rights protections in the
PCSA. 31 It is anticipated that an order incorporating a bridge institution would
be made at or around the same time that the receivership order under the CDIC
Act is made.
The Temporary Stay
The Jobs and Growth Act, 2012 (Canada) 32 passed on December 14, 2012 amended
the CDIC Act to provide for a new temporary stay in the event that an order is
made directing the incorporation of a bridge institution. 33 The stay prevents
reliance on the member institution's insolvency, the making of the order
appointing CDIC as receiver, the making of the order directing incorporation of
the bridge institution, or the assignment of the eligible financial contract to or
assumption of it by the bridge institution as grounds for accelerating or
terminating any eligible financial contract. 34 This stay lasts from the time the
order directing incorporation of the bridge institution is made until 5:00 p.m. on
the following business day 35 (Ottawa time). During this period presumably CDIC
will determine whether or not the bridge institution will assume the eligible
financial contracts.
This temporary stay does not apply to an eligible financial contract between the
federal member institution and a clearing house that provides clearing and
settlement services for a clearing and settlement system designated under section
4 of the PCSA or a securities and derivatives clearing house as defined under
subsection 13.1(3) of the PCSA. 36 It does apply to DCOs that do not have either of
these designations. Currently, no non-Canadian DCOs have such designations.
The bridge institution is not a Crown agent corporation.
PCSA, s. 13(1.2).
32 S.C. 2012, c. 31.
33 CDIC Act, s.39.15(7.01).
34 There is an exemption for certain designated clearing and settlement systems or designated securities and
derivatives clearing houses; CDIC Act, s.39.15(7.02).
35 A business day is a day other than Saturday, Sunday or a day on which the clearing and settlement
systems operated by the Canadian Payments Association are closed; CDIC Act, s.39.15(7.03).
36 CDIC Act, s.39.15(7.02).
30
31
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The Conditional Stay
After or during the operation of the temporary stay, a conditional stay may
become effective. The counterparty of the member institution cannot rely on the
eligible financial contracts exemption if CDIC undertakes to either guarantee
unconditionally the payment of any amount due or that may become due in
accordance with the provisions of the contract by the member institution or
ensure that all obligations arising from the contract will be assumed by the
bridge institution. We refer to this as the conditional stay as it is conditional on
CDIC making these undertakings. The relevant section reads as follows:
39.15 (7.1) If an order directing the incorporation of a
bridge institution is made and the Corporation
undertakes to unconditionally guarantee the payment
of any amount due or that may become due by the
federal member institution, in accordance with the
provisions of the eligible financial contract, or to
ensure that all obligations of the federal member
institution arising from the eligible financial contract
will be assumed by the bridge institution, the actions
referred to in subsection (7) [ed. termination, netting
and dealing with financial collateral for an eligible financial
contract] are not to be taken by reason only of
(a)
the federal member institution's
insolvency;
the making of an order or an order
(b)
appointing the Corporation as receiver in
respect of the federal member institution or the
making of the order directing the incorporation
of the bridge institution; or
(c)
the eligible financial contract being
assigned to or assumed by the bridge
institution. 37
After the temporary stay period, unless and until the CDIC undertakings
referred to in the provision are made there is no impediment to relying on the
EFC safe-harbour, The provision prevents reliance on the exemption only if the
reason for termination of the agreements is one or more of the matters set out in
(a) to (c) immediately above. It does not, for example, preclude relying on the
37
S.C. 2009, c. 2, s. 245(7).
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exemption if there has been a performance Default, such as a failure to transfer
collateral.
The stay is a permanent stay once the contracts have been assigned to the bridge
institution.
A subsequent WURA proceeding with respect to the insolvent member
institution cannot be relied on as a new Event of Default.
CDIC is a federal Crown corporation that is an agent of Her Majesty in right of
Canada so it is the federal Crown that ultimately stands behind the statutory
obligation of CDIC to ensure that the bridge institution meets its financial
obligations (where the eligible financial contracts are assumed by the bridge
institution) or the CDIC guarantee of the payment obligations of the defaulting
member institution (where the eligible financial contracts are not assigned to the
bridge institution and the guarantee is provided).
In summary, the right of the Clearing Member to terminate is not adversely
affected by the making of an order to facilitate a restructuring of a federal
deposit taking financial institution under the CDIC Act. If the federal institution
is placed into receivership under the CDIC Act and if the government makes an
order to incorporate a bridge institution, then a temporary one business day stay
on relying on the eligible financial contracts exemption applies. If CDIC then
makes either the guarantee undertaking or the undertaking to have the bridge
institution assume the obligations, then there is a further stay preventing reliance
on the EFC safe-harbour. The stay is a permanent stay once the contracts have
been assigned to the bridge institution or the guarantee given (subject to a fresh
default).
The PCSA safe-harbour does not override the bridge institution stays under the
CDIC Act. 38
Qualification 3 - Pension Plans
Pension Entities that are insolvent may be wound-up under the supervision of
the pension regulator. In our view the regulator has no jurisdiction to impose a
stay preventing termination in such a context if there is a contractual provision
that permits termination on the basis of such an order being made. More detail as
to the procedure for winding-up a pension plan entity under Ontario law is
provided in Appendix F.
Qualification 4 - Corporate Plans of Arrangement
38
PCSA, s. 13(1.2).
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With respect to Corporate Plans (applicable only to Covered Customers that are
Corporations governed by a statute with a corporate plan of arrangement
procedure), courts do not typically grant orders staying the termination of
contracts. In particular, we are aware of only one case where any order has
purported to stay the exercise of termination and liquidation rights relating to
eligible financial contracts. We do not believe that a court before which the issue
was fully argued would grant such a stay in the face of the generally applicable
bankruptcy principles relating to executory contracts and the statutory
recognition of termination and netting rights in other insolvency regimes.
A case provides further support for the enforceability of close-out and netting or
liquidation rights in a Corporate Plan context. 39 An application was brought
before the courts in Alberta under the arrangement provisions of the Canada
Business Corporations Act in which the applicant sought a stay of termination
rights under what would have been classified as an "eligible financial contract"
under the CCAA and other insolvency legislation. Parties to such contracts had
contractual rights to terminate based on the Chapter 11 filing of the applicant's
parent corporation or other credit events affecting the parent corporation, which
was the applicant's credit support provider. The applicant argued that it was
solvent and that it could remain so if a stay was granted to give it time to
renegotiate credit support arrangements with its counterparties. The court
rejected the application on the basis that it was not appropriate to interfere with
the contractual rights of the parties and that the public policy against interfering
with close-out and netting rights in the case of insolvent counterparties applied
as well to solvent counterparties seeking to reorganize.
However, in a similar later proceeding involving Abitibi-Consolidated Inc. the
court took the unprecedented step of staying the termination of contracts with
the applicant companies and made no exception for eligible financial contracts
entered into with them. The Enron Canada case was not before the court. The
proceeding was made in the context of a proposal to restructure, through a series
of relatively complicated corporate steps, the outstanding bonds and term loans
of the company. Abitibi, which was insolvent, determined to use the corporate
proceeding to restructure not only its relationship with bondholders, but also
with its term lenders in the belief that it would be a more expedited procedure
than a CCAA proceeding.
The court in the Abitibi proceeding made an interim order that looked very much
like the type of order a court would make in a CCAA proceeding. Included in the
order was a temporary stay (until the hearing date for approval of the
arrangement) against any person (not just the bondholders and term lenders)
39
Re Enron Canada (2001), 31 C.B.R. (4th) 15 (Alta. Q.B.).
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accelerating or terminating any contract with any of the Abitibi entities. Unlike
the orders granted under the CCAA, however, there was no exemption for
eligible financial contracts with the Abitibi entities.
The Quebec Superior Court in its reasons associated with the order does not deal
with eligible financial contracts except to note that the orders requested "exclude
from their application swap or derivative transactions or eligible financial
contracts". However, the order itself did not exclude all eligible financial
contracts from the stay. It only excluded eligible financial contracts with persons
"other than the Abitibi parties". The intention here was seemingly to not
interfere with the operation of credit default transactions having Abitibi as a
reference entity or other eligible financial contracts between third parties where
termination may have been triggered by an Abitibi default.
The very fact that the Abitibi order was made raises an issue for the exercise of
termination rights under eligible financial contracts. It is important to note,
however, that the court did not hear arguments from any affected parties
regarding the application of the order to eligible financial contracts and it was
not the focus of Abitibi's submissions to the court. The Enron Canada decision
also was not before the court. Nor was the order subsequently challenged by any
party to an eligible financial contract. The order became moot when Abitibi filed
under the CCAA, it having become apparent that the corporate plan would not
succeed. Given the circumstances, the precedential value of the order on this
issue is not as great as that of the Enron Canada case.
If, as this case suggests, the courts will allow the Corporate Plan proceeding to be
used by an insolvent corporation as an alternative to a CCAA proceeding to deal
not only with bondholder claims but also claims of ordinary creditors such as
term lenders, then it makes sense to treat the commencement of such a
proceeding, at least where creditors' claims are involved, in the same way as
other bankruptcy Events of Default. Parties will be in a better position to
challenge the type of stay order granted in Abitibi if they clearly have a
contractual termination right in this circumstance.
2. Are the provisions of the Covered Base Agreement and CDA
providing for the netting of termination values (and any cash
collateral that is viewed as a title transfer (see discussion in
Section III.a.(e) below), in determining a single lump-sum
termination amount upon the insolvency of a Covered Customer
enforceable under the law of Ontario and Quebec?
The provisions of the Covered Base Agreement and CDA providing for the
netting of termination values (and any cash collateral that is viewed as a title
transfer) in determining a single lump-sum termination amount upon the
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insolvency of a Covered Customer are enforceable under the law of this
jurisdiction subject to the provisos and qualifications set out below.
Proviso 1 - Covered Transactions Must be EFCs Between the Parties or
PCSA applies
The above opinion applies to Covered Transactions as long as (1) the PCSA
applies (see below) or (2) they are eligible financial contracts between the
Clearing Member and the Covered Customer. Calculating the net termination
amount presupposes enforceability of the right to terminate, which is dependent
on the Covered Transactions being eligible financial contracts or the PCSA
applying. Consequently, the analysis in question 1 is relevant. Assuming
termination is not stayed, then the right to net Covered Transactions based on
the terms of the Covered Base Agreement or CDA will be enforceable without
being subject to any stay if the Covered Transactions are eligible financial
contracts or the PCSA applies.
Under certain insolvency proceedings (CCAA, BIA proposal and WURA) the
EFC safe-harbour permits a party to rely on contractual netting rights in an
"eligible financial contract" notwithstanding the automatic or any court ordered
stay. As noted above in the analysis of termination in Question 1, (1) mutuality of
obligations is a requirement for relying on the EFC safe-harbour, (2) any of the
Covered Transactions are potentially eligible financial contracts, and (3) included
in the definition is "an indemnity or reimbursement obligation with respect to
the liabilities under" such an agreement and the Covered Customer's obligation
to indemnify the Clearing Member with respect to the Clearing Member's
liability for the Covered Customer's Covered Transactions novated to the DCO is
itself an eligible financial contract. Consequently, although mutuality of
obligations is a requirement for reliance on the EFC safe-harbour, the required
mutuality exists in this respect even though it may not exist with respect to the
Cleared Derivatives Transaction itself or Covered Transactions that have been
novated to the DCO.
Although there is no express statutory safe-harbour, there is a practice in
Receivership proceedings of providing the same safe-harbour as part of the court
order.
The CDIC Act does stay the exercise of rights of set-off in the context of a CDIC
proceeding. The EFC safe-harbour in the CDIC Act (which applies to CDIC
insured deposit taking institutions) exempts netting rights under an eligible
financial contract from this stay, but this exemption is subject to the same
qualifications and provisos described in answer to Question 1 where a bridge
institution is to be incorporated.
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With respect to the FCM structure, we note that under the FCM clearing model,
the ultimate counterparties to a derivatives contract that has been novated
through the clearing process, are (i) the FCM's customer and (ii) the DCO that
has accepted the customer's derivative contract for clearing. In the context of a
Covered Base Agreement and CDA, the Covered Customer will interact with the
DCO via its clearing FCM (the Clearing Member), and the Clearing Member will
be exposed to the Covered Customer: under applicable DCO rules, the Clearing
Member must meet the Covered Customer's obligations to the DCO under the
Futures Transactions and Cleared Derivatives Transactions it clears regardless of
whether the Covered Customer itself performs. Thus, the DCO will have two
potential sources of payment under a cleared derivatives contract—the Covered
Customer itself and the Clearing Member. The Clearing Member, however, does
not guarantee the obligations of the DCO to the Covered Customer.
We note also that following a Covered Customer's default, the Clearing Member
(liable to the DCO for amounts owed by the Covered Customer under Futures
Transactions and Cleared Derivatives Transactions it clears for the Covered
Customer) would want to reduce its exposure by any amounts owing by the
DCO to the Covered Customer. However, while the Clearing Member owes the
DCO in its capacity as a principal (by virtue of its obligation to perform for its
Covered Customer), the DCO, with respect to its derivatives contracts with the
Covered Customer, owes not the Clearing Member (who serves only as an
intermediary and one-way guarantor) but the Covered Customer. In some cases,
amounts may be owed to and from different DCOs.
As noted in answer to Question 1, an indemnity obligation with respect to a
Covered Transaction is itself an eligible financial contract so to the extent
termination and netting rights relate to that obligation as opposed to the direct
rights or obligations under the Covered Transaction itself, it is not necessary to
adopt a different approach for the FCM model.
Also, section 13 of the PCSA should apply to characterize the Covered Base
Agreement and CDA as a netting agreement even if the netted obligations
between the parties are not directly with respect to the Covered Transactions.
However, if the Covered Customer's claim against the FCM with respect to
amounts paid by the DCO is in the nature of a proprietary claim, there may be a
question as to whether that is the type of claim that can be set-off or netted
pursuant to the EFC safe-harbours or the PCSA safe-harbour. It may be necessary
to grant and perfect a security interest in the Covered Customer's right, title and
interest in its (1) contractual rights under its Futures Transactions and Cleared
Derivatives Transactions, including Futures Payment Rights and Cleared
Derivatives Payment Rights and (2) its Futures Credit Support and Cleared
Derivatives Credit Support held by and returned from DCOs. Such a security
interest could be created and perfected under Ontario and Quebec law (see
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Question III.B.3. and 5. below) and based on the PCSA the rights to deal with
such collateral in a Canadian insolvency proceeding should be exempt from stay
laws or orders (see Question III.B.17 below) (Subject to the bridge institution
exception). The position is not quite as robust as for rights of set-off given the
need to rely on perfection by registration and priority issues that can arise when
relying on a security interest (see Question III.B.14. and 16.)
A further description of the treatment of set-off rights in insolvency proceedings
is set out in the following paragraphs.
BIA Bankruptcy
In our answers to Question 1 above we described the principle that the trustee in
bankruptcy of an insolvent Covered Customer would have no greater rights than
the insolvent person under an agreement. It follows from this principle that the
calculation of the net termination amount will also be enforceable, and that the
Clearing Member will be entitled to determine the amount payable either to or
by the Covered Customer by netting the gains and losses on the Covered
Transactions. We believe that a court would determine that under the Covered
Base Agreement and CDA, one net amount was either owing or owed. This
analysis is not dependent on an application of the law of set-off. The analysis
applies to proceedings in both Ontario and Quebec .
An alternative argument is available based on the express protections in the BIA
for rights of set-off. The BIA incorporates provincial concepts of set-off and,
consequently, the possibility of different outcomes depending on the province
the BIA proceeding is commenced in. The BIA 40 provides that the "law of set-off"
(or compensation) applies to all claims made by a trustee in bankruptcy in the
same manner and to the same extent as if the insolvent party were bringing the
suit. It is clear in Ontario that the "law of set-off" will include rights of set-off
which exist by operation of law, namely legal set-off and equitable set-off.
Although the relevant case law is limited, the "law of set-off" appears to also
include the enforcement of contractual rights of set-off as well as rights of legal
set-off and equitable set-off. 41 In our view, the relevant statutory provisions
would be interpreted to include contractual rights of set-off even if these
contractual rights of set-off were wider than the legal set-off, equitable set-offs or
compensation that might otherwise be available.
4°
BIA, s.97(3).
Re McMurtry & Co. Ltd., [1924] 1 D.L.R. 737; Re Berman (1979), 105 D.L.R. (3d) 380 (Ont. C.A.); Adatia v. A.
Faber Ltd. (2004), 7 C.B.R. (5th) 165 (Ont. S.C.); Re Blue Range Resource Corp., (1999) 245 A.R. 154; Canada
(Attorney General) v. Reliance Insurance Company (2009), 58 C.C.L.I. (4th) 220, 40 C.B.R. (5th) 292, 40 B.L.R.
41
(4th) 204.
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The effect of set-off (or "compensation" as it is known under Quebec law) in a
Quebec BIA bankruptcy proceeding is somewhat different. A bankruptcy court
in Quebec will apply legal, judicial and conventional (contractual)
" compensation" if the appropriate criteria are met. In the absence of contractual
set-off, Quebec courts generally interpret "the law of set-off" to mean the rules of
legal or judicial compensation only, as set out in the CCQ 42 which are not as
broad as the principles of equitable set-off. 43 A Quebec court sitting in
bankruptcy matters will not apply the rules of equitable set-off. Under the CCQ,
the principles of judicial or legal compensation do not require that there be any
connection between the debts, but only that the requirements of Article 1673 of
the CCQ be fulfilled, namely that there coexist debts which are certain, liquid
and exigible and which are either for a sum of money or some other fungible
property identical in kind. Quebec courts have, on certain occasions, permitted
compensation to be operated after the bankruptcy even if the debts are not liquid
and exigible prior to the bankruptcy when the debts were capable of being
quantified by the courts at the time of the bankruptcy and were certain prior to
the bankruptcy. 44 There was some concern until recently that conventional
compensation would not be applied by a Quebec bankruptcy court since it was
not formally recognized by the CCQ provisions on compensation. However, a
recent Supreme Court of Canada decision 45 recognized "conventional
compensation" as operating in bankruptcy although, in the circumstances of the
case, the court held that the terms of the conventional compensation gave rise to
a "security interest". It may, however, be necessary to rely not on rights of
" compensation", but on the general bankruptcy principle noted above.
Where the PCSA applies, however, the Clearing Member will also be able to rely
on the express statutory netting right included in section 13.
Articles 1672 and 1673 provide that debts are extinguished by compensation, up to the amount of the
lesser debt, by the operation of law where the debts are certain, liquid and exigible and both debts are for a
sum of money or a certain quantity of fungible property identical in kind. Upon termination, the remaining
obligations of both parties to a Master Agreement are certain, liquid and exigible, and therefore,
compensation will operate.
43 Structal (1982) Inc. v. Fernand Gilbert Ltee, J.E. 98-1951 (C.A.); Re Nolisair International inc. (Syndic de). J.E.
2000-1665 (C.A.); e d'Auteuill, Benoit, and Motokov Canada inc. , REJB 1999-11931 (C.A.); and Montreal Fast
Print (Faillite de), J.E. 2003 - 1229 (C.A.); D.I.M.S. Construction inc. (Syndic de) c. Quebec (Procureur general),
[2005] 2 R.C.S. 564.
44 Hil-A-Don Ltd. (In re): Bank of Montreal c. Kwiat, (C.A., 1974-12-05), SOQUIJ AZ-75011042, [1975] C.A. 157;
Syndicat d' epargne des epiciers du Quebec (In re): Laviolette c. Mercure, (C.A., 1975-05-08), SOQUIJ AZ-75011180,
[1975] C.A. 599 (res.).
45 Caisse populaire Desjardins de l'Est de Drummond v. Canada, 2009 SCC 29.
42
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BIA Proposal
The BIA proposal provisions expressly provide for the calculation of a net
termination value upon termination of eligible financial contracts. 46 The relevant
provisions read as follows:
65.1(9) Despite subsections 69(1) and 69.1(1), the following
actions are permitted in respect of an eligible financial
contract that is entered into before the filing, in respect of
an insolvent person of a notice of intention or, where no
notice of intention is filed, a proposal, and that is
terminated on or after that filing, but only in accordance
with the provisions of that contract:
(a) the netting or setting off or compensation of
obligations between the insolvent person and the other
parties to the eligible financial contract; and
(10) If net termination values determined in accordance
with an eligible financial contract referred to in subsection
(9) are owed by the insolvent person to another party to
the eligible financial contract, that other party is deemed,
for the purposes of paragraphs 69(1)(a) and 69.1(1)(a), to be
a creditor of the insolvent person with a claim provable in
bankruptcy in respect of those net termination values.
Section 2 defines "net termination value" to mean:
... the net amount obtained after setting off the mutual
obligations between the parties to an eligible financial
contract in accordance with its provisions.
It is our view that this provision would recognize the enforceability of a close-out
netting provision under the Covered Base Agreements and CDA to the extent of
the obligations and mutual obligations.
If the Clearing Member is entitled to payment of the net termination amount
from the Covered Customer, then it is treated as a creditor for that amount in the
proposal process (subject to the discussion in Question 3, of conversion of
amounts into foreign currencies). In the event that the Covered Customer
subsequently becomes bankrupt, the Clearing Member would have a claim
provable in bankruptcy for the net termination amount.
46
To the extent the Transactions are eligible financial contracts. See Question 1.
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CCAA
The CCAA gives express statutory recognition to the right to terminate and to
determine a net termination value in a CCAA proceeding. "Net termination
value" is defined as:
the net amount obtained after setting off the mutual
contract in accordance with its provisions. 47
In addition, the CCAA makes it clear that the non-insolvent party that is owed
the net termination value is a creditor in the proceeding for that amount.
34. (8) The following actions are permitted in respect of an
eligible financial contract that is entered into before
proceedings under this Act are commenced in respect of
the company and is terminated on or after that day, but
only in accordance with the provisions of that contract:
(a) the netting or setting off or compensation of obligations
between the company and the other parties to the eligible
financial contract; and
(9) No order may be made under this Act if the order
would have the effect of staying or restraining the actions
permitted under subsection (8).
(10) If net termination values determined in accordance
with an eligible financial contract referred to in subsection
(8) are owed by the company to another party to the
eligible financial contract, that other party is deemed to be
a creditor of the company with a claim against the
company in respect of those net termination values.
WURA
The WURA provides that nothing in the WURA or the order of a court made
under the WURA prevents the setting-off of obligations pursuant to the terms of
the agreement between the parties. Section 22.1 states:
22.1 (1) Nothing in this Act or an order made under this
Act prevents or prohibits the following actions from being
taken in accordance with the provisions of an eligible
financial contract:
47
CCAA, s.2.
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(b) the netting or setting off or compensation of
obligations between a company in respect of which
winding-up proceedings under this Act are
commenced and another party to the contract; and
Net termination values
(1.01) If the net termination values determined in
accordance with the eligible financial contract referred to
in subsection (1) are owed by the company to another
party to the eligible financial contract, that other party is
deemed to be a creditor of the company with a claim
provable against the company in respect of the net
termination values.
"Net termination value" is defined to mean:
the net amount obtained after setting off the mutual
contract in accordance with its provisions.4 8
It is our view that this provision recognizes the enforceability of a netting
provision.
This analysis is subject to the CDIC Act provisions with respect to bridge
institutions where the Covered Customer is a CDIC insured deposit taking
financial institution.
CDIC Act
The CDIC Act provides that creditors of a federal member institution (or a
provincial member institution in those cases where an agreement exists with the
province for the application of the Act 19) are not entitled to exercise any right of
set-off against the institution where an order has been made vesting in the CDIC
the shares and subordinated debt of the institution. 50 However, the CDIC Act
exempts from these provisions the setting-off of an amount payable under or in
connection with eligible financial contracts. 51
WURA, s.22.1(2).
49 There are, as yet, no such agreements.
5° CDIC Act, s.39.15(1)(c.1).
51 CDIC Act, s.39.15(4).
48
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39.15 (7) Nothing in subsection (1) or (2) prevents the
following actions from being taken in accordance with the
provisions of an eligible financial contract:
(a) the termination of the contract;
(b) the netting or setting off or compensation of an
amount payable under or in connection with the
contract; or
Although the CDIC Act does not include a provision equivalent to s.65.1(10) of
the BIA (which, "for greater certainty", recognizes the calculation of the net
termination value), it is our view that it permits the netting of gains and losses to
the same extent as under the other federal insolvency legislation such as the
WURA and the BIA proposal provisions.
As discussed above in Question 1, the safe harbour is subject to a temporary and
potentially a longer stay under the CDIC Act in circumstances where a bridge
institution is to be incorporated.
Receivership
Contractual rights of set-off also bind receivers. 52
Where the PCSA applies, the Clearing Member will also be able to rely on the
express statutory netting right included in section 13 as described below.
Voluntary Wind-up of Trusts
If the Covered Customer is in the form of a trust and is voluntarily winding-up,
then there is no applicable stay with respect to the netting rights.
Proviso 2 - Application of Payment Clearing and Settlement Act
Above in Question 1 we addressed the express statutory recognition of a right to
terminate Covered Transactions pursuant to a netting agreement under section
13 of the PCSA. Section 13 also protects the right to determine a "net termination
value or settlement amount" and provides that the person to whom such amount
is owed shall be a creditor of the party owing the amount for that amount. "Net
termination value" means the net amount obtained after setting off or otherwise
netting the obligations between the parties to a netting agreement in accordance
Ching v. Jeffrey (1885), 12 O.A.R. 432 (C.A.); Toronto-Dominion Bank v. Block Bros. Contractors Ltd, (1980), 118
D.L.R. (3d) 311 (Alta. Q.B.); Bank of Montreal v. Tudhope (1911),17 W.L.R. 83 (Man. Q.B.).
52
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with its provisions. Subject to the analysis in Question 1, the PCSA would apply
to the Covered Base Agreement and CDA between the Clearing Member and
Covered Customer to the extent the set-off relates to mutual obligations between
the Clearing Member and Covered Customer.
Qualification 1- Pension Plans
Pension Entities that are insolvent may be wound-up under the supervision of
the pension regulator. In our view the regulator has no jurisdiction to impose a
stay preventing netting in such a context. More detail as to the procedure for
winding-up a pension plan entity under Ontario law is provided in Appendix F.
Qualification 2 - Corporate Plans of Arrangement
The qualification set out above with respect to corporate plans applies also to a
right to exercise netting rights or set-off.
3. Assuming the parties have entered into a Covered Base
Agreement and CDA, the Covered Customer is insolvent and the
Clearing Member has determined a lump-sum termination
amount in a currency other than Canadian currency: (1) would
courts in Ontario and Quebec enforce a claim for the net
termination amount in the currency in which it was determined?
(2) can a claim for the net termination amount be proved in
insolvency proceedings in commenced in Ontario and Quebec
without conversion into the local currency? (3) if in either case
the claim must be converted to local currency for purposes of
enforcement or proof in insolvency proceedings, what are the
rules governing the timing and exchange rate for such
conversion?
Claim in Court Proceedings for Net Termination Amount
The Currency Act (Canada) 53 provides that any reference to money or monetary
value in any legal proceeding shall be stated in Canadian currency. This does not
mean, however, that a party to an agreement providing for the payment of
money in a foreign currency must convert the foreign currency to Canadian
currency in its claim.
Ontario. The legislation governing the courts in Ontario contains mechanisms for
the conversion of foreign currency amounts at the date of payment under the
53
R.S.C. 1985, c.C-52, s.12.
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judgment. The Courts of Justice Act (Ontario) 54 provides that an Ontario court in
granting an order to enforce an obligation in a foreign currency is to convert the
amount to the amount of Canadian currency sufficient to purchase the amount of
the obligation in the foreign currency at a bank in Ontario listed in Schedule I to
the Bank Act (Canada) as at the close of business on the first day on which the
bank quotes a Canadian dollar rate for purchase of the foreign currency before
the day payment of the obligation is received by the creditor. The court can
choose conversion as of a different date if this method of conversion would be
inequitable to any party. 55 If the judgment is executed upon, the relevant date for
conversion is the date when the bailiff or sheriff receives the money from the sale
or garnishment. 56 The parties to a contract can also provide for some different
method of conversion and the court must then give effect to that method. 57 Based
on these provisions, we conclude that, as a practical matter, the payment of the
net termination amount in a non-Canadian currency is enforceable in
proceedings brought in Ontario.
Quebec. In Quebec, a court will not give a judgment denominated in a currency
other than Canadian dollars. When a claim in respect of an obligation is in
foreign currency, the courts will generally convert the foreign currency into
Canadian currency for the purposes of the judgment on the date chosen by the
plaintiff between the date of the breach and the date of the judgment as long as
there has been no negligence or inaction by the plaintiff which has prejudiced the
defendant. 58 Therefore, a court would probably give effect to any express
contractual provision which stipulates a date of conversion into Canadian
currency at a specific date, if there was such a provision, provided the plaintiff's
negligence or inaction does not make the application of such a clause "abusive".
Accordingly, we conclude that although the payment of net termination amount
is enforceable in proceedings brought in Quebec, payment in the specified
currency is not enforceable as such, and a residual exchange risk will remain
with respect to the conversion rate, most probably with respect to the period
between the date of judgment and the date of payment. It is not clear whether a
"topping up" provision would be enforceable, whether outside of insolvency or
in an insolvency proceeding.
R.S.O. 1990, c.43, s.121.
s .121 (3).
56 s .121 (5).
57 s.121(4). Tsakonas c. Valkanas, 2009 QCCS 2008 (CanLII) ) appeal dismissed on motion (C.A., 2009-10-05),
2009 QCCA 1916, SOQUIJ AZ-50578999.
58 Cohen v. Hill Samuel & Co. [1989] R.J.Q. 2079 (C.A.); Edelman v. Stendel 1990 CanLII 3046 (QC CA), [1990]
R.L. 430 ( C.A.); Gerald Abelson Holdings Inc. v. Platinum Equity Holdings Inc., J.E. 2002-1059 (S.C.) var'd 2004
CanLII 15626 (QC CA), Equipements Stosik inc. c. Hock Seng Lee Heavy Industries, sdn bhd, 2007 QCCA 2197;
Gestion BIC inc. v. Centre de recherches Silicium Metal Manitoba SMM inc., 100-17-000522-054, S.C.Q., 2005-1229.
54
55
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Claim in Insolvency Proceedings for Net Termination Amount
Some Canadian insolvency statutes expressly deal with the trea ment of foreign
currency claims upon commencement of an insolvency proceeding; others do
not. Even where the relevant insolvency statutes do not expressly say so, it is
accepted that a foreign currency claimant would have to submit its claim to the
insolvency representative valued in Canadian dollars.
Under the liquidation provisions of the BIA, the general principle is that a
creditor is to value its claim as of the date of the bankruptcy, which is the date of
the petition into bankruptcy. 59 The Clearing Member would have to convert the
net termination amount to Canadian funds using a conversion rate applicable on
that date. The BIA does not specify a method of conversion. The trustee in
bankruptcy might accept the Clearing Member's choice of the source for the
conversion rate, so long as it is a generally accepted rate (for example, the rate
quoted by the Bank of Canada or a Canadian Schedule I bank), although the
trustee might establish a rate for all creditors with claims in a particular currency
based on a particular published source.
The WURA does not include any express provisions for conversion, but the
practice is similar to that under the BIA.
A provision requiring "topping-up" of the amount to account for subsequent
foreign currency losses attributable to fluctuations after the bankruptcy or
winding-up order may not be enforceable, on the basis that it infringes the pari
passu distribution principle.
With respect to BIA proposals, claims are to be converted as of (1) the date of
filing the notice of intention to file a proposal (or the proposal itself if no notice is
filed) or (2) the date of bankruptcy where the proposal is filed by an entity that is
already bankrupt, or (3) the date specified in the proposal.
The CCAA is similar to the BIA proposal provisions. 60
There is no method of conversion specified in the BIA or CCAA, but the trustee
or other insolvency representative could establish an acceptable rate for all
creditors with claims in a particular foreign currency for converting the net
termination amount to Canadian currency.
BIA, s.275.
Section 43 -the date of the initial application unless otherwise provided in the proposed compromise or
arrangement
59
60
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Valuation of claims is generally irrelevant to the CDIC reorganization process
and, consequently, there is no conversion issue. CDIC now has power to effect a
liquidation of an insolvent entity and in that context we suspect that a similar
requirement to value claims on the date the proceeding commenced would be
established by CDIC.
None of the statutory provisions or established practices apply to converting
individual transactions to a base currency as part of the netting process and we
do not expect that an insolvency representative would interfere with the contract
provisions in this regard.
IL Netting for Multi branch Parties
A. Assumptions
We assume the same facts as set forth in Part 1.II above with the following
modifications:
When addressing Issue 1 set forth in II. B. 1. below, we assume that a Covered
Customer that is a bank organized in Canada (incorporated pursuant to the Bank
Act (Canada) has entered into a Covered Base Agreement and CDA that permit it
to enter into Covered Transactions acting through branches in multiple
jurisdictions (referred to herein as a "multibranch basis"). The Canadian bank
then has entered into Covered Transactions under a Covered Base Agreement
and CDA through the bank in Canada and also through one or more branches
located in other countries (as permitted by the bank's Covered Base Agreement
and CDA). After entering into these Covered Transactions and prior to their
maturity, the Canadian bank becomes the subject of a voluntary or involuntary
proceeding under the Insolvency Laws.
B. Issues
1. Would there be any change in your conclusions concerning the
enforceability of netting under the Covered Base Agreement and
CDA based upon the fact that the Canadian bank has entered
into Covered Base Agreement and CDA on a multibranch basis
and then conducted business in that fashion prior to its
insolvency?
For purposes of this question we have not considered questions relating to the
jurisdiction of a Canadian liquidator to take title, possession or control of the
bank's assets that are situate in foreign jurisdictions. It is possible that a foreign
liquidator would have control over non-Canadian assets of the bank and that
non-Canadian laws would govern issues as to the type of claims that could be
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made against those assets. Also, a creditor that recovers any part of its claim in
such a foreign proceeding will have to account for that recovery in the Canadian
proceedings so that double recovery is avoided. Furthermore, it is theoretically
possible that a Canadian court would direct a Canadian liquidator to transfer
assets to a foreign liquidator in a concurrent insolvency proceeding. This would
only be a realistic scenario in our view if the Canadian bank had as significant a
presence — or, perhaps, a more significant presence — in the foreign jurisdiction as
it has in Canada. Consequently, it is not likely that an insolvency representative
in a non-netting jurisdiction would be given control over the liquidation or
reorganization of a Canadian bank.
There is no provision of Canadian banking law, insolvency law or Ontario or
Quebec contract law which would prevent a Clearing Member from terminating
all Covered Transactions with the Canadian bank and its foreign branches,
agencies or offices and netting in accordance with the terms of the Covered Base
Agreement or CDA simply because the obligations were contracted through
several different branches in different countries. For Canadian banking,
insolvency and Ontario and Quebec contract law purposes, the bank and its
branches, agencies and offices form a single legal entity. The WURA, for
example, provides that all claims against the company can be proved against the
company in the winding-up. 61 Consequently, based solely on applicable legal
principles, there is no basis for an argument that the Covered Base Agreement
and CDA and Covered Transactions made subject to them do not evidence
obligations and rights of the Canadian bank recognizable and enforceable in the
Canadian insolvency proceeding.
This is not to say that there may not be foreign laws that indirectly affect the
Canadian insolvency proceedings. For example, under an agreement governed
by the laws of the State of New York, the related contract laws of the State of
New York that affect termination and netting may be recognized in Canada. If
potentially applicable foreign laws that purport to affect termination or netting
rights exist, the trealnient of them for Canadian law purposes will be very
sensitive to their precise content and nature. Characterization of an issue for
conflict of laws purposes is very dependent upon how the foreign law is framed
and its precise effect. Therefore, for the purposes of this memorandum, we have
assumed that there are no applicable foreign laws that would adversely affect
enforceability.
61 WURA, s.71(1).
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III. Collateral Under a Covered Base Agreement and CDA
Fact Patterns
You have asked us, when responding to each question, to distinguish between
the following three fact patterns:
I.
the Location of the Covered Customer is in the Province of Ontario or the
Province of Quebec and the Location of the Futures Credit Support and
the Cleared Derivatives Credit Support (Collateral) is outside the
Province of Ontario or the Province of Quebec, as applicable;
II.
the Location of the Covered Customer is in the Province of Ontario or the
Province of Quebec and the Location of the Collateral is in the Province of
Ontario or the Province of Quebec, as applicable;
III.
the Location of the Covered Customer is outside the Province of Ontario
or the Province of Quebec and the Location of the Collateral is in the
Province of Ontario or the Province of Quebec, as applicable.
For the foregoing purposes:
(a)
the "Location" of the Covered Customer is in the Province of
Ontario if it is incorporated or otherwise organized in the Province
of Ontario or Quebec or if it has a branch or other place of business
in the Province of Ontario or the Province of Quebec; and
(b)
the "Location" of Collateral is the place where an asset of that type
is located under the private international law rules of the Province
of Ontario or the Province of Quebec.
"Located" or references to "Location" when used below in relation to a Covered
Customer or any Collateral will be construed accordingly except as expressly
provided in this opinion to the contrary. The PPSA contains specific provisions
with respect to analyzing the validity, perfection and effect of perfection or nonperfection of a security interest, which are based on the location of the Collateral
or the debtor (that is, the Covered Customer), which are different from the above
definitions. The Civil Code of Quebec (the Civil Code or the CCQ) also contains
specific rules with respect to analyzing the validity, publication and the effects of
such publication of a security interest (called a "security" in Quebec), which are
based on the location of the Collateral or the debtor (that is, the Covered
Customer), which rules are different from the above definitions.
Although we do not expressly refer to each fact pattern in our answer to each
question, we have taken them into consideration in our analysis. It should be
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generally clear from the context which of the fact patterns is being discussed in
each case.
A. Assumptions
We assume the same facts as set forth in Part I.II above (as applicable) with the
following modifications:
a) Pursuant to the relevant Covered Base Agreement and CDA, the
counterparties agree that Collateral will include cash credited to an
account (as opposed to physical notes and coins) and certain types of
securities (as further described below) that are located or deemed located
either (i) in this jurisdiction, or (ii) outside this jurisdiction (Eligible
Collateral). "Eligible Collateral" includes the Covered Customer's right,
title and interest in (i) its contractual rights under its Futures Transactions
and Cleared Derivatives Transactions, including its Futures Payment
Rights and Cleared Derivatives Payment Rights, (ii) its right to any
Futures Credit Support and Cleared Derivatives Credit Support and (iii)
the proceeds of such rights.
b) Any securities provided as Eligible Collateral are denominated in either
Canadian currency or any freely convertible currency and consist of (i)
corporate debt securities whether or not the issuer is organized or located
in this jurisdiction; (ii) debt securities issued by the government of
Canada; and (iii) debt securities issued by the government of a member of
the "G-10" group of countries, in one of the following forms:
(i)
directly held bearer debt securities: by this we mean debt securities
issued in certificated form, in bearer form (meaning that ownership is
transferable by delivery of possession of the certificate) and, when held by
a Clearing Member or a DCO as Collateral under a Covered Base
Agreement and CDA, held directly in this form by the Clearing Member
or a DCO (that is, not held by the Clearing Member or DCO indirectly
with an Intermediary (as defined below));
(ii)
directly held registered debt securities: by this we mean debt securities
issued in registered form and, when held by a Clearing Member or DCO
as Collateral under a Covered Base Agreement and CDA, held directly in
this form by the Clearing Member or DCO so that the Clearing Member or
DCO is shown as the relevant holder in the register for such securities
(that is, not held by the Clearing Member or DCO indirectly with an
Intermediary);
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(iii)
directly held dematerialized debt securities: by this we mean debt
securities issued in dematerialized form and, when held by a Clearing
Member or DCO as Collateral under a Covered Base Agreement and
CDA, held directly in this form by the Clearing Member or DCO so that
the Clearing Member or DCO is shown as the relevant holder in the
electronic register for such securities (that is, not held by the Clearing
Member or DCO indirectly with an Intermediary);
(iv)
intermediated debt securities: by this we mean a form of interest in debt
securities recorded in fungible book entry form in an account maintained
by a financial intermediary (which could be a central securities depositary
(CSD) or a custodian, nominee or other form of financial intermediary, in
each case an Intermediary) in the name of the Clearing Member or DCO
where such interest has been credited to the account of the Clearing
Member or DCO in connection with a transfer of Collateral by the
Covered Customer to the Clearing Member under a Covered Base
Agreement and CDA.
The precise nature of the rights of the Clearing Member in relation to its interest
in intermediated debt securities and as against its Intermediary will be
determined, among other things, by the law of the agreement between the
Clearing Member and its Intermediary relating to its account with the
Intermediary, as well as the law generally applicable to the Intermediary, and
possibly by other considerations arising under the general law or the rules of
private international law of this jurisdiction. The Clearing Member's
Intermediary may itself hold its interest in the relevant debt securities indirectly
with another Intermediary or directly in one of the three forms mentioned in (i),
(ii) and (iii). In practice, there is likely to be a number of tiers of Intermediaries
between the Clearing Member and the issuer of such securities, at least one of
which will be an Intermediary that is a national or international CSD.
The Clearing Member will normally hold debt securities in the form of
intermediated debt securities rather than directly in one of the three forms
mentioned in (i), (ii) and (iii).
c) Due to regulatory requirements, Collateral posted will be held by
intermediaries in a way that identifies the Collateral as belonging to
customers of the Clearing Member. For example, if the Collateral is held
by the Clearing Member or any intermediary of the Clearing Member,
that account will show that it is held for customers generally and the
Clearing Member's books will show that the collateral is held for the
individual customer. If the Collateral is held by the DCO or an
intermediary of the DCO, that account will show that it is held for
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customers generally the DCO's books will show that the Collateral is held
for the individual customer.
d) Cash Collateral is denominated in a freely convertible currency and is
held in an account under the control of the Clearing Member or DCO.
e) In the case of cash Collateral that is transferred to a Clearing Member as
margin, such cash Collateral can be viewed either as a transfer of title in
that cash to the Clearing Member, or as collateral in which the Clearing
Member can take a security interest. Under the first alternative, the
Clearing Member can be viewed as receiving such cash Collateral as a
principal and therefore having a right to net that cash margin against
amounts owing from the Covered Customer to the Clearing Member.
f) In the case of questions 11 to 14 below, after entering into the
Transactions and prior to their maturity, an Event of Default exists and is
continuing with respect to the Covered Customer, and/ or the Clearing
Member has designated a date to begin exercising its Futures Liquidation
Rights or Cleared Derivatives Liquidation Rights (a Liquidation Date) as
a result thereof (however, an insolvency proceeding has not been
instituted, which is addressed separately in assumption (k) and questions
15 to 19 below).
g) In the case of questions 15 to 17 below, a Canadian insolvency proceeding
has been instituted by or against the Covered Customer and an Event of
Default has accordingly occurred under the Covered Base Agreement and
CDA.
B. Issues
Validity of Security Interests
1. Under the laws of Ontario and Quebec, what law governs the
contractual aspects of a security interest in the various forms of
Eligible Collateral under the Covered Base Agreement and CDA?
Would the courts of Ontario recognize the validity of a security
interest created under each Covered Base Agreement and CDA,
assuming it is valid under the governing law of such Covered
Base Agreement and CDA?
a) Introduction to Securities Transfer Acts, PPSA and Civil Code Concepts
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The applicable law with respect to transfer of securities and the taking of security
interests in securities is found in the securities transfer legislation in each
province (in Ontario, the Securities Transfer Act 2006 (Ontario) 62 (the STA) and in
Quebec, An Act respecting the transfer of securities and the establishment of security
entitlements (Quebec) 63 (the Quebec STA or the QSTA)) 64 which govern many
aspects of the transfer of investment securities, and also in personal property
security legislation (in Ontario the Personal Property Security Act (Ontario)65 (the
PPSA) and Quebec the Civil Code), which govern the taking of a security interest
in investment securities, futures, contractual rights and cash collateral. The STA
and QSTA distinguish between direct holdings of certificated and uncertificated
securities and indirect holdings (through an Intermediary, including a CSD).
Understanding these distinctions is a precondition to understanding the conflict
of laws rules and the substantive law on the validity, perfection and priority of
securities interests, so we begin with a brief introduction to those concepts.
Under the STA, a person acquires a security or interest in a security 66 if either (a)
that person is a purchaser 67 to whom a security is delivered 68 or (ii) that person
acquires a security entitlement 69 to the security. A person acquires a security
entitlement when a securities intermediary 70 (i) credits a security to such person's
securities account by book entry, 71 (ii) receives or acquires a security from or for
such person and accepts it for credit to such person's securities account, or (iii) is
obligated to credit a security to such person's securities account. 72 A person has a
security entitlement upon satisfaction of one of these three methods of
S.O. 2006, c.8
S.Q., 2008, c.20.
64 All provinces except Prince Edward Island and the Yukon have now passed the legislation.
65 R.S.O. 1990, c. P. 10 as amended in particular by S.O. 2006, c.8.
66 STA, s.17.
67 Note that purchaser is broadly defined and includes a person who acquires a security interest in the
security. STA, s.1(1) - definitions of "purchaser" and "purchase", which "means a taking by sale, discount,
negotiation, mortgage, hypothec, pledge, security interest, issue or reissue, gift or any other voluntary
transaction that creates an interest in property."
68 This method is relevant only in a direct holding system.
69 The term "security entitlement" describes the rights and property interest of an "entitlement holder" with
respect to a financial asset held indirectly through one or more tiers of securities intermediaries. STA, s.1(1).
A security entitlement is both a package of personal rights against the securities intermediary and an
interest in property held by the securities intermediary. It is not, however, a property interest in any specific
financial asset held by the securities intermediary.
70 A "securities intermediary" is a clearing agency (which is also defined in the STA) or a person, including a
bank or broker, that in the ordinary course of its business maintains "securities accounts" for others and is
acting in that capacity (STA, s.1(1)).
71 A "securities account" is an account to which a "financial asset" is credited in accordance with an
agreement under which the person maintaining the account undertakes to treat the person for whom the
account is maintained as entitled to exercise the rights that constitute the financial asset.- STA, s.1(1). A
"financial asset" is, among other things, a certificated or uncertificated security or a "security entitlement"
(STA, s.1(1)).
72 STA s.95(1).
62
63
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acquisition, regardless of whether the securities intermediary actually holds
interests in the financial asset. 73
The QSTA is framed somewhat differently, but essentially to the same effect.
Under the QSTA, a security is transferred 74 to a person when that person
acquires rights in and takes delivery of such security. 75 A person acquires a
security entitlement when a securities intermediary 76 (i) credits a financial asset
to such person's securities account by book entry, 77 (ii) receives a financial asset
from or acquires a financial asset for such person and accepts it for credit to such
person's securities account, or (iii) is obligated to credit a financial asset to such
person's securities account. 78 A person has a security entitlement upon
satisfaction of one of these three methods of acquisition, regardless of whether
the securities intermediary actually holds the financial asset. 79
A security entitlement is a sui generis form of property interest: it is a package of
rights and interests that a person has against the person's securities intermediary
and the property held by the securities intermediary. The provisions in Part VI of
the STA and Chapter IV of the QSTA describe the elements of a security
entitlement, including that (i) the entitlement holder 8° does not take credit risk of
the securities intermediary's other business activity (i.e. property held by the
intermediary as intermediary is not subject to the claims of the securities
intermediary's general creditors), 81 (ii) the securities intermediary will maintain a
one-to-one match between the financial assets that it itself holds and all the
claims of its entitlement holders, 82 (iii) the securities intermediary will pass
through to the entitlement holder payments or distributions made with respect
to the financial assets, 83 (iv) the securities intermediary will exercise voting rights
and other rights and privileges of ownership of the financial assets in the fashion
STA, s.95(2).
Note that purchaser refers to a person who acquires rights in a security. QSTA, s.6 provides that
"Acquisition of rights in a security or financial asset may result from any act constituting or conveying rights
in the security or financial asset including by way of issue, sale, exchange, gift or hypothec provided only
that the act is consensual."
75 QSTA, s.6. This method is relevant only in a direct holding system.
76 A "securities intermediary" is a clearing agency (which is also defined in the QSTA) or a person, including
a bank or dealer that in the ordinary course of its business maintains "securities accounts" for others and is
acting in that capacity QSTA, s.8.
7 A "securities account" is an account to which a "financial asset" is or may be credited in accordance with
an agreement under which the securities intermediary maintaining the account undertakes to consider the
account holder as being entitled to exercise the rights that constitute the financial asset.- QSTA, s.8. A
"financial asset" is, among other things, a certificated or uncertificated security.(QSTA, s.12).
78 QSTA, s.103.
79 QSTA, s.104.
80 The "entitlement holder" is the person identified in the records of the intermediary as the person having a
security entitlement against the intermediary (STA, s.1(1)).
81 STA, s.97(1). QSTA, s.107. See QSTA, s.130 for a limited exception for secured creditors.
82 STA, s.98. QSTA, s. 116.
83 STA, s.99. QSTA, s.117.
73
74
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directed by the entitlement holder /84 (v) the securities intermediary will transfer
or otherwise dispose of the positions at the direction of the entitlement holder, 85
and (vi) the securities intermediary will act at the direction of the entitlement
holder to convert the position into any other available form of securities
holding.86
With respect to other Eligible Collateral property (such as Futures Transactions
and Futures Payment Rights, and Cleared Derivatives Transactions and Cleared
Derivatives Payment Rights, cash collateral (whether a security interest is
granted or provided by way of title transfer) and other intangible property, it
will be necessary for a Clearing Member (1) with respect to Ontario Customers to
perfect by registration of a financing statement and (2) with respect to Quebec
Customers to add language to the CDA or Covered Base Agreement or create a
separate document to create a moveable hypothec without delivery and to
register the security in Quebec. More detail is provided in response to question
5.
b) Relevance of Governing Law
On purely contractual aspects of the agreements the court would apply New
York law as the chosen law. To the extent this question deals with the creation
and validity of a security interest, before an Ontario or Quebec court, this issue
would not be determined by the governing law of the agreement, except to the
extent that their interpretation was relevant to the question.
Under Ontario law any interest in property that secures payment or performance
of an obligation is a security interest 87 and a court would determine, by applying
the contract law interpretation principles of the governing law stated in the
agreement, whether or not the interest in the Eligible Collateral granted by the
agreement secured payment or performance of an obligation. 88 In other words,
an Ontario court would apply the stated governing contract law to determine
whether the Covered Base Agreement granted a "security interest" in the Eligible
Collateral.
Under Quebec law, conflict of laws rules are set out in the Civil Code. Pursuant
to Article 3078 of the Civil Code, characterization is a matter to be determined by
STA, s.100. QSTA, s. 118.
85 STA, s.101. QSTA, s.119.
86 STA, s.102. QSTA, s.122.
S7PPSA, s. 1(1).
88 Generally, Canadian common law courts will apply the parties chosen law to matters of essential validity
of the agreement and to its interpretation. Subsection 8(1)(b) of the Ontario PPSA provide that substantive
issues/matters involving/affecting the enforcement of the rights of a secured party are governed by the
proper law of the contract between the secured party and the debtor.
84
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the law of the forum. Nonetheless, such rule provides that where a legal
institution (concept) is unknown to the court, or known to it under a different
designation or with a different content, foreign law may be taken into account. In
other words, a Quebec court would apply initially Quebec law to determine
whether the Covered Base Agreement created a security in the Eligible
Collateral. Some commentators advance the proposition that for purposes of
determining what constitutes "security" under the Quebec conflict of laws rules,
a functional approach similar to the approach under the Ontario PPSA should be
taken. To a certain extent, the question of whether a security has been granted is
a question of intention. Hence, a Quebec court would likely take into account the
governing law stated in the security document in order to determine this
intention.
c) Validity
(A) General
The PPSA and Civil Code set out conflict of laws rules that apply specifically to
the question of validity (creation and attachment) of the security interest created
by security agreements. This memorandum will consider conflict rules first, in
the abstract, and then apply the rules to specific types of Eligible Collateral
presented in the assumptions above.
There are a number of rules relevant to the validity of security interests in the
type of collateral that is potential Eligible Collateral. These rules are as follows:
•
The validity of a security interest in a certificated security is governed by
the internal law, 89 at the time the security interest attaches, of the
jurisdiction where the certificate is located. 90
•
The validity of a security interest in an uncertificated security is governed
by the internal law, at the time the security interest attaches, in Ontario of
the "issuer's jurisdiction" and similarly in Quebec (although without
using the defined term "issuer's jurisdiction"). 91
•
The validity of a security interest in a security entitlement (which includes
an entitlement to a financial asset credited to a securities account) or a
securities account is governed by the internal law, at the time the security
interest attaches, in Ontario of the "security intermediary's jurisdiction"
s. 8.1. Art. 3080 CCQ.
PPSA, s. 7.1(1)(a). Art. 3108.8 CCQ.
91 PPSA, s. 7.1(1)(b). Arts 3108.2 to 3108.4 and 3108.8 CCQ. Functionally equivalent to the "issuer's
jurisdiction" under the Ontario STA.
89 PPSA,
90
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(and similarly in Quebec although without using the defined term
"security intermediary's jurisdiction"). 92
•
In Ontario, the validity of a security interest in a futures contract or a
futures account is governed by the internal law, at the time the security
interest attaches, of the futures intermediary's jurisdiction. 93
•
In Ontario, the validity of a security interest in an intangible (excluding
securities, titles in bearer form and security entitlements) is governed by
the internal law, at the time the security interest attaches, of the
jurisdiction where the debtor is located. 94
•
In Quebec, the validity of a non-possessory security in incorporeal
movable property (excluding securities, titles in bearer form and security
entitlements) is governed by the internal law, at the time the security is
created, of the jurisdiction where the debtor has its domicile. 95
Section 17 of the QSTA provides that commodity futures contracts, security
futures contracts, financial instrument futures contracts and other similar futures
contracts and options on such contracts are neither securities nor financial assets
for purposes of the QSTA. They are considered to be financial assets, for
purposes of security law (the law applicable to security interests in Quebec such
as under the Civil Code) and related rules for publication (perfection) and
conflicts of law, if such are held in a securities account as per the third bullet
above). There has been no reported case considering this provision and it is
unclear as to its application, particularly if such futures contracts are actually in a
futures account, as such term is used in the PPSA. In the absence of clarity on the
application of this rule, only the rule on the validity of a non-possessory security
in incorporeal property (excluding securities, titles in bearer form and security
entitlements) as per the last bullet above would apply to commodity futures
contracts, security futures contracts, financial instrument futures contracts and
other similar futures contracts and options on such contracts.
(B)
Cash Collateral
The PPSA and Civil Code distinguishes between Cash held in a securities
account and Cash which is not held in a securities account.
92 PPSA, s. 7.1(1)(c). Arts 3108.7 and 3108.8 CCQ. Functionally equivalent to the "securities intermediary's
jurisdiction" under the Ontario STA.
93 PPSA, s.7.1(1)(d).
94 Ontario PPSA, s. 7.1(1)(a).
95 Art. 3105 CCQ.
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Manner of Holding
Characterization
Governing Law - Validity
of Security Interest
Cash not held in a "securities
account"
Ont.- Intangible
Ont. - Debtor's location at
time of attachment
Que. - Incorporeal
movable property
Cash held in a securities
account where intermediary
and account holder have not
agreed that it is not a
financial asset
Ont. - Investment
Property
account where intermediary
and account holder have
agreed that it is not a
financial asset
Ont. - Intangible
Que. - Financial
asset/ securi ty
entitlement
Que. - Incorporeal
Movable Property
Que. - Debtor's domicile at
time of creation
Place where the security
intermediary is located at
the time of
attachment/creation
Ont. - Debtor's location at
time of attachment
Que. - Debtor's domicile at
time of creation
Cash not held in a securities account would likely be characterized for these
purposes as an intangible or incorporeal movable property (whether in an
account in the name of the Clearing Member or under the Clearing Member's
control). Consequently, the validity of the security interest in Cash would be
governed by the law of the jurisdiction where the Covered Customer is located
(if proceedings are in Ontario) or domiciled (if proceedings are in Quebec) at the
time the security interest attaches (in Ontario) or is created (in Quebec). Just to be
clear, this means that the place where the deposit is held is not relevant to the
conflict of laws analysis.
Under the current Ontario PPSA, a debtor (in this case, the Covered Customer) is
located at its place of business and if it has more than one place of business at its
chief executive office. 96 There are no relevant cases considering the meaning of
the phrase "chief executive office". In our view, it refers, not to the registered
head office, but to the place where the chief executives of the entity have their
offices. It is worth noting, accordingly, that the PPSA does not currently
determine location of a debtor on the basis of the jurisdiction of incorporation
and organization of the debtor. 97 For Quebec law purposes, legal persons
Ontario PPSA, s.7(4).
Not all jurisdictions in Canada apply a chief executive office test for location. For example, in Quebec,
currently, registered office is the governing connecting factor.
96
97
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(corporations) are generally held to have their domicile at the place of their
registered office. 98
However, the Ontario government has passed further amendments to the PPSA,
which will (if and when they come into force) significantly amend the definition
of "location of the debtor." Business corporations and limited partnerships
organized provincially will be located in the jurisdiction of incorporation/
organization. Federal corporations will be located where their head office or
registered office is located. 99 Ordinary partnerships will be located in the
province of the law governing the partnership agreement. It is anticipated that
the Ontario government will not proclaim these amendments into force unless
and until several other provinces follow suit, which has not yet happened. If and
when these changes are brought into force, secured parties relying on financing
statements filed in the jurisdiction of the chief executive office will have to
consider the transitional rules to determine whether any further action is
required.
Generally, credit balances in a securities account are characterized as
"investment property" (in Ontario) and a "financial asset" 100 which may give rise
to a security entitlement (in Quebec) and not as intangibles. Consequently,
validity is governed by the law of the "securities intermediary's jurisdiction" 101 .
"Investment property" includes a "security entitlement". 102 " Security
entitlement" is defined in the Ontario STA as the rights and property interest of
an entitlement holder with respect to a "financial asset" that are specified in Part
VI of the STA. 103 Included in the definition of "financial asset" under the STA
and the QSTA is:
a credit balance in a securities account, unless the
securities intermediary has expressly agreed with the
person for whom the account is maintained that the
credit balance is not to be treated as a financial asset
under this Act.
(If the securities intermediary and the person in whose name the account is held
did agree that the credit balance was not a financial asset, then the Cash would be
an intangible for this purpose.)
Art. 307 CCQ. The test for the location of the debtor differs from the test under the Ontario PPSA. Such
latter test focuses on the principal place of business and chief executive office. Hence depending upon the
jurisdictions having a connecting factor in the analysis, it may be necessary to obtain valid security in
various jurisdictions.
99 There are special rules for U.S. corporations and for other foreign corporations.
100 A "financial asset" would also constitute incorporeal movable property in most cases under Quebec law.
101 Discussed immediately below.
102 PPSA, s. 1(4
103 PPSA, s.1(1) and STA, s.1(1). QSTA, s.12.
98
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Not every account holding financial assets is a securities account. The person
(e.g. a broker, bank or trust company) maintaining the account must be either a
clearing agencyl° 4 or it must be in the ordinary course of its business to maintain
securities accounts for others, and it must be acting in that capacity with respect
to the account. So, while a bank could be a securities intermediary, a typical
deposit account would likely not be characterized as a securities account.
(C)
Directly Held Certificated Securities
The validity of a security interest in a certificated security 105 held directly by the
secured party or its agent is governed by the law of the place where the
certificate is located at the time the security interest attaches (in Ontario) or is
created (in Quebec). 106 This includes debt securities issued by governments or
government agencies.
(D)
Directly Held Dematerialized or Uncertificated
Securities
The validity of a security interest in an "uncertificated security"107 is governed by
law of the "issuer's jurisdiction".
The "issuer's jurisdiction" is defined in the STA. 108 The definition specifies a
jurisdiction, but allows the issuer to specify a different jurisdiction if the laws of
the otherwise applicable jurisdiction allow. The "issuer's jurisdiction" is not
defined in the Quebec STA or the Civil Code, as it is in the Ontario STA. The
rules do, however, specify a jurisdiction in substantively the same manner as the
Ontario STA, but allow the issuer to specify a different jurisdiction if the laws of
the otherwise applicable jurisdiction allow. So, for example, the jurisdiction of an
Ontario or Quebec incorporated or organized entity or the Ontario or Quebec
Crown is normally Ontario or Quebec respectively, but the STA and QSTA
expressly allows the issuer to choose another jurisdiction: 109 The specified
jurisdictions are:
Type of Entity
Jurisdiction
Canadian federally
The province or territory in which it has its head
As defined in the STA, s.1(1) or QSTA, s.4.
los A security represented by a certificate. STA, s.1(1). It does not include a security represented by an
electronic certificate (see the definition of security - STA, s.1(1)); QSTA, s.9).
106 PPSA, s.7.1(1)(a). Art. 3108.8 CCQ.
107 A security which is not represented by a certificate.
los As provided for in PPSA, s.7.1(3)(b). Section 44(5) of the STA.
109 STA. s.44(3); Art. 3108.4 CCQ.
104
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incorporated issuers
office or registered office (Ontario) or head office
(Quebec), or, if Canadian federal law permitsllo,
another jurisdiction specified by the issuer
The Canadian federal
Crown
The jurisdiction it specifies as its jurisdiction
A Canadian provincial
Crown or a territory
The province (or territory) or, if the provincial (or
territorial) law permits, another jurisdiction
specified by the issuer
Other issuers
The jurisdiction under which the issuer is
incorporated or otherwise organized, or, if the law
of that jurisdiction permits, another jurisdiction
specified by the issuerm
(E)
Intermediated Securities - Securities Accounts and
Security Entitlements
The law of the securities intermediary's jurisdiction governs the validity of a
security interest in a security entitlement or securities account. 112 The "securities
intermediary's jurisdiction" is not defined in the Quebec STA or the Civil Code.
However, the rules specify a jurisdiction in substantively the same manner as the
Ontario STA.
The securities intermediary's jurisdiction is determined in accordance with the
rules set out in the STA and QSTA. 113
The STA rules specify a number of alternatives for determining the securities
intermediary's jurisdiction applied in the following order:
no It does not yet do so.
111 The Ontario STA, for example, permits an Ontario issuer to choose another jurisdiction. Ontario STA, s.
44(3)(1). The Civil Code permits a Quebec issuer to choose another jurisdiction. Art. 3108.4 CCQ.
112 PPSA, s.7.1 (1)(c).
113 Ontario PPSA, s.7.1(3)(c) provides that the securities intermediary's jurisdiction is determined under
section 45 of the Ontario STA. Article 3108.7 of the Civil Code.
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the jurisdiction specified as the securities
(i)
intermediary's jurisdiction for the purpose of Ontario,
the STA or any provision of the STA in the securities
account agreement between the intermediary and its
entitlement holder; 114
the expressly stated governing law of the
(ii)
securities account agreement;
if the securities account agreement expressly
(iii)
provides that the securities account is maintained at
an office in a particular jurisdiction, then that
jurisdiction;
the jurisdiction in which the office identified in
(iv)
an account statement as the office serving the
entitlement holder's account is located; or
the jurisdiction where the chief executive office
(v)
of the securities intermediary is located.
In Quebec, the rule specifies the jurisdiction as:
(i)
the law of the jurisdiction specified as governing the matters set out in the
first paragraph of Article 3108.7 of the Civil Code, including the
acquisition of a security entitlement from the securities intermediary, in a
juridical act (agreement) governing the securities account between the
intermediary and its entitlement holder; 115
(ii)
the expressly stated governing law of a juridical act (agreement)
governing the securities account;
(iii)
if a juridical act (agreement) governing the securities account expressly
provides that the securities account is maintained at an establishment in a
particular jurisdiction, then the law of that jurisdiction;
(iv)
the law of the jurisdiction in which the establishment identified in an
account statement as the establishment serving the entitlement holder's
account is located; or
114 Note that the CDS Clearing and Depository Services Inc, a clearing agency and therefore a securities
intermediary, has specified Ontario as its jurisdiction - CDS Rule 1.13.18.
115 Note that CDS Clearing and Depository Services Inc. a clearing agency and therefore a securities
intermediary, has specified Ontario as its jurisdiction - CDS Rule 1.13.18.
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(v)
the law of the jurisdiction where the decision-making centre of the
securities intermediary is located.
The STA, but not the QSTA, specifically states that the following factors are not
to be taken into account in determining the securities intermediary's jurisdiction:
(i)
the physical location of certificates representing the financial assets;
(ii)
the jurisdiction in which the issuer of the financial asset is incorporated or
otherwise organization; and
the location of facilities for data processing or other record keeping
(iii)
concerning the securities account.
(F)
‘
CO
Futures and Options Contracts and Futures Accounts
Ontario
The PPSA provides that the law of the "futures intermediary's jurisdiction" at
the time of attachment governs the validity of a security interest in a futures
contract or futures account . "Futures contract" is defined to mean:
a standardized future or an option on futures, other than a
clearing house option, that is,
(a) traded on or subject to the rules of a futures exchange 116
recognized or otherwise regulated by the Ontario
Securities Commission or by a securities regulatory
authority of another province or territory of Canada, or
(b) traded on a foreign futures exchange and carried on the
books of a futures intermediary for a futures customer 117;
"Futures account" is defined to mean:
an account maintained by a futures intermediary in which
a futures contract is carried for a futures customer;
"Futures intermediary" is defined (unfortunately and perhaps in error) to
include only dealers or clearing houses registered in a province of Canada.
"futures intermediary" means a person that,
"futures exchange" means an association or organization operated to provide the facilities necessary for
the trading of standardized futures or options on futures.
117 "futures customer" means a person for which a futures intermediary carries a futures contract on its
books.
116
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(a) is registered as a dealer permitted to trade in futures
contracts, whether as principal or agent, under the
securities laws or commodity futures laws of a province or
territory of Canada, or
(b) is a clearing house recognized or otherwise regulated
by the Ontario Securities Commission or by a securities
regulatory authority of another province or territory of
Canada;
Futures carried by Clearing Members that do not have a Canadian registration or
exemption are "intangibles" and the issue of the validity of the security interest
would be determined by the location of the Covered Customer. 118
For those futures that are carried by a Canadian registrant or regulated Clearing
Member, the futures intermediary's jurisdiction is determined in accordance
with the rules set out in section 7.1(4) of the PPSA. Those rules specify a number
of alternatives for determining the futures intermediary's jurisdiction applied in
the following order:
the jurisdiction specified as the futures intermediary's jurisdiction
(i)
for the purpose of Ontario law, the STA or any provision of the STA in the
futures account agreement between the intermediary and its customer;
(ii)
the expressly stated governing law of the futures account
agreement;
(iii)
if the futures account agreement expressly provides that the futures
account is maintained at an office in a particular jurisdiction, then that
jurisdiction;
(iv)
the jurisdiction in which the office identified in an account
statement as the office serving the customer's account is located; or
(v)
the jurisdiction where the chief executive office of the futures
intermediary is located.
(ii)
Quebec
Please see the discussion above (A) in respect of Section 17 of the QSTA.
(G) Intangibles such as Contractual Rights
The validity of the security interest in intangibles, which would include
receivables and contractual rights such as the contractual rights under its Futures
Transactions (to the extent the Clearing Member is not a "futures intermediary"
118
It is hoped that this issue will be addressed in the next round of PPSA revisions.
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as defined above, at least under Ontario law) and Cleared Derivatives
Transactions and its right to payment from DCOs in respect of those Futures
Transactions and Cleared Derivatives Transactions and, for Quebec purposes
futures contracts in a futures account, would be governed by the law of the
jurisdiction where the Covered Customer is located (Ontario) or domiciled
(Quebec) at the time the security interest attaches (Ontario) or is created
(Quebec). See above under the Validity heading (B) re Cash Collateral for a
discussion of location and domicile.
2. Under the laws of Ontario and Quebec, what law governs the
proprietary aspects of a security interest (that is, the formalities
required to protect a security interest in Eligible Collateral
against competing claims) granted by the Covered Customer
under each Covered Base Agreement and CDA (for example, the
law of the jurisdiction of incorporation or organization of the
Covered Customer, the jurisdiction where the Eligible Collateral
is located, or the jurisdiction of location of the Clearing Member
or DCO's Intermediary in relation to Eligible Collateral in the
form of indirectly held securities)? What factors would be
relevant to this question? Where the location (or deemed
location) of the Eligible Collateral is the determining factor,
what are the principles governing such determination under the
law of this jurisdiction with respect to the different types of
Eligible Collateral? How do the laws of this jurisdiction apply
to each form in which securities Eligible Collateral may be held
as described in assumption (b) above?
(a) Ontario
The rules for determining the law governing perfection and the effect of
perfection or non-perfection depend to some extent on the method of perfection.
Some of the rules are the same as those governing validity of the security interest
except with respect to the time at which the determination is made. (Validity is
determined as of the time of attachment.) The rules with respect to perfection
have no express temporal element, because perfection is a status to be
determined throughout the relationship. In other words, it has to be reassessed if
circumstances (e.g. the location of a security certificate) change. 119 The rules are
as follows:
119 The PPSA includes provisions to continue perfection for a period of time after a change in circumstances.
See Ontario PPSA, s.7(2) with respect to Cash collateral not in a securities account and s.7.1(7) with respect
to investment property.
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1.
The perfection of a security interest in a certificated security is
governed by the law of the jurisdiction where the certificate is
located. 120
2.
The perfection of a security interest in an uncertificated security
is governed by the law of the issuer's jurisdiction. 121
3.
The perfection of a security interest in a security entitlement or a
securities account is governed by the law of the security
intermediary's jurisdiction. 122
4.
The perfection of a security interest in a futures contract or a
futures account is governed by the internal law of the futures
intermediary's jurisdiction, where the intermediary is a
Canadian registrant or is regulated but exempt from registration
in Canada. 123
5.
The perfection of a security interest in an intangible is governed
by the law of the jurisdiction where the debtor is located. 124
6.
The perfection of a security interest in investment property 125 (e.g.
futures, futures accounts, securities, securities accounts and
securities entitlements) by registration is governed by the law of
the jurisdiction where the debtor is located. 126
See Question 1 above for a further explanation of the meaning of securities
intermediary's jurisdiction, futures intermediary, futures intermediary's
jurisdiction, location of the debtor and issuer's jurisdiction.
It should be noted that if there is not a perfection by control or possession regime
in the securities intermediary's jurisdiction, but registration is the means of
perfection, then it is the conflict of laws rule with respect to registration (6 above)
that will apply.
(b) Quebec
120 PPSA, s.7.1(2)(a).
121 PPSA, s.7.1(2)(b).
122 Ontario PPSA, s.7.1(2)(c).
123 PPSA, s.7.1(1)(d).
124 Ontario PPSA, s.7(1)(a).
125 A security interest in any type of property can be perfected by registration of a financing statement. As
discussed below in the context of priority, this method of perfection does not ensure priority.
126 PPSA, s.7.1(5)(a). There is in addition a special conflict rule for security interests in investment property
granted by a broker or securities intermediary where the secured party is relying on attachment of the
security interest to perfect the interest. This is also governed by location of the debtor: PPSA, s.7.1(5)(b).
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The rules for determining the law governing publication and its effects (roughly
equivalent to perfection, the effect of perfection or non-perfection and priority) 127
depend to some extent on the method of publication. Some of the rules are the
same as those governing validity of the security except with respect to the time at
which the determination is made. (Validity is determined as of the time of
creation.) The rules with respect to publication have no express temporal
element, because publication is a status to be determined throughout the
relationship. In other words, it has to be reassessed if circumstances (e.g. the
location of a security certificate) change. 128 The rules are as follows:
1.
Publication of a security in a certificated security and the effects
of such publication are governed by the law of the jurisdiction
where the certificate is located. 129
2.
Publication of a security in an uncertificated security and the
effects of such publication are governed by the law of the
"issuer's jurisdiction". 130
3.
Publication of a security in a security entitlement and the effects
of such publication are governed by the law of the "security
intermediary's jurisdiction". 131
4.
Publication of a non-possessory security in incorporeal movable
property that is not securities, titles in bearer form or security
entitlements, and the effects of such publication are governed by
the law of the jurisdiction where the debtor is domiciled. 132
5.
Publication by registration (but not its effects) of a security in
securities and security entitlements is governed by the law of the
jurisdiction where the debtor is domiciled. 133
See Question 1 above for a further explanation of the meaning of "securities
intermediary's jurisdiction", domicile of the debtor and "issuer's jurisdiction".
Please see above in respect of Section 17 of the QSTA for futures contracts.
Art. 2941 CCQ.
128 The Civil Code includes provisions to continue publication for a period of time after a change in certain
circumstances. See Art. 3106 CCQ with respect to Cash collateral not in a securities account.
129 Art. 3108.8 CCQ.
130 Arts 3108.2 to 3108.4 and 3108.8 CCQ.
131 Arts 3108.7 and 3108.8 CCQ.
132 Art. 3105 CCQ.
133 Art. 3108.8 CCQ. There is in addition a special conflict rule for publication (but not its effects) of a
security in securities and security entitlements granted by a securities intermediary where the secured party
is relying on creation of the security to render opposable such security. This is also governed by the law of
the domicile of the grantor: Art. 3108.8 CCQ.
127
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It should be noted that if there is not a publication by control or possession
regime in the securities intermediary's jurisdiction, but registration is the means
of perfection, then it is the conflict of laws rule with respect to registration (5
above) that will apply.
3. Would the courts of Ontario and Quebec recognize a security
interest in each type of Eligible Collateral created under each
Covered Base Agreement and CDA bearing in mind the different
forms in which securities Collateral may be held, as described in
assumption (b) above.
An Ontario or Quebec court would recognize the validity of a security interest in
each type of Eligible Collateral created under each Covered Base Agreement and
CDA if the security interest was valid under the applicable law as determined
pursuant to the rules described in Question 1. above, and recognizing that in the
case of indirectly held securities the security interest is actually in the sui generis
property that is the security entitlement as opposed to the underlying security
held by the CSD. See Question 5 below for a description of the conditions for
validity where Ontario or Quebec is the applicable law determined pursuant to
those rules.
With respect to cash Collateral, neither the location of the account nor the
currency is relevant.
4. What is the effect, if any, under the laws of Ontario and Quebec
of the fact that the amount secured or the amount of Eligible
Collateral subject to the security interest will fluctuate under
the Covered Base Agreement and CDA (including as a result of
entering into additional Covered Transactions from time to
time)? In particular: (a) would the security interest be valid in
relation to future obligations of the Covered Customer?134 (b)
would the security interest be valid in relation to future
Collateral (that is, Eligible Collateral not yet delivered to the
Clearing Member at the time of entry into the relevant Covered
In relation to (a), the security interest in any specific Collateral would only be relevant in relation to
future obligations, if ever, at the time such future obligations arise and then only in relation to Collateral
held at that time. This question concerns whether it would be necessary for either party to perform any
action at such time in order to ensure the effectiveness of the security interest as security for such obligations
or whether the security interest would take effect in relation to those future obligations without further
action by either party.
134
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Base Agreement and CDA)? 135 (c) is there any difficulty with the
concept of creating a security interest over a fluctuating pool of
assets, for example, by reason of the impossibility of identifying
in the Covered Base Agreement and CDA the specific assets
transferred by way of security (assuming each specific delivery
to the Clearing Member and return by the Clearing Member of
Collateral under the Covered Base Agreement and CDA from
time to time would be properly recorded by the Clearing
Member, so that, while the pool of Collateral would change from
time to time, at any specific time the composition of the pool of
Collateral could be clearly identified by the Clearing Member)?
(d) is it necessary under the laws of Ontario and Quebec for the
amount secured by each Covered Base Agreement and CDA to be
a fixed amount or subject to a fixed maximum amount? (e) is it
permissible under the laws of Ontario and Quebec for the
Clearing Member to hold Collateral in excess of its actual
exposure to the Covered Customer under the related Covered
Base Agreement and CDA?
a) Future Obligations
The security interest would be valid in relation to future obligations of the
Secured Covered Customer. The PPSA expressly provides that a security
agreement may secure future advances if it expressly so provides. 136 The Civil
Code expressly provides that a hypothec including a pledge may secure future
advances if it expressly so provides. 137
b) Future Collateral
The security interest would be valid in relation to future Collateral.
Ontario. The PPSA expressly provides that a security agreement may cover afteracquired property. 138 The security interest would not attach, however, until the
In relation to (b), it is understood that the security interest in Collateral to be delivered at some point in
the future after the time of entry into the relevant Covered Base Agreement and CDA would not take effect
in relation to such Collateral until the Collateral had been delivered to the Clearing Member in accordance
with the Covered Base Agreement and CDA. This question concerns whether it would be necessary for
either party to perform any action at such time in order to ensure the effectiveness of the security interest in
relation to such Collateral or whether the security interest would take effect in relation to such Collateral
without further action (other than the delivery) by either party.
136 Ontario PPSA, s.13.
137 Arts 2687, 2688 and 2797 CCQ. The Quebec Court of Appeal has confirmed that a hypothec may secure
future obligations. See St-Jacques c. Charbonneau (1999), [1999] R.D.I. 200 (C.A.).
138 Ontario PPSA, s.12.
135
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Eligible Collateral met the conditions for attachment described below in
Question 5.
Quebec. The Civil Code expressly provides that a conventional movable
hypothec without delivery (roughly equivalent to a non-possessory security
interest) may cover after-acquired property and therefore such security would be
valid in relation to future Collatera1. 139 For a movable hypothec with delivery
(also known as a pledge), the security would not charge the Eligible Collateral
until the conditions described below in Question 5 are met, including obtaining
control.
c) Fluctuating Pool of Assets
There is no difficulty with the concept of creating a security interest over a
fluctuating pool of assets 140, for example, by reason of the impossibility of
identifying the specific assets pledged, so long as the pool is identified in such a
way that the Collateral in aggregate is identifiable at any given time and the
debtor's proportionate interest in the pool can be determined and otherwise
meets the conditions described below or under the applicable jurisdiction's
law. 141
d) Necessity for Fixed Amount
It is not necessary for the amount secured to be a fixed amount or subject to a
fixed maximum amount.
Under Quebec law, however, please note that for a conventional movable
hypothec without delivery, such security must set out a charging amount in
Canadian funds. 142 The charging amount is a purely notional amount and need
not be related to any quantification of the secured obligations. The general
practice is also to include a notional interest rate in addition to a principal
charging amount which in total are in an amount large enough that they would
not be reached.
e) Excess Collateral
Arts 2670 and 2954 CCQ.
This assumes that the pool of assets is not being held by the debtor.
141 PPSA, s. 17(2)(d) recognizes that fungible Collateral may be commingled and this, in our view, implicitly
recognizes that a security interest in a pool of fungible securities is possible and, because fluctuations are
inevitable for a pool of assets, that fluctuations will not affect the security interest. Fungible securities are
defined in s. 1(2) of the Ontario PPSA as securities of which any unit is, by nature or usage of trade, the
equivalent of any other like unit and includes unlike units to the extent that they are treated as equivalents
under a security agreement.
142 See the discussion below under Question 5(b)(iii).
139
140
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It is permissible for the Clearing Member to hold Collateral in excess of its actual
exposure to the Covered Customer if so provided for under the related Covered
Base Agreement and CDA. The Clearing Member would, however, be required
to return any excess after default and liquidation of the Collateral depending on
the particular remedies exercised.
5. Assuming that the courts of Ontario and Quebec would
recognize the security interest in each type of Eligible Collateral
created under each Covered Base Agreement and CDA, is any
action (filing, registration, notification, stamping, notarization
or any other action or the obtaining of any governmental,
judicial, regulatory or other order, consent or approval) required
in Ontario or Quebec to perfect that security interest? If so,
what actions must be taken and how would such actions differ
depending on the type of Eligible Collateral in question?
(a) Ontario
(i) General
If Ontario is the applicable law with respect to validity or perfection (as
determined by applying the rules set out above), then with respect to certain
types of Eligible Collateral there are steps that must be taken to ensure
attachment and perfection of the security interest.
(ii) Attachment of a Security Interest in Eligible Collateral
Where Ontario is the law governing validity of the security interest, the Covered
Base Agreement and CDA would create a valid security interest upon
"attachment" of the security interest. 143 Attachment and validity mean essentially
the same thing in the context of the PPSA. We will discuss attachment with
respect to each type of Eligible Collateral. However, there are some elements of
attachment common to each type of property. Three requirements for all types of
property are: (1) value has been given, (2) the debtor has rights in the collateral
or the power to transfer rights in the collateral to a third party, and (3) the parties
have not agreed to postpone the time for attachment. 144 There is a fourth
condition relating to identifying the collateral, but it can be satisfied in a number
of different ways depending on the type of collateral.
143
144
Ontario PPSA, s.11.
Ontario PPSA, s. 11(3). If they have so agreed, attachment is delayed until the agreed time.
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With respect to any type of collateral, the fourth element that will complete the
conditions for attachment is the signing of a security agreement by the debtor
that contains a description of the collateral sufficient for it to be identified.
The PPSA also expressly provides that describing the collateral by the terms
" security entitlement", "securities account", "futures account" or "investment
property" is sufficient where collateral is in that form. Section 17(4) of the STA
contains a rule designed to eliminate the problems of coordination of
terminology. It provides that unless the context shows otherwise, a person who
is required by an agreement to transfer, deliver, present, surrender, exchange or
otherwise put in the possession of another person a security or other financial
asset satisfies that requirement by causing the other person to acquire an interest
in the security or other financial asset as set out in sections 17(1) and (2) of the
STA. Also, describing the underlying financial assets in a futures account or
securities account or subject to a securities entitlement is sufficient to describe the
futures account, securities account or securities entitlement.145 The Ontario
government has published a commentary which is based on the U.C.C. Article 8
Official Commentary. This Ontario commentary states (at p. 255) that a
description of collateral in a security agreement does not need to refer to the
security entitlement or securities account terminology.
For certain types of Eligible Collateral the fourth element of attachment can also
be met in ways other than having a description in the security agreement. Taking
control of investment property pursuant to a security agreement also constitutes
attachment. The concept of "control" will be described below in the context of
the discussion of perfection.
If the Eligible Collateral is a directly held certificated security in registered form
an additional element that will complete satisfaction of the attachment criteria is
the certificate being "delivered" to the secured party. 146 Delivery of a certificated
security occurs when the secured creditor either:
1. acquires possession of the security certificate,
2. another person, other than a securities intermediary, either
(i) acquires possession of the security certificate on behalf of
the secured creditor or (ii) having previously acquired
possession acknowledges that it is holding the certificate for
the secured creditor, or
145
Ontario PPSA, s. 11, s.5.
s. 68.
146 STA,
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3. a securities intermediary acting for the secured creditor
acquires possession of the certificate, the certificate is in
registered form and the certificate is either (i) registered in
the secured creditor's name, (ii) payable to the order of the
secured creditor, or (iii) specially endorsed to the secured
creditor by an effective endorsement and has not been
endorsed to the securities intermediary or in blank. 147
Attachment of a security interest in a securities account is also attachment of a
security interest in the security entitlements carried in the securities account. 148
(iii)
Perfection of a Security Interest in Cash Collateral not
held in a securities account
As noted above 149, perfection of cash collateral that is not credited to a securities
account (no matter in what currency or jurisdiction the deposit is made) is likely
governed by the law of the place where the Covered Customer is located because
of the likely characterization of this Collateral as an intangible. This is also the
case for other intangibles such as contractual rights against the DCO. Under
Ontario law the means to perfect a security interest in an intangible is the filing
of a financing statement.
The filing of a financing statement would be made in Ontario if the Covered
Customer was located in Ontario. 150 The registration is made with a central
government registry. The financing statement can be filed either manually or
electronically. The fee varies depending on the length of the registration and
perpetual registrations are possible. One financing statement can cover a number
of transactions (and fluctuating obligations) and different types and fluctuating
amounts of Collateral. For example, the Clearing Member would only have to file
one financing statement with respect to Transactions under a particular Covered
Base Agreement and CDA. It is possible for a small fee to obtain search reports
that disclose all financing statements against a debtor. The agreements are not
filed.
With respect to cash provided on a title transfer basis, under Ontario law it is
nevertheless recommended that the Clearing Member perfect on the basis that it
may be characterized as a security agreement regardless of its form as a title
transfer agreement.
If the certificate is registered to the intermediary or in blank, then the property becomes subject to the
rules of the indirect holding system.
148 Ontario PPSA, s.11.4.
149 Question 1.
150 See Question 1 above for a description of the concept of "location of the debtor."
147
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It is anticipated that the Ontario government may introduce amendments to the
PPSA in 2013 that would permit perfection of a security interest in cash collateral
accounts by control (similar to control with respect to a securities account).
(iv)
Perfection of a Security Interest in Investment
Property - Directly Held Certificated Securities, Directly
Held Uncertificated Securities, Indirectly Held Securities,
Cash Held in a Securities Account
Generally, under the PPSA a security interest in investment property (as defined
in the PPSA), which includes credit balances in a securities account, may be
perfected by "control" of the collatera1. 151 The PPSA and STA, in pertinent part,
provide that a secured party:
(1)
has control of a certificated security in bearer form if the certificated
security is delivered to the secured party or its agent, other than a
securities intermediary (i.e. the secured party or its agent acquires
possession of the security certificate) and remains perfected by control
until (a) the secured party does not have control, and (b) the debtor has or
acquires possession of the security certificate;
(2)
has control of a certificated security in registered form if the certificated
security is delivered to the secured party or its agent or securities
intermediary and the certificate is endorsed to the secured party or in
blank by an effective endorsement, or the certificate is registered in the
name of the secured party at the time of the original issue by registration
of transfer by the issuer and remains perfected by control until (a) the
secured party does not have control, and (b) the debtor has or acquires
possession of the security certificate;
(3)
has control of an uncertificated security if it is delivered to the secured
party152 or if the issuer has agreed that it will comply with instructions
that are originated by the secured party without the further consent of the
registered owner, and remains perfected by control until (a) the secured
party does not have control and (b) the issuer has registered or registers
the debtor as the registered owner; and
151 Ontario PPSA, s. 22.1(1). The concept of "control" is dealt with in the STA, s. 23, 24, 25.
152 Delivery of an uncertificated security to a secured creditor occurs when (a) the issuer registers the
secured creditor as the registered owner on the original issue or the registration of transfer or (b) another
person, other than a securities intermediary, either, becomes the registered owner on behalf of the secured
creditor or having previously become the registered owner acknowledges that the person holds for the
secured creditor. STA, s.68(2).
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(4)
has control of a securities entitlement if the secured party becomes the
entitlement holder or the securities intermediary agrees that it will comply
with entitlement orders originated by the secured party without further
consent by the entitlement holder, and remains perfected by control until
(a) the secured party does not have control and (b) the debtor is or
becomes the entitlement holder. A person becomes the entitlement holder
when the security entitlement is transferred to an account in the person's
name.
Registration of a financing statement also perfects a security interest in any type
of collateral, including investment property. 153 Also, a secured party may also
perfect a security interest through automatic perfection (i.e. it is perfected when
it attaches) if the secured party is a broker or securities intermediary. 154
However, these methods of perfection are not as powerful as control in terms of
priority protection. 155
Accordingly, under Ontario, the Clearing Member should have a perfected
security interest by control in the Eligible Collateral:
(1)
in the case of directly held bearer debt securities, when the Covered
Customer delivers the security certificates to the Clearing Member or its
agent (provided such agent is not a securities intermediary);
(2)
in the case of directly held registered debt securities, when the Covered
Customer delivers the security certificates to the Clearing Member or its
agent or the Clearing Member's own securities intermediary, in each case
accompanied by any duly executed documents necessary to constitute a
legally valid transfer (and in the case of delivery to a securities
intermediary the security cannot be endorsed in blank); 156
(3)
in the case of directly held dematerialized securities, when the Covered
Customer's position is transferred to the Clearing Member so that the
Ontario PPSA, s.23. Perfection of a security interest by filing and automatic perfection of a security
interest in investment property granted by a broker or securities intermediary, however, are governed by
the local law of the jurisdiction in which the debtor is located.
154 PPSA, s.19.2(2).
155 The security interest of a secured party who has control over investment property has priority over a
conflicting security interest of a secured party who does not have control (Ontario PPSA, s.30.1(2)).
Moreover, a creditor of a securities intermediary, who has a security interest in investment property held by
the securities intermediary, has priority over the intermediary's entitlement holders if the creditor has
control over the investment property (STA, s.105(2)).
156 STA, s.23, s.68(1). "Delivery" itself also perfects a security interest in a certificated security in registered
form. Delivery is a wider concept than control, but as stated above it is better to have control as it confers a
more powerful priority position. Note that for certificated securities there is no provision that says there is
still control if the registered owner retains the right to make substitutions, originate instructions or
otherwise with the certificated security as there is with uncertificated securities.
153
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Clearing Member or its agent (other than a securities intermediary) is
registered on the books of the issuer as the owner of such security or the
issuer has agreed that it will comply with instructions that are originated
by the purchaser without the further consent of the registered owner; 157
(4)
in the case of securities entitlements with respect to financial assets (e.g.
indirectly held debt securities and Cash credited to a securities account): 158
(i)
assuming that the Covered Customer gives written instructions to
the relevant securities intermediary to transfer the security
entitlements into an account held in the Clearing Member's name at
an Intermediary (which may be acting as Custodian), at the point
when that transfer takes place and the security entitlements are
credited (or should be credited) to the Clearing Member's account
at the relevant Intermediary (i.e. the Clearing Member becomes the
entitlement holder); 159
(ii)
the Intermediary of the Covered Customer has agreed that it will
comply with entitlement orders that are originated by the Clearing
Member without the further consent of the Covered Customer; 160
(iii)
an agent has control of the security entitlement on behalf of the
Clearing Member; or
(iv)
automatically if the Clearing Member is the Covered Customer's
own Intermediary. 161
(v) Futures Contracts and Futures Accounts 162
Generally, under the PPSA a security interest in investment property (as defined
in the PPSA), which includes futures contracts and futures accounts, may be
perfected by "control" of the collatera1. 163 The PPSA164 provides that a secured
party has control of a futures contract if (i) the secured party is the futures
intermediary with which the futures contract is carried, or (ii) the futures
STA, s.24, s.68(2). The Clearing Member has control even if the Covered Customer remains the registered
owner and retains the right to make substitutions, originate instructions or otherwise deal with the
uncertificated security (STA s.24(2)).
158 STA, s.25.
159 This method of perfection provides the highest level of protection.
160 The Clearing Member has control even if the Covered Customer remains the entitlement holder and
retains the right to make substitutions for the security entitlement, to originate instructions to the securities
intermediary or to otherwise deal with the security entitlement (s.25(2)).
161 STA, s.26.
162 See Question 1 above for an explanation of what futures and futures accounts are covered.
163 Ontario PPSA, s. 22.1(1). The concept of "control" is dealt with in the STA, s. 23, 24, 25.
164 PPSA Section 1(2)(d).
157
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customer, secured party and futures intermediary have agreed that the futures
intermediary will apply any value distributed on account of the futures contract
as directed by the secured party without further consent by the futures customer.
A secured party having control of all futures contracts carried in a futures
account has control over the futures account. 165
If the Clearing Member meets the definition of a futures intermediary (see above
question III.), then it would have control of the futures account and futures
contracts. As noted above, however, futures carried in non-Canadian accounts
are not covered by these rules.
(vi)
Intangibles such as Rights against DCOs
The perfection of the security interest in intangibles, which would include
receivables and contractual rights such as the Futures Payment Rights under its
Futures Transactions (to the extent the Clearing Member is not a "futures
intermediary" as defined above) and its Cleared Derivatives Payment Rights
under its Cleared Derivatives Transactions and its other rights against CDOs in
respect of those Futures Transactions and Cleared Derivatives Transactions
would be by registration of a financing statement with respect to Covered
Customers located in Ontario.
(b) Quebec
(i) General
If Quebec law is the applicable law with respect to validity or publication and the
effects of publication (as determined by applying the rules set out above), then
with respect to certain types of Eligible Collateral there are steps that must be
taken to ensure creation and publication of such security.
(ii) Creation of a Security in Eligible Collateral
We will discuss creation with respect to each type of Eligible Collateral.
However, there are some elements of validity common to each type of property.
Two requirements for all types of property are: (1) the debtor must have the
capacity to alienate the collateral, and (2) the debtor must have rights in the
There
collateral or the power to transfer rights in the collateral to a third party
is a third condition relating to identifying the collateral, but it can be satisfied in a
number of different ways depending on the type of collateral.
. 166
165
166
PPSA, s.1(2)(e).
Arts 2681 and 2682 CCQ. See also Art. 2670 CCQ.
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With respect to any type of collateral, other than cash that is not a financial asset
in a securities account, an additional element that will complete the conditions
for creation of a pledge is the evidence of the intention to grant security which is
satisfied by the terms of the security agreement.
We have assumed that the debtor has the requisite capacity. Assuming that the
Covered Customer has rights in Eligible Collateral, the second element of a valid
security interest would also be satisfied. If the Covered Base Agreement
evidences the intention to grant security and sufficiently describes the pledged
Eligible Collateral it will be valid. Accordingly, we believe that under the
applicable document, a security interest in the Eligible Collateral, other than in
respect of cash, futures contracts in futures accounts and general contracts and
contract rights, in circumstances described below, would be validly created
under Quebec law when the Clearing Member obtains control. The concept of
"control" will be described below.
We believe that describing the collateral by the terms "security entitlement" and
"securities account" is sufficient where collateral is in that form. 167 Section 3 of the
Quebec STA contains a rule designed to eliminate the problems of coordination
of terminology. It provides that unless the context shows otherwise, a person
who is required by an agreement to transfer, deliver, present, surrender,
exchange or otherwise put in the possession of another person a security or other
financial asset satisfies that requirement by causing the other person to acquire
an interest in the security or other financial asset.
If the Eligible Collateral is a directly held certificated security in registered form,
an additional element that will complete satisfaction of the creation criteria is the
certificate being "delivered" to the secured party. Delivery of a certificated
security occurs when the Secured Creditor either: 168
1.
acquires possession of the security certificate,
2.
another person, other than a securities intermediary, either
(i) acquires possession of the security certificate on behalf of the
Clearing Member or (ii) having previously acquired possession
acknowledges that it is holding the certificate for the Clearing
Member, or
By extension of the general principles of Arts 1373 and 1374 CCQ and QSTA, s.3. Neither the QSTA nor
the Civil Code contain a provision similar to the Ontario PPSA, s. 11(4) whereby attachment of a security
interest in a securities account is also attachment of a security interest in the security entitlements carried in
the securities account. We do not believe that the absence of such a provision adversely affects our
conclusions.
168 QSTA, s. 50.
167
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3.
a securities intermediary acting for the Clearing Member acquires
possession of the certificate, the certificate is in registered form and
the certificate is either (i) registered in the Clearing Member's
name, (ii) payable to the order of the Clearing Member, or
(iii) specially endorsed to the Clearing Member by an effective
endorsement and has not been endorsed to the securities
intermediary or in blank. 169
See the discussion below in respect of the validity of a security interest in the
contract rights or the futures.
(iii)
Validity and publication of a Security Interest in Cash
Collateral not held in a securities account
As noted above,170 creation and publication of a security interest over cash
collateral that is not credited to a securities account (no matter in what currency
or jurisdiction the deposit is made) is likely governed by the law of the place
where the Covered Customer is domiciled because of the likely characterization
of this Collateral as incorporeal movable property which is not a security, title in
bearer form or a security entitlement.
Under Quebec internal law, the only way of obtaining a valid security on cash
would, therefore, be by way of a conventional movable hypothec without
delivery. This security must be in writing containing a sufficient description of
the collatera1. 171 In addition, it must be clear that a hypothec is granted and the
document must contain a charging amount in Canadian currency (which as
described above can be a large notional amount to cover all potential future
exposure). Registration is required in order to perfect (render opposable to third
parties) a conventional movable hypothec without delivery. The registration is
made by way of a Form RH with a central government registry, the Register of
personal and movable real rights (the "Register"). Unique Quebec law language
must be added to the Covered Base Agreement to create a valid conventional
movable hypothec without delivery against a Quebec Customer.
The Form RH can be filed either manually or electronically. The fee is CDN$42
and a maximum initial registration period of 10 years is possible. The registration
may be extended by way of a renewal prior to the then applicable expiry date.
One Form RH may only cover a specific conventional movable hypothec without
delivery but the underlying conventional movable hypothec without delivery
If the certificate is registered to the intermediary or in blank, then the property becomes subject to the
rules of the indirect holding system.
17o Question 1.
171 Art. 2697 CCQ.
169
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and the related Form RH may cover different types and fluctuating amounts of
obligations and collateral. It is possible for a fee to obtain search reports that
disclose all registrations against a particular debtor.
In order for a conventional movable hypothec without delivery which charges
claims (receivables), other than bearer instruments, to be enforceable against the
account debtors of such claims, the account debtors must either acquiesce
(consent to) or be appropriately notified of the charge (Arts 2710, 1641 CCQ).
(iv)
Validity and Publication of a Security Interest in
Futures Transactions and Cleared Derivatives Transaction
and other contractual rights and intangibles
In respect of receivables and contractual rights, such as the contractual rights
under Futures Transactions and Cleared Derivatives Transactions, including
Futures Payment Rights and Cleared Derivatives Payment Rights and its other
rights against CDOs in respect of those Futures Transactions and Cleared
Derivatives Transactions, the security interest must be granted by a conventional
movable hypothec without delivery (as described in the section immediately
above in respect of the validity and publication of security interest in cash
collateral not in a securities account) and perfected by registration. Any
document constituting the hypothec will need to contain a sufficient description
of the property being charged.
(v) Validity and Publication of a Security in Directly Held
Certificated Securities, Directly Held Uncertificated
Securities, Indirectly Held Securities, Cash Held in a
Securities Account
Generally, under the Civil Code a security interest in securities and security
entitlements (as such terms are used in the Quebec STA), which latter concept
may include credit balances in a securities account, may be created and rendered
opposable to third parties (perfected) by "control" of the collatera1. 172 The Quebec
STA provides that a secured party:
1.
has control of a certificated security in bearer form if the
certificated security is delivered to the secured party or its agent,
Arts 2702 and 2714.1 CCQ. The concept of "control" is dealt with in the QSTA, s. 55, 56 and 113. We
believe that the registration seemingly required under Art. 2711 CCQ is not necessary if the Security
Documents charge a universality of claims in light of Art. 2714.1 CCQ i.e. obtaining control is all that is
required to render the security opposable to all third parties. For similar reasons, no notification to account
debtors under Art. 2710 CCQ should be necessary. This reasoning would not apply to a conventional
movable hypothec without delivery and, as discussed, it may be necessary to take such security in order to
charge cash not held in a securities account.
172
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other than a securities intermediary (i.e. the secured party or its
agent acquires possession of the security certificate) and remains
published until the secured party does not have contro1; 173
2.
has control of a certificated security in registered form if the
certificated security is delivered to the secured party or its agent or,
provided the endorsement is not in blank, securities intermediary
and the certificate is endorsed to the secured party or in blank by
an effective endorsement, or the certificate is registered in the name
of the secured party at the time of the original issue or by
registration of transfer by the issuer and remains published until
the secured party does not have control; 174
3.
has control of an uncertificated security if it is delivered to the
secured party (i.e. the issuer transfers the uncertificated security
from the debtor to the secured party or its agent, other than a
securities intermediary) 175 or if the issuer has agreed with the
secured party that it will comply with instructions that are
originated by the secured party without the further consent of the
registered holder and remains published until the secured party
does not have control; and
4.
has control of a security entitlement if the secured party becomes
the entitlement holder or the securities intermediary agrees with
the secured party that it will comply with entitlement orders
originated by the secured party without further consent of the
entitlement holder and remains published until the secured party
does not have control. A person becomes the entitlement holder
when the security entitlement is transferred to a securities account
in the person's name.
As indicated in respect of cash, a valid and opposable security may also be
obtained by way of a conventional movable hypothec without delivery but there
are particular formalities which are required. Also, a secured party may also
obtain a conventional movable hypothec without delivery through automatic
publication (i.e. it is published when it is created) if the debtor is a securities
173 Art. 2705 CCQ does not apply in light of the specific requirements of Art. 2714.1 CCQ. See QSTA s. 50.
174 See Arts. 2702 to 2704, 2714.1, 2736 and 2798 CCQ.
175 Delivery of an uncertificated security to a secured creditor occurs when (a) the issuer registers the
secured creditor as the registered holder on the original issue or the registration of transfer or (b) another
person, other than a securities intermediary, either, becomes the registered holder on behalf of the secured
creditor or having previously become the registered holder acknowledges that the person holds for the
secured creditor. QSTA, s.51.
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intermediary. 176 However, these methods of publication are not as powerful as
control in terms of priority protection. 177
Accordingly, under Quebec law, the Clearing Member should have a valid and
opposable security interest by control in the Eligible Collateral that is securities
pledged:
1.
in the case of directly held bearer debt securities, when the Covered
Customer delivers the security certificates to the Clearing Member
or its agent (provided such agent is not a securities intermediary);
2.
in the case of directly held registered debt securities, when the
Covered Customer delivers the security certificates to the Clearing
Member or the Clearing Member's agent or the Clearing Member's
securities intermediary, in each case accompanied by any duly
executed documents necessary to constitute a legally valid transfer
(and in the case of delivery to a securities intermediary the security
cannot be endorsed in blank); 178
3.
in the case of directly held dematerialized securities, when the
Covered Customer's position is transferred to the Clearing Member
so that the Clearing Member or an agent of the Clearing Member
(other than a securities intermediary) is registered on the books of
the issuer as the owner of such security or the issuer has agreed
with the Clearing Member that it will comply with instructions that
are originated by the purchaser without the further consent of the
registered holder; 179
Publication of a security by registration and automatic publication of a security in securities and security
entitlements granted by a securities intermediary, however, are governed by the local law of the jurisdiction
in which the debtor is domiciled. Arts 2701.1 and 3108.8 CCQ.
177 The security of a secured party who has control over securities and security entitlements has priority over
a conflicting security of a secured party who does not have control (Art. 2714.2 CCQ). Moreover, a creditor
of a securities intermediary, who has a security in a financial asset held by the securities intermediary, has
priority over the intermediary's entitlement holders if the creditor has control over the financial asset
(QSTA, s.130).
178 QSTA, s.50 and 55. "Delivery" itself also publishes a security in a certificated security in registered form.
See Arts 2714.4 and 2714.6 CCQ. Delivery is a wider concept than control, but as stated above it is better to
have control as it confers a more powerful priority position. Note that for certificated securities there is no
provision that says there is still control if the registered holder retains the right to make substitutions,
endorsements or otherwise dispose of the certificated security as there is with uncertificated securities.
179 QSTA, s.51 and 56. The Clearing Member has control even if the Covered Customer remains the
registered holder and retains the right to make substitutions, originate instructions or otherwise dispose of
the uncertificated security (QSTA s.56).
176
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4.
in the case of security entitlements with respect to financial
assets: 180
(i)
assuming that the Covered Customer gives written instructions to the
relevant securities intermediary to transfer the security entitlements into a
securities account held in the Clearing Member's name at an Intermediary
(which may be acting as Custodian), at the point when that transfer takes
place and the security entitlements are credited (or should be credited) to
the Clearing Member's account at the relevant Intermediary (i.e. the
Clearing Member becomes the entitlement holder); 181
(ii)
the Intermediary of the Covered Customer has agreed with the Clearing
Member that it will comply with entitlement orders that are originated by
the Clearing Member without the further consent of the Covered
Customer; 182
(iii)
an agent has control of the security entitlement on behalf of the Clearing
Member; or
(iv)
automatically if the Clearing Member is the Covered Customer's own
Intermediary. 183
(vi)
Validity and publication with respect to Futures and
Futures Accounts
Please refer to the discussion above in respect of the application of Section 17 of
the QSTA to futures contracts in a securities account in Part III question 1(c)(A).
For futures contracts in a futures account, the discussion in respect of Cash
Collateral not held in a securities account is applicable.
6. What other requirements are there under the laws of Ontario
and Quebec to ensure the validity or perfection of a security
interest in each type of Eligible Collateral created by the
Covered Customer under each Covered Base Agreement and
CDA? For example, is it necessary as a matter of formal validity
that the Covered Base Agreement and CDA be expressly
governed by the law of Ontario or Quebec or translated into any
other language or for the Covered Base Agreement and CDA to
180 QSTA, s.113.
181 This method of control provides the highest level of protection. Art. 2714.2 CCQ and QSTA s.129.
182 The Clearing Member has control even if the Covered Customer remains the entitlement holder and
retains the right to make substitutions for the security entitlement, to originate entitlement orders to the
securities intermediary or to otherwise dispose of the security entitlement (QSTA, s.113).
183 QSTA, s.115.
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include any specific wording? Are there any other documentary
formalities that must be observed in order for a security interest
created under each Covered Base Agreement and CDA to be
recognized as valid and perfected in Ontario or Quebec?
(a) Ontario
We are not aware of any other requirements under Ontario law. It is not
necessary for the agreements to be expressly governed by the law of Ontario, to
be translated into any particular language or for them to include any specific
wording, so long as the intention to create a security interest is clear, and there is
a sufficient description of the collateral, as discussed in Question 5 above.
A secured creditor does have an obligation to deliver a copy of the security
agreement to the debtor within 10 days after its execution. This requirement
should be satisfied where the Covered Customer receives or has in its possession
an executed copy of the Covered Base Agreement and CDA. Electronic delivery
suffices. Failure to deliver does not affect the validity, perfection or priority of
the security interest.
(b) Quebec
Under Article 2692 of the Civil Code, if the conventional movable hypothec
without delivery secures bonds or other titles of indebtedness issued by a trustee,
limited partnership or a corporation, the hypothec must be in notarial form in
favour of a person holding the power of attorney of the creditors (fonde de
pouvoir).
The Quebec Charter of the French Language requires, for standard form documents
in a language other than French, that the parties agree that the document is to be
drawn-up in such other language. Provisions of this Charter also restrict the
ability of certain governmental entities to conclude contracts in the province of
Quebec in a language other than French. In this regard, we note that a bill
currently at a preliminary stage before the Quebec National Assembly would
provide greater flexibility for governmental entities to conclude such contracts.
An example of the language that could be added to the Covered Base Agreement
or the CDA is:
The parties herein confirm their express wish that this agreement and all
documents related thereto be drawn up in English. Les parties aux presentes
confirment leur volonte expresse de voir le contrat et tous les documents s'y rattachant
etre rediges en anglais.
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We are not aware of any other requirements under Quebec law. Subject to the
discussion above, it is not necessary under Quebec law for the security
documents to be expressly governed by the law of Quebec, to be translated into
any particular language or for them to include any specific wording, so long as
the intention to create a security is clear, and there is a sufficient description of
the collateral as discussed in Question 5 above. Note also our discussion above in
respect of the requirements for a conventional movable hypothec without
delivery.
7. Assuming that the Clearing Member has obtained a valid and
perfected security interest in the Eligible Collateral under the
laws of this jurisdiction, to the extent such laws apply, by
complying with the requirements set forth in your responses to
questions 1 to 6 above, as applicable, will the Clearing Member
or the Covered Customer need to take any action thereafter to
ensure that the security interest in the Eligible Collateral
continues and/or remains perfected, particularly with respect to
additional Collateral transferred by way of security from time
to time when required pursuant to the Covered Base Agreement
and CDA?
(a) Ontario
No additional steps will be necessary to ensure that the security interest in the
Eligible Collateral continues or remains perfected assuming the financing
statement is filed. If the Clearing Member is relying on control to perfect the
security interest in the Eligible Collateral, then it need only take control of any
additional Eligible Collateral in order to be perfected with respect to that
Collateral as long as the Collateral is of a type that can be perfected by control.
If the Clearing Member is relying on the registration of a financing statement,
then a single filing (together with attachment) will perfect the security interest in
after acquired property under the same security agreement. Filings can be
perpetual or for a specified period of years. New filings will be required to
update expiring registrations.
If the Clearing Member is relying on control as the means of perfection and the
Eligible Collateral gives rise to Cash proceeds (that do not remain in the
securities account), the Clearing Member will be temporarily and continuously
perfected for 10 days, but must within that time take steps to perfect with respect
to the proceeds. The financing statement filed at the time of entering into the
agreements will cover the proceeds.
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Also, perfection is a status that is relevant at any given time. To the extent that
any fact or circumstance changes that would result in a different governing law
applying to the issue of perfection that will have to be considered. So, for
example, if perfection is governed by the law of the debtor's location, if the
debtor changes location, perfection will have to be reassessed. The PPSA 184
provides that if a debtor relocates, a security interest in an intangible (e.g. Cash
not in a securities account) remains perfected until the earliest of (a) 60 days after
the day the debtor relocates, (b) 15 days after the secured party receives notice
that the debtor has relocated to another jurisdiction, and (c) the day perfection
ceases under the previously applicable law (e.g. the filing expires). Also, if the
location of a directly held certificated security changes, the applicable law will
also change. If a security interest in investment property is perfected under the
law of the issuer's jurisdiction or the securities intermediary's jurisdiction and
there is a change of that jurisdiction, it will remain perfected until the earliest of
(a) 60 days after the change, (b) 15 days after the secured party knows of the
change, and (c) the day perfection ceases under the previously applicable law.
(b) Quebec
A hypothec on specific property that is transferred in the ordinary course of
business of an enterprise will extend to any property that replaces it, if a notice
identifying the new property is registered. 185 A movable hypothec on property
that is alienated out of the ordinary course of business of an enterprise may be
preserved if a notice of preservation of hypothec is filed in the Register. The
notice must be registered within fifteen days after the creditor is informed in
writing of the transfer of the property and the name of the purchaser or after the
creditor consents in writing to the transfer. A notice must also be sent to the
purchaser within the same time period. 186
No additional steps will be necessary to ensure that the security interest in the
Eligible Collateral continues or remains published. If the Clearing Member is
relying on control for the security in the Eligible Collateral, then it need only take
control of any additional Eligible Collateral in order to have an enforceable and
opposable security with respect to that Collateral as long as the Collateral is of a
type whereby a security may be obtained and published by control. So for
example, if the Eligible Collateral gives rise to cash not credited to a securities
account which is also to be held as Collateral, subject to our discussion below,
because that form of Collateral cannot be subject to a valid security by way of
Art 2674 CCQ.
186 Art. 2700 CCQ. These rules are seemingly more applicable to movable hypothecs without delivery. If a
secured creditor benefits from a movable hypothec with delivery, possession or control, as the case may be,
of the applicable property will constitute sufficient publication.
184
185
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control, the Clearing Member will have to ensure that it has valid and opposable
security under the applicable law at the time the proceeds or distributions arise.
If the Clearing Member is relying on a conventional movable hypothec without
delivery, then a single registration will render the security opposable in after
acquired property under the Covered Base Agreement. Registration may be for a
maximum specified period of 10 years. A renewal registration may be registered
prior to the expiry date.
If the Clearing Member is relying on control and the Eligible Collateral gives rise
to cash proceeds (that do not remain in the securities account), Article 2737 of the
Civil Code may apply. This Article provides that the creditor under a movable
hypothec with delivery or pledge collects the fruits and revenues of the charged
property. Under Quebec internal law, revenues comprise sums of money yielded
by property, such as rents, interest and dividends, except those representing the
distribution of capital of a legal person (Art. 910 CCQ). The reinvestment of fruits
and revenues and the price for any disposal of capital or its reinvestment
constitute capital (Art. 909 CCQ). Fruits comprise things spontaneously
produced by property without any alteration to the substance of the property.
Unless stipulated otherwise, the creditor applies the revenues to expenses, then
interest and finally principal. 187 In addition, Article 2674 of the Civil Code would
lead to the conclusion that the Clearing Member continues to have a valid and
published security in Cash proceeds that are identifiable. If distributions arise
that are in the form of intangibles and the parties' intention is that the security
would extend to those distributions (and they will not be credited to a securities
account), then consideration should be given to obtaining and publishing valid
security in the jurisdiction where the Covered Customer is domiciled.
Also, publication is a status that is relevant at any given time. To the extent that
any fact or circumstance changes that would result in a different governing law
applying to the issue of publication and its effects, that will have to be
considered. So, for example, if publication is governed by the law of the debtor's
domicile, if the debtor changes domicile, publication will have to be reassessed.
The Civil Code188 provides that if a debtor relocates its domicile to Quebec, a
security in incorporeal movable property other than securities, titles in bearer
form and security entitlements (e.g. Cash not in a securities account) remains
published until the earliest of (a) 30 days after the day the debtor relocates, (b) 15
This provision seems to apply with difficulty to the types of obligations secured by the Security
Documents. Principal may refer more to the principal obligations secured. An alternative to a nonpossessory security interest would be to render any monetary distributions subject to this same set-off
provision if the distributions are not to remain in the securities account to which the securities collateral is
credited.
188 Art. 3106 CCQ.
187
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days after the secured party receives notice that the debtor has relocated to
Quebec, and (c) the day publication ceases under the previously applicable law
(e.g. the registration expires). Also, if the location of a directly held certificated
security changes, the applicable law will also change. There is no rule in Quebec
analogous to the rules in Ontario in case of a change of the "issuer's jurisdiction"
or the "securities intermediary's jurisdiction". 189
8. Assuming that (a) pursuant to the laws of Ontario and Quebec,
the laws of another jurisdiction govern the creation and/or
perfection of a security interest in the Eligible Collateral
transferred by way of security pursuant to each Covered Base
Agreement and CDA (for example, because such Collateral is
located or deemed to be located outside Ontario or Quebec) and
(b) the Clearing Member has obtained a valid and perfected
security interest in the Eligible Collateral under the laws of such
other jurisdiction, will the Clearing Member have a valid
security interest in the Collateral so far as the laws of Ontario
or Quebec are concerned? Is any action (filing, registration,
notification, stamping or notarization or any other action or the
obtaining of any governmental, judicial, regulatory or other
order, consent or approval) required under the laws of Ontario
and Quebec to establish, perfect, continue or enforce this
security interest? Are there any other requirements of the type
referred to in question 6 above?
If, pursuant to the laws of this jurisdiction, the laws of another jurisdiction
govern the creation, validity and perfection of a security interest in the Eligible
Collateral and the Clearing Member has obtained a valid and perfected security
interest pursuant to the laws of that other jurisdiction, then a court applying
Ontario or Quebec law will recognize that the Clearing Member has a valid and
perfected security interest in the Eligible Collateral. No action is required in this
jurisdiction or under its law to establish, perfect, continue or enforce 190 this
security interest. There are no other requirements of the type referred to in
Question 6 above.
9. Are there any particular duties, obligations or limitations
imposed on the Clearing Member under the laws of Ontario or
Quebec in relation to the care of the Eligible Collateral held by it
pursuant to each Covered Base Agreement and CDA?
Ontario PPSA s. 7.1(7).
We assume that "enforce" in this context does not refer to the procedural requirements that apply to
realizing on the Collateral, which are dealt with below in Questions 12 to 15.
189
190
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There are particular duties, obligations and limitations under the Ontario PPSA
and Quebec Civil Code imposed on a secured party in relation to the care of the
collateral in its possession or contro1. 191
A preliminary question, however, is whether either the PPSA or Civil Code
would govern this issue. There is no specific conflict of laws rule in these statutes
that applies to a secured party's obligations with respect to the collateral. If the
issue arose in the context of whether or not a secured party had breached a
security agreement, then the governing law of the security agreement might be
the applicable law. There is a specific conflict of laws rule in the PPSA (but not
the Civil Code) that applies to "substantive matters affecting the enforcement of
the rights of a secured party against collateral". Such matters are determined by
the governing law of the agreement. 192 If a wide interpretation is given to the
words "enforcement" and "rights", then the issue of duties of care with respect
to collateral may be a matter for the governing law in Ontario.
However, because the duty of care is essentially a matter of protecting the
position of the debtor, it is possible that a court would find that this issue was
governed by the law of the place where the debtor was located (Ontario) or
domiciled (Quebec). If so and if the Covered Customer was located in Ontario or
domiciled in Quebec, then the question of what duties it has in relation to the
Collateral would be a matter of Ontario or Quebec law.
If Ontario law is the applicable law then the following duties apply (subject to
the rehypothecation rights with respect to investment property described
below):
•
A secured party must use reasonable care in the custody and
preservation of collateral in its possession. 193 A secured party cannot
contract out of this obligation 194 (except to the extent it has
rehypothecation rights with respect to investment property as
described below), although a security agreement may set out the
standards by which the rights of the debtor and duties of the secured
party are to be measured, so long as those standards are not manifestly
unreasonable having regard to the nature of the rights and duties. 195
•
There is also a duty imposed on a secured party in possession of
collateral to keep collateral identifiable (although fungible collateral
PPSA, s.17 and 17.1.
Ontario PPSA, s.8(1)(b).
193 PPSA, s.17(1). Note that this has not been amended to add collateral in the control of a secured party.
194 Ontario PPSA, s.59(5).
195 Ontario PPSA, s. 59(4).
191
192
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can be commingled). This duty applies unless otherwise agreed
between the parties. 196 Under the Ontario PPSA, fungible securities are
securities of which any unit is, by nature or usage of trade, the
equivalent of any other like unit and includes unlike units to the extent
that they are treated as equivalents under a security agreement. 197
These duties are modified in Ontario with respect to "investment property"
where the secured party has "control" of the investment property.
PPSA section 17.1(1) specifically states that a secured party having control may
hold as additional security any proceeds received from the collateral, must either
apply money or funds received from the collateral to reduce the secured
obligation or remit the money or funds to the debtor, and may create a security
interest in the collateral.
Further, section 17.1(2) provides that despite the duties otherwise imposed, a
secured party having control of investment property may sell, transfer, use or
otherwise deal with the collateral in the manner and to the extent provided in the
security agreement.
In Quebec, in accordance with Article 2714.6 of the Civil Code, a secured party
with control of securities or security entitlements may alienate or grant a
hypothec on the collateral unless provided otherwise.
If Quebec law is the applicable law then the following duties apply:
•
The Civil Code contains the requirement that a secured party must act
in good faith in the performance of an obligation and in the exercise of
rights. 198
•
Additionally, a creditor holding a pledge may not "abuse" the property
and must do whatever is necessary to preserve it although the creditor
may use the property with the permission of the debtor. 199 A secured
party is not liable for loss of pledged property by force majeure or as a
result of its ageing, perishability or normal and authorized use.
•
Article 2737 of the Civil Code specifically states that a secured party
holding property collects fruits and revenues received from the
collateral and, unless otherwise stipulated, must apply revenues
PPSA, s.17(2).
198 Arts 6, 7 and 1375 CCQ.
199 Arts 2736, 2739 and 2741 CCQ.
196
197
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received from the collateral to reduce the secured obligation. The
secured party remits the fruits to the debtor.
10. A Covered Base Agreement and CDA may grant the Clearing
Member broad rights with respect to the use of Collateral.
Additionally, the Covered Base Agreement and CDA are subject
to the rules of DCOs, which may also grant DCOs similar rights
with respect to the use of Collateral that has been on-posted
from a Clearing Member to a DCO. Such use might include
pledging or rehypothecating the securities, disposing of the
securities under a securities repurchase (repo) agreement or
simply selling the securities. Do the laws of Ontario and Quebec
recognize the right of the Clearing Member or DCO so to use
such Collateral pursuant to an agreement with the Covered
Customer? In particular, how does such use of the Collateral
affect, if at all, the validity, continuity, perfection or priority of
a security interest otherwise validly created and perfected prior
to such use? Are there any other obligations, duties or
limitations imposed on the Clearing Member or DCO with
respect to its use of the Collateral under the laws of Ontario and
Quebec?
As noted in the answer to Question 9, the laws of Ontario and Quebec do
expressly recognize the rights of a secured party to use collateral that is
"investment property" (Ontario) or security entitlements (Quebec) if the secured
party has "control" of it. PPSA Section 17.1(2) provides that despite the duties
otherwise imposed, a secured party having control of investment property may
sell, transfer, use or otherwise deal with the collateral in the manner and to the
extent provided in the security agreement. Article 2714.6 of the Civil Code
provides that a secured party having a movable hypothec with delivery on
securities or security entitlements may alienate or grant a hypothec on the
collateral unless agreed otherwise with the debtor. 200 This provides another
reason why perfection by control is a superior form of perfection from a secured
party's perspective. Given this express permission, such use by the Clearing
Member will not affect the validity or perfection of its security interest in
securities Collateral.
This conclusion is affirmed in Ontario by the provisions described in the answer
to Question 8 regarding the continuity of perfection of a security interest in
investment property as long as the debtor does not reacquire full control.
200
In light of this specific provision, the prohibition in Art. 1801 CCQ will not apply.
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The Quebec STA and the Civil Code do not contain a provision similar to
Section 22.1(2) of the Ontario PPSA (stating that control continues until the
secured party no longer has control and the debtor has reacquired possession of
the certificated security, been registered by the issuer as the registered holder of
the uncertificated security or become the entitlement holder of a security
entitlement, as the case may be). Hence, a secured party must continue to have
control in order to continue to have a valid and published security. From a
practical standpoint, if a creditor has obtained control of a security entitlement
by becoming the entitlement holder, then it may deal with the security
entitlement as it pleases without any intervention from the debtor. The same is
also true in respect of control by way of a control agreement for all security
entitlements in a securities account over which the Clearing Member has control.
The creditor would have control of all present and future financial assets in such
securities account irrespective of the moment that a financial asset is credited to
the securities account. Perhaps the only practical concern will be in respect of a
certificated security. We note however that in all cases, if the secured party again
regains control, it will have a valid and published security. Additionally, see
below the discussion concerning priority and in respect of adverse claims.
This express right, however, does not apply to cash collateral that is not
investment property (i.e. cash not in a securities account). In Ontario it is clear
that damages are the only remedy for breach of the non-waivable duty to use
care in the custody and preservation of collateral and to keep collateral
identifiable and it is unlikely that the Covered Customer would suffer any
damage where cash is concerned. It is also specifically stated in the Ontario PPSA
that breach does not affect the validity of the security interest. 201 Since perfection
is by means of filing a financing statement, use would also not affect the
perfection of the security interest.
Similarly in Quebec, since validity and publication of a security in cash is by
means of a registered conventional movable hypothec without delivery, use
would also not affect the publication of the security.
There are no other obligations, duties or limitations imposed on the Clearing
Member with respect to its use of the Collateral. In this regard we have not
considered the rules of any self-regulatory organization applicable to the
Clearing Member or securities, commodities or other regulatory laws.
The same analysis would apply to the DCO so long as the DCO had control of
the Collateral as long as there is an agreement between the DCO and the
Customer that authorizes such use of the Collateral.
201
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Enforcement of Futures Credit Support Rights and Cleared Derivatives Credit Support
Rights under the Covered Base Agreement and CDA by the Clearing Member in the
Absence of an Insolvency Proceeding.
Note the additional assumption (d) which applies to questions 11 to 14.
11. Assuming that the Clearing Member has obtained a valid and
perfected security interest in the Eligible Collateral as
recognized under the laws of Ontario and Quebec by complying
with the requirements set forth in our responses to questions 1 to
6 above, as applicable, what are the formalities (including the
necessity to obtain a court order or conduct an auction),
notification requirements (to the Covered Customer or any other
person) or other procedures, if any, that the Clearing Member
must observe or undertake in enforcing its security interest in the
Eligible Collateral and exercising its Futures Credit Support
Rights and Cleared Derivatives Credit Support Rights (Credit
Support Rights) as a Clearing Member under each Covered Base
Agreement and CDA, such as the right to liquidate Eligible
Collateral? For example, is it free to sell the Eligible Collateral
(including to itself) and apply the proceeds to satisfy the
Covered Customer's outstanding obligations under the Covered
Base Agreement and CDA? Do such formalities or procedures
differ depending on the type of Eligible Collateral involved?
The Clearing Member must follow the procedures contemplated in the Covered
Base Agreement and CDA and, where Ontario law applies to the enforcement
issues, in the PPSA and where Quebec law applies to the enforcement issues, in
the Civil Code and, to the extent applicable, the Code of Civil Procedure (Quebec).
(a) What Law Governs Enforcement Issues?
(i) Ontario
The formalities and notification requirements that apply to the enforcement of
rights against collateral are not necessarily governed by the same law that
governs validity and perfection/publication.
The Ontario PPSA contains its own set of conflict of laws rules dealing with
enforcement issues. The governing law for enforcement issues depends on
whether the particular enforcement issue is procedural or substantive and on the
nature of the collateral. Therefore, these conflict of laws rules must be considered
whether or not Ontario governs validity and perfection of the security interest (as
described in Part I, Questions 1 and 2 above).
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In proceedings in Ontario, procedural issues in the enforcement of the right of a
secured party against collateral are governed by the law of the "jurisdiction in
which the enforcement rights are exercised." 202
Substantive issues involved in the enforcement of the rights of a secured creditor
against collateral are governed by the proper law of the agreement between the
parties (e.g. the governing law of the agreements). 203
If any of these rules lead to the application of Ontario law, then the procedures
described in Question 12 apply. If Eligible Collateral is being held in Ontario, it is
possible that Ontario procedural rules would apply to the extent any court
involvement is required.
(ii) Quebec
The Civil Code does not contain conflict of laws rules dealing with substantive
enforcement issues.
The Civil Code states that procedure is governed by the law of the forum. 204
Unlike the Ontario PPSA, the Civil Code does not contain a specific conflict of
laws rule dealing with substantive issues involved in enforcement of a right of a
secured creditor. The law applicable to the enforcement of a security, including
recourses and remedies, is the subject of some debate. One view is that the law
applicable at the time of the creation of the security should also govern the effect
of the security, including content, recourses of the creditor and enforcement
issues. Others have argued that, as with the effects of publication, it would be the
law of the actual situs that applies. Furthermore, certain commentators have
argued that the exercise of rights should be governed by the law of the forum.
Article 3132 of the Civil Code provides that it is the law of the forum which
governs procedure. Additionally, a Quebec court may be influenced by the
mandatory regime for realization in the Civil Code and impose such regime on
the enforcement of a valid foreign security when enforcement is sought in the
Province of Quebec.
If any of these rules lead to the application of Quebec law, then the procedures
described below apply.
(b) Enforcement Rights and Restrictions
(i) Collection rights
Ontario PPSA, s.8(1)(a).
Ontario PPSA, s.8(1)(b).
204 Art. 3132 CCQ.
202
203
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We would characterize collection rights as substantive rights with respect to
enforcement, which would be governed by the proper law of the security
agreement as far as Ontario law is concerned. Since New York law is the
governing law, Ontario law is not relevant to this particular remedy.
Collection rights are also provided for under Quebec law (Art. 2743 and 2745
CCQ). Unless the security provides that the debtor is authorized to collect any
claims (which we assume would not be the case with respect to any of the
Eligible Collateral in the form of receivables from the DCO for example or
proceeds and distributions forming part of the Collateral), from the moment of
execution of a hypothec on a claim, the creditor has the right to collect the same
(Art. 2743 CCQ). This right is in addition to any hypothecary rights respecting
enforcement. If the Clearing Member is authorized in the security agreement to
collect the claims, this authorization may be withdrawn at any time by the
creditor, subject to the terms of the security agreement (Art. 2745 CCQ).
However a notice of withdrawal must be registered and the debtor and the
account debtors appropriately notified. We would not characterize these as
matters of a procedural nature with respect to enforcement.
(ii) Disposal of Eligible Collateral - Ontario
Under Ontario law, upon the debtor's default, a secured party has a statutory
right to dispose of any collateral and to satisfy the obligation as well as recover
realization expenses from the proceeds. The disposition must be conducted in a
commercially reasonable manner and can be by way of public or private sale,
lease or otherwise. 205 Under the PPSA, disposition can be delayed by a secured
party for such period of time as is commercially reasonable. 206 A right of disposal
is in our view a substantive right with respect to enforcement which would be
governed by the governing law of the security agreement.
Notice of Sale. Subject to certain exceptions, a secured party must give 15 days
notice (under the Ontario PPSA) of the disposition, in writing: 207
•
to the debtor,
•
every person the secured party knows to be an owner of the
collateral or to owe payment of the secured obligation,
•
every person with a perfected security interest in the collateral, and
If Cash Collateral is characterized as an intangible (see above Question 1), then in principle the account in
which the cash is held should also be "disposed of" in such a way. This is impractical and, we believe, is
ignored as a matter of practice. Please see, however, our comments below concerning foreclosure.
206 Ontario PPSA, s.63(3).
207 Ontario PPSA, s. 63(4).
205
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•
every person with an interest in the collateral who has delivered a
written notice to the secured party of its interest in the collateral
before the secured party's notice is sent.
The written notice must contain a brief description of:
•
the collateral,
•
the amount required to satisfy the obligation secured by the
security interest,
•
the amount of actual realization expenses or, where they have not
yet been incurred, a reasonable estimate of them,
•
a statement that upon receipt of payment the payor will be credited
with any rebates or allowances to which the debtor is entitled by
law or under the security agreement,
•
a statement that upon payment of the amounts due (obligation plus
realization expenses), the person can redeem the collateral,
•
a statement that the collateral will be disposed of and the debtor
may be liable for a deficiency unless the amounts due are paid, and
•
the date, time and place of any public sale or the date after which
any private disposition of the collateral is to be made.
Exemption from Notice Requirements. This notice is not required where:
•
the collateral is perishable,
•
the secured party believes on reasonable grounds that the collateral
will decline speedily/ substantially in value,
•
the collateral is of a type customarily sold on a recognized market,
•
the cost of care and storage of the collateral is disproportionately
large relative to its value,
•
the court orders that notice is not required,
•
after default every person entitled to notice agrees to immediate
disposition of the collateral, or
•
a receiver and manager disposes of the collateral in the course of
the debtor's business.
It is not clear whether this notice requirement is a procedural or substantive
matter affecting the enforcement of the right of a secured party in respect of
collateral. We think it likely that it is a procedural matter. Consequently, this
notice provision will apply only if the enforcement action against the Collateral
takes place in Ontario.
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Where Ontario law applies and where the Collateral is investment property, the
exemption for Collateral sold on a recognized market could apply. For Cash
Collateral, there is no particular exemption, but because secured parties would
not as a practical matter sell the Cash Collateral, this is not an issue. (See our
comments with respect to Cash Collateral below in the discussion of foreclosure.)
If it was a foreign currency, then the exemption for collateral, which a secured
party believes on reasonable grounds, will decline speedily in value might apply
in the circumstances.
(iii)
Hypothecary Rights - Quebec - sale, foreclosure etc.
The exercise of hypothecary rights under any hypothec, whether a pledge or a
movable hypothec without delivery, is subject to the enforcement provisions of
the Civil Code and the Code of Civil Procedure, most of which are of public order.
This includes (i) sending a prior notice of the intention to exercise a specific
hypothecary right (which notice must be registered at the Register), and (ii) in
general, waiting the required period, normally 20 days, before exercising the
specific right. There are four hypothecary rights available if the security charges
assets used in an enterprise: taking of possession for the purposes of
administration, taking in payment, sale by the creditor and sale by judicial
authority. Only one of these rights may be exercised at a time. The rights of
taking in payment (roughly equivalent to foreclosure) and sale by judicial
authority are available even if the security does not charge assets used in an
enterprise.
It should be noted that by virtue of Article 2759 of the Civil Code, a creditor who
has a hypothec on securities or security entitlements that has obtained control,
may, where permitted by its agreement with the grantor, sell the securities or
security entitlements or otherwise dispose of them without giving prior notice,
obtaining surrender or observing any time limits prescribed under the Civil
Code. A creditor who disposes of securities or security entitlements acts on
behalf of the grantor and is not bound to declare the creditor's position as
creditor to the purchaser. The secured party must impute the proceeds to
payment of the costs incurred to dispose of the securities or the security
entitlements, to payment of the obligations secured by prior ranking security and
finally to payment of the secured obligations. The secured party must remit any
surplus to the grantor.
(iv)
Setting Off against Collateral Value
A secured party may buy the collateral itself only at a public sale unless the court
orders otherwise. Any term of a security agreement allowing a secured party to
appropriate the collateral and credit its value to the debtor (which would be akin
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to the secured party buying the collateral) will not be enforceable if Ontario law
applies and may not be enforceable if Quebec law applies.
The CDA and Covered Base Agreements allow the Clearing Member to set off or
apply the value of Collateral without selling it in a private sale. Under Ontario
law, set-off is a concept that applies only to monetary claims which parties have
against each other208; there is no concept of setting off a property claim against a
monetary claim. The right of the Clearing Member to keep the Collateral and setoff its value against the Covered Customer's obligations could be seen as a
private sale of the Collateral to the Clearing Member itself.
It is unclear whether this restriction on private sale would be characterized as a
procedural or a substantive matter affecting the enforcement of a secured party's
rights. In our view, it is probably a procedural matter because of the fact that it
sets out a process and because it refers to an application to the court, which
would generally only be appropriate if the court was otherwise the appropriate
one to deal with the issues. 209 Therefore, it would apply if the enforcement action
was being taken in Ontario and likely apply if enforcement was being taken in
the Province of Quebec.
(v) Foreclosure - Ontario
There is a notice requirement if a secured party proposes to accept its collateral in
satisfaction of the secured obligations. Exercising a right of set-off against
collateral might be characterized as accepting the collateral in satisfaction of an
obligation if set-off was the only remedy being asserted. The notice must be sent
to the same persons that the notice of disposition must be sent to (see above).
There are no exceptions. If any person entitled to be notified who would be
adversely affected by the proposal objects in writing to the proposal within 30
days (under the Ontario PPSA), then the collateral must be disposed of (subject
to the requirements described above). A secured party can apply to the court for
an order that the objection is ineffective and the court can grant the order if the
person's objection was not for the purpose of protecting its interest in the
collateral or its proceeds or the fair market value of the collateral is less than the
total amount owing to the secured party plus realization expenses. If no objection
is made, the secured party is deemed to have accepted the collateral in full
satisfaction of the obligation secured (i.e. it has no claim for any deficiency) and
the debtor has no claim for any excess value of the collateral above the amount of
the debt.
K. Palmer, The Law of Set-Off in Canada, (Aurora: Canada Law Book, 1993) at 24; Dresser v. Vos (1985), 60
A.R. 226 (Q.B.); Telford v. Holt, [1987] 2 S.C.R. 193.
209 McLaren, Secured Transactions in Personal Property in Canada, 2nd ed., 1989, (suppl.) §6.05, p. 6-49, describes
procedural matters as the steps necessary to enforce rights against Collateral.
208
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As with the notice of disposition and for the same reasons, this process for
foreclosure could be characterized as a procedural matter. Therefore, it would
apply to foreclosure actions taken in Ontario.
As stated above, cash collateral not held in a securities account is an intangible.
The PPSA does not specifically provide for the exercise of set-off rights. There is
some risk that the exercise of the set-off right would be characterized as a private
sale of the Cash Collateral to the Clearing Member or perhaps as a foreclosure. If
so, then the notice requirements set out above would apply and a court order
would be required. Obviously, these requirements are not practical. It appears
that in practice secured parties exercise rights of set-off against cash collateral
without complying with such procedures.
For Quebec, this issue is addressed above under the Hypothecary Rights section.
12. Assuming that (a) pursuant to the laws of Ontario and Quebec,
the laws of another jurisdiction govern the creation and/or
perfection of a security interest in the Eligible Collateral
transferred by way of security pursuant to each Covered Base
Agreement and CDA (for example, because such Eligible
Collateral is located or deemed located outside Ontario and
Quebec) and (b) the Clearing Member has obtained a valid and
perfected security interest in the Eligible Collateral under the
laws of such other jurisdiction, are there any formalities,
notification requirements or other procedures, if any, that the
Clearing Member must observe or undertake in Ontario and
Quebec in exercising its Credit Support Rights as a Clearing
Member under each Covered Base Agreement and CDA?
Even if the laws of another jurisdiction govern validity and priority, Ontario or
Quebec law may impose notification requirements and a requirement of court
approval of a private sale on the Clearing Member. These requirements and the
circumstances in which they could potentially apply are discussed above in
Question 11.
13. Are there any laws or regulations in Ontario and Quebec that
would limit or distinguish a creditor's enforcement rights with
respect to Eligible Collateral depending on (a) the type of
transaction underlying the creditor's exposure, (b) the type of
Eligible Collateral, or (c) the nature of the creditor or the debtor?
For example, are there any types of "statutory liens" that would
be deemed to take precedence over a creditor's security interest
in the Eligible Collateral?
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There are no limitations that depend on the type of underlying transaction, the
nature of the creditor or the debtor or the type of Collateral, but there are
statutory liens that could potentially take precedence over a creditor's security
interest in Collateral.
Debtor in Possession Financing Under the CCAA and BIA Proposals. The
CCAA210 confers on the court the statutory jurisdiction to authorize a security
interest or a charge in favour of the debtor-in-possession financier and to order
that this security interest or charge has priority over the security interest of any
other secured party. A similar jurisdiction to grant a priority charge is available
with respect to (i) credit granted by critical suppliers to the debtor, (ii)
indemnities in favour of directors and officers who continue to service the debtor
company after the filing, and (iii) fees and expenses of the monitor and experts
(such as lawyers and financial experts) engaged by the monitor, the debtor or
any other interested person 211 for the purpose of the proceedings under the Act.
Affected secured creditors are entitled to prior notice of any application
requesting such a charge on the assets of the debtor.
Similar provisions apply in BIA proposal proceedings. 212
However, there are applicable exemptions to these priorities. Both the BIA and
CCAA provide that no order can be made under the Act that has the effect of
subordinating "financial collateral" for an "eligible financial contract." 213 Not all
Eligible Collateral may be financial collateral. See Question 16.
There are certain other statutory liens that would or might take precedence over
the Clearing Member's security interest in the Collateral.
Crown and other Statutory Claims. Certain statutes create Crown priorities for
certain amounts that apply with respect to certain types of collateral. These
include such debts as employee income tax remittances, Canada Pension Plan
contributions, contributions to the Employment Insurance Plan, statutory
vacation pay claims, employer contributions to employee pension plans, and
sales tax remittances. They may take priority over certain types of collateral only.
Crown priorities may apply only in certain circumstances and priority also may
depend on whether or not there is a bankruptcy proceeding. 214 This is a very
complex area of law that cannot be adequately addressed in the context of a
S.C. 2005, c. 47 as amended by S.C. 2007, c. 36.
211 Where engaged by a person other than the debtor or the monitor the court must be satisfied that the
security or charge is necessary for their effective participation in the proceedings.
212 Although the BIA does not expressly provide for a charge for critical suppliers.
213 S.C. 2007, c. 29; see CCAA, s.34(11); BIA, s. 88.
214 Certain Crown claims have priority outside of bankruptcy, but not if the debtor becomes bankrupt under
the BIA or WURA.
210
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memorandum such as this. Generally, however, it can be said that these types of
Crown priorities should not attach to Eligible Collateral in the possession or
control of the Clearing Member. 215
However, a prior ranking security interest might, in certain circumstances, attach
to Eligible Collateral in the possession or control of the Clearing Member, where
the Covered Customer owes Canadian Revenue Agency (the Canadian federal
taxing authority) with respect to amounts it did or should have withheld at
source under the Income Tax Act (Income Tax Act (Canada), Section 227(4.1)).
Because these are federal liens, the provincial STA provisions regarding a
purchaser taking a financial asset free of adverse claims may not be effective with
respect to them. A recent decision of the Supreme Court of Canada held that the
Crown's claim for income tax and employment insurance remittance arrears
arising prior to the date of the exercise of the set-off right took priority over a
credit institution's right to set off loan obligations against its own term deposit
liability to the borrower. 216 This case is discussed in more detail below in the
answer to Question III.B.16.
The BIA also includes a secured priority charge for employee wage claims of up
to $2000 per employee that can take priority over any other secured creditors.
Provincially created special liens and charges are generally subordinated in a
federal bankruptcy proceedings under the BIA. In restructuring proceedings
generally the order of priorities that would prevail in bankruptcy is adhered to
(to avoid legal arbitrage among the different types of proceedings). However,
there are some provincial liens and charges that could prevail over certain
secured creditors. For example, the provincial lien and deemed trust over the
assets of an employer for the amount of the unfunded liabilities in certain types
of pension plans may prevail over cash collateral arrangements. A recent
decision of the Supreme Court of Canada held that this provincial lien extended
to all unfunded liabilities in provincially regulated defined benefit pension plans
(not just for funding payments actually due at the time but which would have
been payable over time). 217
14. How would your response to questions 11 to 13 change, if at all,
assuming that an insolvency proceeding described in assumption
(e) above has occurred with respect to the Clearing Member
(notwithstanding that the Covered Base Agreement and CDA
On the other hand, assignments of receivables as collateral are clearly subordinate to Crown claims for
employee income tax remittances, Canada Pension Plan and Unemployment Insurance contributions and in
certain cases Goods & Services Tax on the sale of the goods or services that gave rise to the receivable.
216 Caisse Desjardins de l'Est du Drummond v. Canada, 2009 SCC 29 (S.C.C.)
217 Sun Indalex, Finance LLC v United 2011 ONCA 265. Steelworkers, 2013 SCC 6 (February 1, 2013)
215
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may not provide for any events of default in respect of the
Clearing Member) rather than or in addition to the Covered
Customer (for example, would this affect this ability of the
Clearing Member to exercise its enforcement rights with respect
to the Eligible Collateral)?
This would not affect the responses.
Enforcement of Credit Support Rights Under the Covered Base Agreement and CDA by
the Clearing Member after the Commencement of an Insolvency Proceeding
Note the additional assumption in (3) above, which applies to questions 15 to 17 below.
15. How are competing priorities between creditors determined in
Ontario and Quebec? What conditions must be satisfied if the
Clearing Member's security interest is to have priority over all
other claims (secured or unsecured) of an interest in the Eligible
Collateral, other than claims of a DCO?
(a) Law Governing Priority
The PPSA choice of law rules described in Question 2 apply to priority as well as
perfection, where the priority dispute is between competing secured creditors.
Similar conflict of laws rules in the STA and QSTA govern the priority of a
Clearing Member's interest over other adverse claimants.
The additional STA and QSTA conflict of laws rules affecting priority are the
following:
Certificated Securities
The internal law of the issuer's jurisdiction 218 governs whether an adverse claim
can be asserted against a person to whom the transfer of a certificated security is
registered. 219 Ontario and Quebec incorporated issuers or the provincial Crown
may specify a different jurisdiction to govern this issue. 220
The internal law of the place where the security certificate is located at the time
of delivery governs whether an adverse claim may be asserted against a person
to whom the security certificate is delivered. 221
For a definition of "issuer's jurisdiction" see Question 1.
219 STA, s.44(2)(d); Art. 3108.2 CCQ.
220 STA, s.44(3); Art. 3108.4 CCQ.
221 STA, s.46; Art. 3108.6 CCQ.
218
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Uncertificated Securities
The law of the issuer's jurisdiction 222 governs whether an adverse claim can be
asserted against a person to whom the transfer of an uncertificated security is
registered or who obtains control of an uncertificated security. 223 Ontario and
Quebec incorporated issuers or the provincial Crown may specify a different
jurisdiction to govern this issue. 224
Security Entitlements (including Cash in a securities account)
The internal law of the securities intermediary's jurisdiction 225 governs whether
an adverse claim may be asserted against a person who (i) acquires a security
entitlement from the securities intermediary, or (ii) purchases (which includes
taking a security interest) a security entitlement, or interest in it, from an
entitlement holder. 226
Generally, a party with a prior perfected/ published security interest has priority
over unsecured parties and lien creditors, including a bankruptcy trustee. As for
priority between secured creditors and other adverse claimants, see the following
discussion.
(b) Cash Collateral Not in a Securities Account and other
Intangibles such as Contractual Rights
If the PPSA or Civil Code applies, priority between competing secured creditors
with an interest in Cash (not credited to a securities account) or other intangibles
would be determined by the order of registration of the financing statements in
Ontario or by order of registration of the conventional movable hypothec
without delivery in Quebec 227 (subject to our comments below with respect to
set-off arrangements). For example, if a secured creditor has a security interest in
all "accounts" of an entity that is a Covered Customer and had filed a financing
statement prior to the Clearing Member's own filin g228, the secured creditor
would have priority over the Clearing Member. Consequently, to be certain of
priority over other consensual secured creditors, it is necessary with respect to
Cash Collateral and other intangibles not in a securities account to conduct
For a definition of "issuer's jurisdiction" see Question 1.
STA, s.44(2)(d); Art. 3108.2 CCQ.
224 STA, s.44(3); Art. 3108.4 CCQ.
225 For a definition and discussion of "securities intermediary's jurisdiction" see Question 1.
226 STA, s.45(1); Art. 3108.7 CCQ.
227 Ontario PPSA, s.30(1)1; Art. 2945 CCQ. However, in Quebec a movable hypothec that charges claims may
have priority from the date that the creditor advances money if registered within 10 days Art. 2699 CCQ.
228 Recall that in Ontario the secured party can file at any time, including upon entering into the Security
Documents. In Quebec, the secured party can file only after the grantor enters into the hypothec.
222
223
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searches of the register and obtain subordinations or waivers (called cessions of
rank in Quebec).
If, however, the Clearing Member has a right of set-off against the cash collateral,
then any competing creditor should take subject to this right of set-off. 229 The setoff must be true set-off (or contractual compensation in Quebec), namely a right
to set off personal (i.e. mutual claims in the same capacity) claims between the
parties. If the cash or the trust for the Covered Customer is maintained in an
account with a third party institution in the name of the Covered Customer, then
any set-off of amounts in the account against obligations is not a personal claim
set-off; the obligation with respect to Cash is not an obligation of the Clearing
Member, but of the third party institution. The same would be true of setting off
any amounts owing by the DCO to the Covered Customer.
In Caisse Desjardins de l'Est du Drummond v. Canada230 the majority of the court
characterized an agreement that permitted a lender to set-off the value of its
borrower's term deposit with the lender as creating a "security interest" 231 in the
term deposit. The court applied what it described as a "functional" approach to
characterization. It adopted a security interest characterization largely because
the borrower was required to maintain the term deposit with the lender, because
the lender had a right to withhold payment of the deposit until the loan was paid
and because the right of set-off was intended to ensure that the loan was repaid.
Effectively the court viewed the right of set-off as a remedy to realize on its
security interest in the term deposit as opposed to an independent right that
defined the nature of the borrower's interest in the term deposit. The court
arguably found that because the arrangement was intended to provide assurance
that the loan would be repaid, it was a security interest. This is using the term
"security" in a generic and arguably vernacular sense. The agreements between
the parties also did grant express charges to the Caisse over its own term deposit
and did use language consistent with a security interest characterization.
However, that was not the main reason for the court's conclusion. The result in
the case was that the federal Crown took priority over the term deposit with
PPSA, s.40(1); The CCQ provides rules for legal and judicial compensation at Articles 1672 - 1682.
Contractual compensation has been recognized in a number of Quebec cases. (See 2866-9992 Quebec Inc. c.
Caisse populaire de Ste-Anne-des-Monts [2004] R.RA. 1259 (S.C.)). See also M. Deschamps, "La compensation
comme mecanisme de garantie et les sfiretes sur les depots bancaires ", Le Droit Bancaire en 2011 :
Nouveautes et Tendances, Montreal, Les Editions Themis, 2011 p.1 and Gennium Pharmaceutical Products Inc.
c. Genpharm Inc., [2008] Q.J. No. 4888 (C.S.). Article 2682 CCQ may also be of assistance as it provides as
follows : "a person whose right in a property is conditional...may only grant a hypothec subject to the same
condition..."
230 [2009] 2 S.C.R. 94 (S.C.C.).
231 As defined in the Income Tax Act (Canada).
229
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respect to income tax and employment insurance employee source deductions
that arose prior to the Caisse purporting to exercise its set-off right. 232
It is not clear that the case would apply outside of the Crown lien context to
determining whether a security interest within the meaning of the PPSA was
created by the agreements.
Even if it did, where Ontario law applies parties should be able to rely on section
40 of the Ontario PPSA to ensure that any other consensual secured creditor,
having taken an assignment by way of security of any rights of a party with
respect to Cash it has delivered as collateral (including those with prior
registrations), takes subject to the rights of set-off with respect to the cash.
Section 40(1.1) of the Ontario PPSA provides that an account debtor, unless it has
contractually waived defences, (e.g., the party having the obligation to return the
cash, the Clearing Member) may set up by way of defence against the assignee
(e.g. a competing secured party) all defences available to the account debtor
against the assignor (e.g. the Collateral Provider) arising out of the terms of the
contract or a related contract. The "account" in this case is the amount owing by
the Clearing Member with respect to the cash and the "defence" is the right to set
off the net termination amount. Perfection should not be relevant to priority as
against competing assignees, including secured creditors.
Because section 40 of the Ontario PPSA has not been considered in the context of
a priority dispute between competing secured creditors, there is some
uncertainty as to how they relate to the priority rules of the PPSA. It is also
somewhat unclear, how these provisions would relate to the rights of a trustee in
bankruptcy or others who have priority over unperfected security interests and
who are not competing assignees (e.g. statutory lien holders, garnishees, other
creditor representatives). Consequently, it would be advisable to file a financing
statement in the jurisdiction where the Counterparty is located to preclude any
argument that there is an unperfected security interest in the cash that has no
priority over the interests of unsecured creditors, other secured creditors with
subsequent registrations and lien holders. Even if the security interest is
perfected by registration, there is a possibility, given the lack of certainty as to
the effect of section 40(1.1) of the Ontario PPSA, that a secured creditor with a
security interest in the type of property that would include the Counterparty's
rights against a Clearing Member with respect to cash and that registered a
financing statement to perfect that security interest before the Clearing Member's
registration would have priority. Consequently, the Clearing Member may also
The Income Tax Act and Employment Insurance Act give the federal government a prior claim over property
of the debtor even if it is subject to a "security interest" (as defined in the Income Tax Act).
232
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choose to conduct searches of the PPSA register and obtain subordinations or
waivers from potentially competing secured creditors.
The Quebec legislator recently amended the Derivatives Act (Quebec)
(the "QDA") to add two sections in respect of cash collateral. The sections
provide
MARGIN OR SETTLEMENT DEPOSIT
11.1. An instrument under which a person is
required to pay an amount of money to a party to a
derivative, including as a margin or settlement
deposit, and which allows that party, in all
circumstances described in the instrument, to
extinguish or reduce, by means of a set-off, its
obligation to repay that amount to the person is
enforceable against third persons without further
formality.
Such an instrument is governed by the law expressly
designated in it or the designation of which may be
inferred with certainty from the terms of the
instrument.
11.2. For the purpose of section 11.1, the following
are considered to be derivatives:
an exchange, securities lending or securities
(1)
redemption contract, including any contract
governing such a contract; and
a contract between a clearing house and one of
(2)
its members, and the rules governing their
relationship.
A derivative is defined in the QDA as an option, a swap, a futures contract, a
contract for difference or any other contract or instrument whose market price,
value, or delivery or payment obligations are derived from, referenced to or
based on an underlying interest, or any other contract or instrument designated
by regulation or considered equivalent to a derivative on the basis of criteria
determined by regulation.
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Given the more formalistic requirements under Quebec law for the creation and
publication of a movable hypothec without delivery and in light of the recent
modifications to the QDA, 233 we believe that a Quebec court, in a properly
presented and argued case, would not require the creation and publication of a
movable hypothec without delivery in addition to the constitution of rights of
set-off or compensation in order to have valid, enforceable rights of
compensation opposable as against third parties. Consequently, we believe that,
if the Covered Base Agreement and CDA are modified in order to clarify the
establishment of a debtor-creditor relationship with respect to cash collateral, in
respect of margin in connection with derivatives, as defined in the QDA, which is
not in a securities account, it would not be necessary to modify such documents
to create a movable hypothec without delivery or register the same to the extent
that internal Quebec law applies to the issues of validity or opposability with
respect to cash collateral. However, since it is necessary in any event to create a
movable hypothec without delivery for some other Eligible Collateral, such as
the Futures Payment Rights and Cleared Derivatives Payment Rights, the
analysis here with respect to cash and the possibility of set-off will not avoid the
requirement to have the Customer grant such security.
(c) Investment Property - Directly Held Securities, Securities
Entitlements and Cash in a Securities Account
The security interest of a secured party with control of "investment property"
(which includes directly held certificated securities, directly held uncertificated
securities, indirectly held securities (i.e. securities entitlements, including cash
credited to a securities account, and securities accounts), and, in Ontario, certain
futures and futures accounts) has priority over the secured interest of a secured
party who does not have control (i.e. a secured party that perfects
automatically 234 or by filing a financing statement in Ontario or a conventional
movable hypothec without delivery in Quebec). 233 This is true even if the security
interest perfected by control was perfected after the security interest perfected
automatically or by filing. If a secured party maintains sole control of the directly
held securities or the securities account, it will have priority over any other
secured creditor of the debtor. If more than one secured party has control of the
investment property, then priority is determined by the order of satisfaction of
the requirements for control.
See Arts 2663, 2664 and 2938 CCQ and the Commentaires du ministre de la Justice (Quebec : Les Publications
du Quebec, 1993) p. 1654 and 1846.
234 Art. 2714.2 CCQ.
235 Ontario PPSA, s.30.1(2); Art. 2701.1 CCQ.
233
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A "protected purchaser" of directly held certificated or uncertificated securities
acquires the transferee's interest in them free from other adverse claims. 236 A
protected purchaser is a purchaser who gives value, does not have notice of any
adverse claim to the property and obtains control of the security. 237 A purchaser
includes someone taking a security interest in the property. If the Clearing
Member follows the steps set out in Question 5 above with respect to obtaining
control, and it does not have notice of an adverse claim, then it should qualify as
a protected purchaser with respect to directly held debt securities.
With respect to security entitlements to financial assets (including cash credited
to a securities account), section 96 of the STA and section 110 of the QSTA
provides that a legal proceeding or action based on an adverse claim to a
financial asset, however framed, may not be brought against a person who
acquires a security entitlement for value and without notice of the adverse
claim. 238 If the Clearing Member follows the steps outlined in Question 5 above,
the Clearing Member should become the entitlement holder with respect to
Collateral consisting of security entitlements and assuming that the Clearing
Member does not have notice of any adverse claim, the Clearing Member should
take any Eligible Collateral consisting of such financial assets free from adverse
claims. 239
If the Clearing Member is a securities intermediary its interest as purchaser has
priority over a conflicting purchaser who also has control unless the
intermediary has subordinated its interest. 240
If the Covered Customer is itself a securities intermediary (such as an Investment
Firm), then, in addition to the above rules, section 105 of the STA and 130 of the
QSTA address the priority between the Covered Customer's entitlement holders
STA, s. 70; QSTA, s.53.
STA, s.1; Quebec, ibid.
238 Section 104 of the STA provides priority rules for a case not covered by the priority rules in the PPSA. We
believe that these rules are intended to apply where the purchaser (or secured party's) rights are derivative
of the entitlement holders and not when the secured party becomes the entitlement holder. Section 104(1)
provides that a legal proceeding based on an adverse claim to a financial asset, however framed, may not be
brought against a person who purchases a security entitlement, or interest in it, from an entitlement holder
if that purchaser gives value, does not have notice of the adverse claim and obtains control. Section 111 of
the QSTA provides priority rules for a case not covered by the priority rules in the Civil Code regarding
hypothecs and the general priority rules of the QSTA. Such section provides that an action based on an
adverse claim to a security entitlement or the financial asset to which an entitlement holder has a security
entitlement, however framed, may not be brought against a purchaser of the security entitlement who
purchased the security entitlement from the entitlement holder if that purchaser purchases the security
entitlement for value, does not, at the time of the purchase, have notice of any adverse claim and obtains
control of the security entitlement or if such an action could not have been brought against the entitlement
holder under section 110 of the QSTA.
239 Subject to the discussion of super-priority statutory liens and charges in Question 13 above.
240 STA, s.104(4); QSTA, s.129 and Art. 2714.3 CCQ.
236
237
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and the Clearing Member as secured party. That section provides that a secured
party who has obtained control over a security entitlement pledged to it by a
securities intermediary has priority over entitlement holders of the securities
intermediary. If the actions to take control specified above in Question 5 are
taken the Clearing Member's security interest should have priority over claims of
the Covered Customer's entitlement holders and other secured creditors.
(d) Futures Contracts and Futures Accounts
(i) Ontario
The security interest of a secured party with control of a futures contract or
futures account has priority over the secured interest of a secured party who
does not have control (eg. a secured party that perfects by filing a financing
statement). 241 If a secured party maintains sole control of the directly held
securities or the securities account, it will have priority over any other secured
creditor of the debtor. If more than one secured party has control of the
investment property, then priority is determined by the order of satisfaction of
the requirements for control.
A security interest held by a futures intermediary in a futures contract or futures
account maintained with the futures intermediary has priority over a conflicting
security interest held by another secured party. 242
Conflicting security interests granted by a futures intermediary that are perfected
without control rank equally with each other. 243
There are no statutory provision that otherwise provide protection against
adverse claims (as with securities entitlements).
(ii) Quebec
See the discussion above in respect of Section 17 of the QSTA and futures
contracts in a securities account as well as the discussion in respect of futures
contracts in a futures account.
16. Would the Clearing Member's right to enforce its security
interest in the Eligible Collateral and exercise its Credit Support
Rights under each Covered Base Agreement and CDA, such as
the right to liquidate the Eligible Collateral, be subject to any
241 PPSA, s.30.1(2).
242 PPSA, s.30.1(6).
243 PPSA, s.30.1(7).
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stay or freeze or otherwise be affected by commencement of the
insolvency (that is, how does the institution of an insolvency
proceeding change your responses to questions 11 and 12 above,
if at all)?
In insolvency proceedings there are generally stays that can prevent or delay a
secured creditor from liquidating the Collateral or otherwise dealing with it.
However, in CCAA, WURA, BIA bankruptcy and proposal proceedings, and,
subject to the bridge institution provisions, CDIC Act proceedings there is
express statutory protection for "dealings with financial collateral". The PCSA
also provides the same express protection with an expanded definition of
"financial collateral". The specific context for each proceeding is set out in the
discussion with respect to each proceeding below. In this section we highlight
the relevant definitions and common elements of the protections.
Dealing with Collateral. The express protection applies to any "dealing" or right
to "deal with" "financial collateral" in the manner provided for in the agreement
between the parties. "Dealing with" includes the following actions:
(a) selling or foreclosing or, in the Province of Quebec, surrendering
financial collateral; and
(b) setting off or compensating financial collateral or applying the
proceeds or value of financial coil atera1. 244
Financial Collateral. In the BIA, CCAA and WURA, "financial collateral" is
defined as:
"financial collateral" means any of the following that
is subject to an interest, or in the Province of Quebec a
right, that secures payment or performance of an
obligation in respect of an eligible financial contract
or that is subject to a title transfer credit support
agreement:
cash or cash equivalents, including negotiable
(a)
instruments and demand deposits,
securities, a securities account, a securities
(b)
entitlement or a right to acquire securities, or
BIA bankruptcy, s.69.3(2.1); BIA proposal, s.65.1(9); CCAA, s.34(8) and (9)); CDIC Act, s.35.15(7); PCSA,
s.13(1.1); WURA, s.22.1(1). The BIA bankruptcy provision (s.69.3(2.1)) protects dealings with financial
collateral but does not go on to include this wider description of what constitutes dealing with.
244
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(c) a futures agreement or a futures account; 245
A title transfer credit support agreement is:
"title transfer credit support agreement" means an
agreement under which a debtor company has
provided title to property for the purpose of securing
the payment or performance of an obligation of the
debtor company in respect of an eligible financial
con tract;246
The Collateral which is cash, securities, securities entitlements, securities
accounts, futures contracts and options and futures accounts would constitute
"financial collateral". "Securities", "securities account", "securities entitlement",
are not defined, but in our view would at least include any publicly traded debt
or equity securities. "Futures" and "futures account" are also not defined, and
consequently are not restricted to accounts held with Canadian registered
intermediaries.
The PCSA was recently amended 247 to expand the definition of "financial
collateral" to also include:
an assignment of a right to payment or
(d)
delivery against a clearing house 248' or
(e)
any other collateral that is prescribed. 249
This expanded definition is incorporated by reference into the CDIC Act as well,
but not the BIA or CCAA. The drafting of (d) is odd in terms of a reference to "an
BIA, s.2; CCAA, s.2; CDIC Act, s.35.15(9); PCSA, s.13(2); WURA, s.22.1(2).
BIA, s.2; CCAA, s.2; CDIC Act, s.35.15(9); PCSA, s.13.2; WURA, s.22.1(2).
247 By the Jobs and Growth Act, 2012, S.C. 2012, c.31.
248 An "entity that provides clearing or settlement services for a clearing and settlement system". A "clearing
and settlement system" means a system or arrangement for the clearing or settlement of payment
obligations or payment messages in which
(a) there are at least three participants, at least one of which is a Canadian participant and at least
one of which has its head office in a jurisdiction other than the jurisdiction where the head office of
the clearing house is located;
(b) clearing or settlement is all or partly in Canadian dollars; and
(c) except in the case of a system or arrangement for the clearing or settlement of derivatives
contracts, the payment obligations that arise from clearing within the system or arrangement are
ultimately settled through adjustments to the account or accounts of one or more of the
participants at the Bank.
For greater certainty, it includes a system or arrangement for the clearing or settlement of securities
transactions, derivatives contracts, foreign exchange transactions or other transactions if the system or
arrangement also clears or settles payment obligations arising from those transactions.
249 None have been prescribed as yet.
245
246
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assignment" since that defines a method of transfer not a type of collateral. The
intention, however, would appear to be to include collateral that a clearing
member is holding in the form of rights that the customer has against the
clearing house. A clearing house for purposes of this section of the PCSA is not
restricted to those designated under the PCSA. Consequently, the rights to
payment and/ or delivery in respect of Futures Transactions and Cleared
Derivatives Transactions with a DCO should constitute financial collateral.
Consequently, to the extent the PCSA applies and the Collateral is financial
collateral, the commencement of an insolvency proceeding will not alter the
conclusions in Question 16.
Bankruptcy and Winding-Up
As a general matter, secured creditors fall outside the bankruptcy provisions of
the BIA and the WURA and are not prevented from realizing on collateral. The
BIA prevents creditors from taking any remedy against the bankrupt's property
once a proceeding has commenced, but specifically states that this stay provision
does not prevent a secured creditor from realizing or otherwise dealing with its
security in the same manner as it would have been entitled to do in the absence
of the stay. 250 The court may, however, make a specific order staying a secured
creditor, but the maximum stay period is six months where the debt is owing to
the creditor at the date of commencement of the bankruptcy. 251 Such stay orders
are rarely asked for or granted. They may be appropriate in situations where the
trustee in bankruptcy requires a period of time to value the collateral and
determine if it should exercise a right to redeem. There are no similar provisions
in the WURA, but the case law has established a similar position for liquidations
under the WURA. If the WURA proceeding is a restructuring, as opposed to a
winding-up, the court might grant a wider general stay.
If the secured creditor has already exercised its realization rights prior to the
trustee in bankruptcy obtaining the stay order, then it will be unaffected by the
stay, so there is some benefit to prompt realization. Stay orders generally do not
bind a person until it becomes aware of the order.
A trustee in bankruptcy or liquidator might also delay 252 a secured creditor in
realizing on its collateral by giving the secured creditor notice of its intention to
BIA, s.69.3(2).
BIA, s.69.3(2).
252 No specific period is provided for, but it would generally be a short time.
250
251
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inspect the property of the bankrupt that is subject to the security, generally for
the purpose of valuing the collatera1. 253
A trustee in bankruptcy or liquidator is also entitled to require a secured creditor
to value its collateral and the trustee or liquidator may redeem the collateral on
payment to the secured creditor of the debt or the value of the collateral as
assessed. 254 Exercise of this right is unlikely to significantly prejudice the
Clearing Member. It is also unlikely to be exercised by a trustee in bankruptcy or
liquidator as it provides little or no benefit to the estate given the nature of the
Collateral (e.g. securities) and their usually easily determined value.
Neither the BIA bankruptcy provisions nor the WURA (including both the
reorganization and liquidation provisions) impose any stay on the exercise of
rights of set-off against cash collateral.
Both the BIA and WURA exempt dealings with financial collateral. The WURA
expressly provides that nothing in the WURA and no order of a court prevents or
prohibits any dealing with financial collatera1. 255 Also, the BIA exempts any
dealing with "financial collateral" from the court's power to grant the stay of up
to six months. 256 The definition of "financial collateral" is set out in part (ii) above
but does not include the expanded definition in the PCSA and so would not
protect rights to deal with contractual payment rights against the DCO. If the
protections of the PCSA apply, then any of the limited stays described above
would not apply to the Collateral.
Receivership Orders
If a Receivership order was made that covered the Collateral, given the
protections that exist under the federal insolvency statutes with respect to
"financial collateral" for "eligible financial contracts", we believe that a court
could be persuaded to not maintain a stay even though there is no express
statutory exemption. Nor should any stay prevent the set-off.
Also, if the PCSA applies, the protections described above should override any
inherent power of the court to grant a stay in a receivership proceeding.
253 BIA, s.128.
254 BIA, s.128(3); WURA, s.78, 79.
255 WURA, s. 22(1). This section only applies to a Canadian branch of a foreign bank, however, with respect
to eligible financial contracts with respect to its business in Canada.
256 Section 69.3(2.1). The trustee still has the power to redeem the collateral under s.128.
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Proposals under the BIA
Once the amount of a claim is determined, subject to certain exceptions, the BIA
proposal provisions prevent any proceeding against the property of a debtor to
collect payment of the claim, including the realization of collateral, during the
reorganization period. 257 This stay is automatic and is not dependent on notice
being sent or received.
The BIA also permits a party affected by any of the stays to the court for an order
permitting it to exercise its rights and the court will grant the order if satisfied
that the operation of the stay would likely cause it financial hardship. 258
Any stay against enforcing payment lasts until a bankruptcy order is made or
until completion of the restructuring.
The proposal provisions of the BIA do not specifically provide for a stay on the
exercise of rights of set-off. Therefore, set-off rights against cash collateral, will be
enforceable in a BIA proposal proceeding, although they may be temporarily
delayed until the claims are processed. The plan proposed by the debtor and
voted upon by its creditors could propose a compromise of the rights of secured
creditors and this compromise could involve a continuance of the stay in whole
or in part pending a new default.
The stay on realization does not apply to a secured creditor who took possession
of the secured assets "for the purpose of realization" before the notice of
intention under section 50.4 was filed. A secured creditor must be in the process
of exercising its realization rights prior to the section 50.4 notice being filed in
order to be exempt from the stays on this basis.
In addition, any dealings with financial collateral for obligations under eligible
financial contracts entered into before the filing are exempt from the stay. The
definition of "financial collateral" is as set out above, but does not include the
expanded definition in the PCSA and so would not protect rights to deal with
contractual payment rights against the DCO. If the protections of the PCSA
apply, then any of the limited stays described above would not apply to the
Collateral.
Restructuring or Receivership Under the CDIC Act
Once the amount of the claim is determined, subject to certain exceptions, the
CDIC Act prevents any proceeding against the property of a debtor to collect
257 BIA, s.69(1)(1).
258 BIA, s.65.1(6).
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payment of the claim, including the realization of collateral, during the
reorganization period. 259 This stay is automatic and is not dependent on notice
being sent or received.
The CDIC Act also voids any stipulation in an agreement that provides that the
insolvent institution ceases to have the rights to use or deal with assets that it
would otherwise have, upon the institution's insolvency, default under the
agreement or the Superintendent having made a vesting order under the Act. 260
In our view, this provision does not have any effect on the Clearing Member if it
is already in possession and control of the Collateral prior to insolvency, an
Event of Default or the CDIC Act order.
The CDIC Act also permits a party affected by any of the stays to apply to the
court for an order permitting it to exercise its rights and the court will grant the
order if satisfied that (a) the person is likely to be materially prejudiced if the
permission is not granted or (b) it is equitable on other grounds to grant the
permission.261
Subject to the bridge institutions provisions discussed below, the CDIC Act also
includes the exemption from these stays for dealings with "financial collateral"
for an eligible financial contract and for this purpose the expanded definition of
financial collateral in the PCSA applies (i.e. contractual rights against a DCO are
financial collateral). 262 Consequently, subject to the bridge institution provisions,
it should override any of the other provisions imposing stays.
The restructuring provisions of the CDIC Act do stay the exercise of set-off
rights,263 but expressly state that the insolvent financial institution cannot require
payment of any amount owing by the other party that could otherwise be set off.
The provisions for lifting the stay against the realization of collateral apply also
to this stay against exercise of set-off rights. If the set-off relates to the value of
collateral, the exemption for dealings with financial collateral would also apply.
The CDIC Act permits CDIC to assign all of the eligible financial contracts
between a member institution that is subject to a receivership order under the
CDIC Act and its counterparty to a bridge institution. If the transactions are
assigned to the bridge institution, the collateral rights related to the transaction
CDIC Act, s.39.15(1)(c). With respect to financial institutions subject to the CDIC Act, the Superintendent
of Financial Institutions in giving permission to create security interests, has the power to exempt the
security agreement from the application of these stay provisions (s. 39.15(3)(b)), but has not exercised this
power as far as we are aware.
260 CDIC Act, s.39.15(2).
261 CDIC Act, s.39.16(1).
262 CDIC Act, s. 35.15(7).
263 But this does not apply to close-out netting rights under certain eligible financial contracts.
259
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must also be assigned. Where an order directing the incorporation of a bridge
institution is made, (1) the automatic temporary stay discussed above in I.B.1,
question 1 prevents reliance on the eligible financial contract safe-harbour that
would otherwise permit dealings with financial collateral and (2) the potential
permanent stay 264 applies if the Covered Customer's obligations under the
Covered Base Agreement and CDA are either assumed by a bridge institution or
CDIC guarantees the payment obligations under them. These stays take
precedence over the stay protections in the PCSA. 265
In summary, the right of the Clearing Member to deal with financial collateral for
an eligible financial contract is not adversely affected by the making of an order
to facilitate a restructuring of a federal deposit taking financial institution under
the CDIC Act. If the federal institution is placed into receivership under the
CDIC Act and if the government makes an order to incorporate a bridge
institution, then a temporary one business day stay on relying on the eligible
financial contracts exemption applies. If CDIC then makes either the guarantee
undertaking or the undertaking to have the bridge institution assume the
obligations, then there is a further stay preventing reliance on the eligible
financial contracts exemption. The stay is a permanent stay once the contracts
have been assigned to the bridge institution or the guarantee given (subject to a
fresh default).
CCAA
A court order in a CCAA proceeding typically stays the ability of a secured party
to realize on collatera1 266 pending development of a plan of compromise and
arrangement. The plan itself may provide for a permanent stay of these rights,
subject to any new event of default. A secured party would have a right to vote
on this plan, but would not necessarily have sufficient power within the voting
class (e.g. all secured creditors) to veto the plan. Dissenting creditors are bound
by a plan approved by the requisite majorities and the court.
Set-off rights are respected in a CCAA proceeding. 267 This express protection
should apply to the right to set off against Cash Collateral.
In addition, any dealings with financial collateral for obligations under eligible
financial contracts entered into before the filing are exempt from the stay. 268 The
definition of "financial collateral" is set out in Qualification 3 of I. 1 above but
264 This does not apply to rights to terminate based on new defaults.
265 PCSA, s. 13(1.2).
266 But this stay does not apply to close-out netting rights under certain eligible financial contracts.
267 CCAA, s. 21.
268 CCAA, s. 34(8) and (9)).
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does not include the expanded definition in the PCSA and so would not protect
rights to deal with contractual payment rights against the DCO. If the protections
of the PCSA apply, then any of the limited stays described above would not
apply to the Collateral.
To the extent that the exemption does not apply and Collateral has a volatile
value, the Clearing Member should have grounds to ask the court to lift the stay,
but there is no specific statutory procedure for applying for a lift of the stay
order.
Corporate Plans of Arrangement
The analysis in I.I would apply equally to the issue of enforcement of rights
against Collateral. In summary, while there is some precedent granting a stay, 269
we do not believe that a stay should be granted in a properly argued case.
Voluntary Wind-up
If the trustee of a trust is conducting a voluntary wind-up outside of a court
process, then there is no stay possible with respect to the collateral realization
rights.
Involuntary Wind-up under Supervision of Pension Regulator
For the reasons outlined in more detail in Appendix F - pension entity windingup there is no material stay risk with respect to collateral realization where a
pension plan is being wound up under the supervision of the applicable pension
regulator.
Special Circumstances of CPPIB and PSPIB
Given the statutory immunity from insolvency proceedings, there are no
insolvency laws currently in place that could interfere with the exercise of
collateral enforcement rights. The Canada Pension Plan Investment Board
(CPPIB) and the Public Sector Pension Investment Board (PSPIB) cannot be
subject to an insolvency type proceeding unless Parliament takes the very
significant step of passing legislation.
Summary of Collateral Realization
In summary, collateral enforcement rights may be delayed as follows:
269
Example, the proceedings involving Abitibi-Consolidated which are discussed in this memorandum.
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Likelihood of
Stay on
Realization of
Collateral
Length of Stay on Realization of
Collateral (without statutory
exemption)
Likelihood
of Stay on
Set-off
Statutory Exemption for
Financial Collateral for
Eligible Financial
Contracts
Up to 6 months
Bankruptcy
Unlikely for
securities, futures
or cash collateral
No stay
likely
Yes (financial collateral does
not include contractual rights
against DCO unless PCSA
applies)
BIA Proposal
Automatic stay
Up to 6 months plus possibility
that plan may stay permanently
(subject to new default ) or
otherwise compromise rights
No stay
likely
applies)
WURA
Unlikely for
securities or cash
collateral
Up to 6 months (may be longer in
restructuring proceedings)
No stay
Yes, subject to bridge
institution provisions if
preceded by CDIC Act
receivership proceeding
BIA
(financial collateral does not
include contractual rights
applies)
CCAA
Automatic stay
No limit; plus possibility that plan
or court order may stay
permanently (subject to new
default) or otherwise compromise
rights
No stay
applies)
CDIC
Automatic stay
No limit; if proceeding is a
liquidation, Superintendent may
realize on secured party's behalf
Automatic
stay
Yes, but subject to bridge
institution provisions
Receivership
Unlikely
No limit
Unlikely
No, unless PCSA applies
Corporate
Plan
Unlikely
No limit
Unlikely
No
Voluntary
Wind up
No stay
N/A
No stay
No
Windup by
pension
regulator
No stay
N/A
No stay
No unless PCSA applies
CPPIB, PSPIB
No stay
N/A
No stay
No
-
Note that bankruptcy, reorganization or other insolvency proceedings under
Canadian law could extend to all assets of the Covered Customer, wherever
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located. The court has the power to sanction an agreement with a foreign
insolvency representative for a co-ordinated insolvency. This could involve an
agreement whereby the Canadian trustee or liquidator or court has jurisdiction
over Canadian assets and a foreign representative over the foreign assets.
Alternatively, a Canadian court could empower the Canadian insolvency
representative to take whatever proceedings are permitted by the foreign
country. This usually involves commencing an ancillary insolvency proceeding
in the foreign jurisdiction, particularly if there are significant assets in the foreign
jurisdiction. In addition, a Clearing Member would be required to bring into
account assets recovered abroad when proving its claim or exercising its rights of
enforcement or set-off in Canada.
17. Will the Covered Customer (or its administrator, provisional
liquidator, conservator, receiver, trustee, custodian or other
similar official) be able to recover any transfers of Collateral
made to the Clearing Member during a certain "suspect period"
preceding the date of the insolvency as a result of such a transfer
constituting a "preference" (however called and whether or not
fraudulent) in favor of the Clearing Member or on any other
basis? If so, how long before the insolvency does this suspect
period begin? If such a period exists, would the substitution of
Collateral by the Covered Customer during this period
invalidate an otherwise valid security interest if the substitute
Collateral is of no greater value than the assets it is replacing?
Would the posting of additional "variation margin" in an
amount that reflects a change in the mark-to-market value of
one or more Covered Transactions) during the suspect period be
subject to avoidance, either because the Collateral was
considered to relate to an antecedent or pre-existing obligation
or for some other reason?
(a) General
The Covered Customer (or its administrator, provisional liquidator, conservator,
receiver, trustee, custodian or other similar official) may be able to recover any
transfers of Collateral made to the Clearing Member during a certain "suspect
period" preceding the date of the insolvency. Whether it will be able to or not
depends very much on the facts of the case. There are a number of different
preference laws with potential application, some of which apply only to certain
types of entities.
There are a number of potentially applicable fraudulent conveyance or creditor
preference laws. Two of these are federal laws. These are the preference
provisions in the BIA and those in the WURA. They would apply to proceedings
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in both Ontario and Quebec. Two are Ontario provincial laws. These are the
preference and fraudulent conveyance provisions of the Assignments and
Preferences Act (APA) and the fraudulent conveyance provisions of the Fraudulent
Conveyances Act. Under Quebec law the relevant action is the Paulian action
under the Civil Code
The discussion below refers to the preference laws only, as it seems unlikely to us
that a fraudulent conveyance issue could be raised in a typical transaction. 270 The
BIA currently applies only where the Covered Customer is the type of entity
subject to the BIA (see Appendix C) and the WURA would apply only where the
Covered Customer is an entity subject to the WURA (see Appendix C). The BIA
provisions are incorporated by reference into the CCAA. The preference periods
relate to the period prior to commencement of the proceeding, and under the
CCAA the monitor (as opposed to the bankruptcy trustee) would have the right
to bring the proceeding.
The Ontario acts, the APA and FPA, can apply to any entity and can be enforced
by creditors, a trustee in bankruptcy, a receiver or a liquidator.
In summary, under any of the preference laws there is a risk (although in the
typical situation probably not a significant one) that a transfer of Collateral made
by an insolvent Covered Customer or Covered Customer on the verge of
insolvency, particularly to the extent it relates to a pre-existing transaction (i.e.
providing Collateral as Exposure increases as opposed to delivering an
Independent Amount at the inception of the Transaction), will be set aside as a
creditor preference even if it is made pursuant to a binding security agreement
entered into prior to the insolvency. In most cases, if the transfer or payment is
made with the genuine intent to try to avoid bankruptcy and to remain in
business, then any presumption that the transfer or payment prefers the secured
creditor will be rebutted. The risk of transfers of Collateral being set aside as
creditor preferences is unlikely to be material. However, the risk is not one that
can be accurately assessed at the time of entering into the agreement because the
relevant intention is the intention of the transferee at the time of making the
transfer.
The federal statutes do recognize a limited protection for transfers of financial
collateral under terms of an eligible financial contract in that there is no
presumption that transfers are preferential if they have a preferential effect, as
there is for other types of collateral. These provisions are discussed below.
An atypical transaction might be one where there were unusual circumstances, such as, for example,
substantial over-collateralization with a view to removing assets from other creditors.
270
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In our view, the substitution of Collateral by the Covered Customer during this
period would not invalidate an otherwise valid pledge if the substitute Collateral
was of no greater value than the asset it was replacing.
A more detailed discussion of preference laws follows.
(b) BIA271
Section 95 of the BIA would allow a trustee to move to set aside a transfer of
Collateral to a Clearing Member if it showed that:
•
the transfer was a transfer of property, a charge on property, or a payment
made,
•
the Clearing Member was a "creditor" at the time of the conveyance or
transfer,
•
the Covered Customer was insolvent at the time of the transfer,
•
the transfer was made with the intent of preferring the Clearing Member
over the Covered Customer's other creditors, and
•
the transfer, charge or payment took place within three months of the
commencement of the Covered Customer's bankruptcy.
In the past, the trustee would not have had to prove that the debtor intended to
prefer a secured party, but only that the transfer, charge or payment had the
effect of preferring a secured party. The onus would then shift to the secured
party272 to prove that the debtor did not intend to prefer it. This "presumption"
was repealed with respect to a transfer made in connection with "financial
collateral" and in accordance with the provisions of eligible financial contracts. 273
Consequently, the trustee must now prove intent with respect to this type of
collateral.
If the Clearing Member and Covered Customer are not at arm's length, then
section 95 operates slightly differently. Usually it is not necessary to prove intent
in such a case, only that the transfer, charge or payment has the effect of
preferring the creditor. The suspect period is 12 months before the date of the
initial bankruptcy event. However, the parties are deemed to be dealing with
each other at arm's length in respect of a transfer, charge or payment made in
connection with financial collateral and in accordance with the provisions of an
These apply also in and with respect to a CCAA proceeding.
Technically speaking it shifts to the debtor, but practically it is the transferee that must rebut the
presumption.
273 BIA, s. 95(2.1); see Question 17 (ii) above.
271
272
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eligible financial contract. In other words, the law with respect to non-arm's
length transfers of financial collateral for an eligible financial contract is the same
as for arm's length transfers except that the suspect period is 12 months.
If the trustee did satisfy the onus to prove each of these elements, any such
transfer would be void. The trustee may have difficulty proving intent, however.
Canadian cases generally have taken the position that an agreement to provide
security in future upon request is not in and of itself preferential. The fact that
the Collateral is provided pursuant to an agreement that pre-dates the Covered
Customer's insolvency and particularly the three-month suspect period, will be
considered evidence, possibly determinative evidence, that the Covered
Customer did not have the requisite intent to prefer the Clearing Member. There
is case law, however, where a pre-existing contractual obligation to post margin
to a futures account has not, in and of itself, rebutted the presumption. Also, if
the Covered Customer is insolvent at the time it enters into the Transactions,
then the Clearing Member might not be able to rely on the fact of this preexisting contract to disprove intent to prefer. In any event, other evidence may be
relevant to intent. For example, the Covered Customer may have valid reasons to
transfer the Collateral to the Clearing Member in preference to its other creditors.
Delay in the transfer of Collateral to the Clearing Member would constitute an
Event of Default and, consequently, an acceleration of its obligations. Nonpayment of other creditors may not be as disadvantageous. The Covered
Customer might honestly and reasonably believe that by transferring the
Collateral it buys time necessary to allow it to carry on in business. In such a
case, the trustee would not likely be able to prove the requisite intent as long as
the Covered Customer's hope that the business would recover was both bona fide
and reasonable.
(c) WURA
The WURA contains fraudulent conveyance and preference provisions that differ
from those under the BIA and the provincial statutes. Because the WURA applies
to limited types of entities and, consequently, liquidations are far less common
than bankruptcies, the jurisprudence is not very well developed. Although the
form of the provisions are different from those in the BIA, in substance most of
them operate in much the same way and are intended to effect the same result.
Therefore, the following analysis relies on the case law considering the
analogous provisions in these other statutes.
The WURA contains two sets of provisions with potential application. These are:
•
the unjust preference provisions, and
•
the payments within 30 days of winding-up provision.
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Unjust Preferences
Section 100 of the WURA voids any deposit, transfer or payment to a creditor "in
contemplation of insolvency" that has the effect of giving the creditor an "unjust
preference". Normally, any deposit, transfer or payment made within 30 days of
the appointment of the liquidator is deemed to have been made in contemplation
of insolvency. This presumption does not apply to a sale, deposit, pledge or
transfer of "financial collateral" made in accordance with the provisions of an
"eligible financial contract." 274 This means that the liquidator would have to
prove the transfer of collateral was made with the intention to provide the
secured party an unjust preference as it would for transfers more than 30 days
prior to the proceeding. Although the wording is quite different, the intent of this
provision is similar to the unjust preference provisions in Section 95 of the BIA
and in the APA and FPA. However, unlike the BIA, it is not just transfers and
transactions that take place within the suspect period (i.e. three months) that are
subject to being set aside; any transaction made with the requisite intent and
effect can be set aside.
Transfers of Collateral would be transfers of property and so are subject to the
preference analysis. The meaning of the term "unjust" in this context is unclear.
However, there is some early case law suggesting that it means only that the
transfer or payment interferes with the rateable distribution of the insolvent
company's assets. Therefore, there is a risk that a court would view the transfers
of Collateral as having the effect of unjustly preferring the Clearing Member.
The meaning of the phrase "in contemplation of insolvency" is also unclear.
However, by analogy to the BIA preference provision, it likely means that the
transfer or payment is made at a time when the Covered Customer is either
insolvent or very nearly insolvent with the intention of giving the creditor a
preferred position over other creditors. The liquidator has the onus to prove
intent for transfers or payments with respect to financial collateral for an eligible
financial contract; transfers of other types of collateral or other types of payments
made within 30 days of the commencement of liquidation would be deemed to
be made with this intent.
A Clearing Member would have to bring forth evidence to generally meet the
liquidator's case with respect to the Covered Customer's intent. It will always be
essential to demonstrate that in making any transfer at a time when it is
insolvent, the Covered Customer had a reasonable and bona fide belief that by
doing so it would be able to carry on in business and the fact that a failure to
deliver Collateral is an Event of Default entitling the Clearing Member to
274
WURA, s.100(3); See Question 17 (ii) and (iv) above.
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terminate all Transactions will be of assistance in this regard. As with the BIA,
the preferential intent might be disproved by evidence that the transfer was
made pursuant to an agreement that pre-dated insolvency and the suspect
period.
Payments within 30 Days of Winding-up
With respect to entities subject to the WURA, there is an additional provision,
not found in the BIA or provincial legislation, which must be considered in
relation to any transfers of money. Transfers of money made within 30 days of
the commencement of liquidation can be set aside. Subsection 101(1) voids every
" payment" made within 30 days of commencement of the liquidation by an
insolvent company to a person who knows of the insolvency or who has reason
to know of it. Intent in making the payment is not relevant under this provision.
If, during this 30-day period, the Clearing Member had actual knowledge of the
Covered Customer's insolvent state or reason to question its solvency, then the
payments made during this period might be set aside.
This provision does not apply, however, to a payment made in connection with
financial collateral in accordance with the provisions of an eligible financial
contract. 275
(d) APA and FPA
In Ontario, the relevant provision in the APA is Section 4, which is similar to
Section 95 of the BIA. 276 Unlike the BIA, however, an intent to prefer is presumed
if the effect of the transfer is to prefer a creditor over others; but this presumption
only operates if there is an assignment for the benefit of creditors or a proceeding
is brought to attack the transfer within 60 days of the transfer. 277 In other words, a
creditor could attack any of the transfers as preferential, but it would only have
the benefit of the presumption for deliveries of Collateral in the prior 60 days.
WURA s.101(3).
4(1) "Subject to section 5, every ... conveyance ... or transfer ... or payment ... of any .. property, real or
personal, made by a person when insolvent or unable to pay the person's debts in full or when the
person knows that he, she or it is on the eve of insolvency, with intent to defeat, hinder, delay or
prejudice creditors, or any one or more of them, is void as against the creditor or creditors injured,
delayed or prejudiced.
(2) Subject to section 5, every such ... conveyance ... or transfer ... or payment made by a person being at
the time in insolvent circumstances, or unable to pay ... its debts in full, or knowing ... itself to be on
the eve of insolvency, to or for a creditor with the intent to give such creditor an unjust preference
over other creditors or over any one or more of them is void as against the creditor or creditors
injured, delayed, prejudiced or postponed". [Emphasis Added]
277 Subsections 4(3) and 4(4).
275
276
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The case law and analysis discussed above in relation to the preference provision
in Section 95 of the BIA is also relevant in this context. The only significant
differences between the two provisions are (1) there is no presumption of a
preference under the BIA if the effect of the transfer is to prefer and there is such
a presumption under the APA, and (2) the fact that the APA and FPA can void
transactions that take place any time outside the 60 day and 1 year period,
respectively, so long as the applicant (i.e. creditors and a trustee in bankruptcy)
proves the requisite intent. The crucial issue is intent and the analysis would be
the same as that described with respect to the BIA.
(e) When Suspect Periods Commence
A summary of the suspect periods is as follows. Under the BIA the period begins
90 days278 prior to the commencement of bankruptcy proceedings. A bankruptcy
commences upon the filing of the petition in bankruptcy or the assignment into
bankruptcy by the insolvent party. Under the WURA (both Sections 100 and
101(2)), the period begins 30 days prior to commencement of the liquidation
proceedings. These commence when a court order is obtained appointing a
liquidator.
Under the WURA unjust preference provision (Section 100), the APA and the
FPA there is no true preference period. A rebuttable presumption of a preference
applies with respect to transactions that have the effect of preferring a creditor
during certain periods. Under the APA the presumption applies if the
proceedings to set the transfer aside are commenced within 60 days of the
transfer. Under the FPA the presumption applies if the proceedings to set the
transfer aside are commenced within 1 year of the transfer.
Also under WURA, section 101(1), the period during which payments can be
challenged is 30 days prior to commencement of the liquidation proceedings.
(f) Transfers at an Undervalue
The BIA and CCAA 279 include a transfer at an undervalue provision. Under this
provision a "transfer at an undervalue" is void as against or may not be set up
against the trustee. In addition, any person that is a party to the transaction or is
a privy of a party to the transaction may be ordered to make compensatory
payments to the estate if the transaction is found to be a transaction at an
undervalue. A "transfer at an undervalue" is:
278 One year if not arm's length.
279 S.C. 2005, c. 47 as amended by S.C. 2007, c. 36.
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a disposition of property or provision of services for which no
consideration is received by the debtor or for which the
consideration received by the debtor is conspicuously less than the
fair market value of the consideration given by the debtor;
Where the debtor and the party to the transaction are dealing at arm's length, the
trustee must prove that (i) the transfer occurred during the period that begins on
the day that is one year before the date of the initial bankruptcy event (e.g. the
date of the assignment, the filing of a notice to make a proposal etc.) and that
ends on the date of the bankruptcy, (ii) the debtor was insolvent at the time of
the transfer or was rendered insolvent by it, and (iii) the debtor intended to
defraud, defeat or delay a creditor. Where proved the transfer is void and the
transferee may be ordered to pay the difference between the value of the
consideration given or received by the debtor and the fair market value of the
property or services given or received by the debtor.
This provision does not appear to be directed at transfers of collateral or
additional collateral to existing creditors. Those types of transactions would be
considered pursuant to the creditor preference provisions discussed above.
(g) Paulian Action
Articles 1631 to 1636 of the Civil Code set out when a creditor can challenge a
"juridical act" (which term would include, inter alia, both (i) a contract and (ii) a
payment made for the performance of a contract) made by a party who is
insolvent or on the brink of insolvency.
The trustee or creditor challenging the transaction must prove that the act was
done "in fraud of his rights" and that the effect of the transaction was (i) to grant
a preference to another creditor when the debtor was insolvent or (ii) to render
the debtor insolvent. While the sanction in a Paulian action is not the nullity of
the juridical act but that the act is declared "inopposable", that is, of no effect, visa-vis the attacking creditor, the effect is the same. The act is also inopposable to
any creditor who could have taken a Paulian action and the property involved or
payment may be seized and sold, or paid to the creditors.
Article 1635 provides that a Paulian action must be brought within one year of
the appointment of the trustee in bankruptcy where the action is brought by a
trustee. The same article provides that, if a creditor challenges the transaction, it
must be brought within one year of his learning of the prejudice resulting from
the act which is being attacked or the fraudulent nature of the act. There is
jurisprudence, including cases from the Quebec Court of Appeal, holding that
the one-year period is of strict application and therefore the creditor or the
trustee will not be able to take an action after this period has expired. However,
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there is also jurisprudence holding that the Paulian action may also be subject to
the general prescription period of three years for all personal actions which is set
out at Article 2925 of the Civil Code. According to this jurisprudence, despite the
one-year period set out in Article 1635, Article 2925 also applies to a Paulian
action and therefore a creditor has three years from its knowledge of the
fraudulent or prejudicial nature of the transaction to institute a Paulian action. In
our view, it is likely that the one-year period applies although this conclusion is
not free from doubt.
In order to attack a transaction under the Paulian action provisions, a trustee or
creditor must prove fraudulent intent and the ease with which he can do so will
be determined by whether the transaction or payment is in the context of a
gratuitous contract - a contract made without consideration - or an onerous
contract - a contract made for consideration. In our view, a transfer of Eligible
Collateral would not be considered to be a payment made in the context of a
gratuitous contract because it is originally negotiated in the context of an onerous
contract. Therefore, it is the presumption in Article 1632 of the Civil Code with
respect to onerous contracts that might be held to apply. Pursuant to
Article 1632, in the case of an onerous contract or a payment made for the
performance of an onerous contract, the contract or payment is deemed to have
been made with fraudulent intent if the advantaged creditor knew of the debtor's
insolvent state or knew that the debtor was rendering himself or was seeking to
render himself insolvent.
Generally, a "deemed" presumption in the Civil Code is held to be an irrebuttable
one. 280 There has been some controversy, however, in the legal writing and case
law as to whether this is the case with Article 1632. In our view, which is
supported by some legal writing and several recent cases, the presumption in
Article 1632 should be rebuttable even though the word "deemed" is used. 281
In light of the most recent decisions and especially that of the Court of Appeal in
Soracchi, there is now a strong argument to be made that a creditor may, on proof
of its good faith and/ or that the transaction was in the ordinary course of
business, be able to rebut the presumption of fraudulent intent even if the
creditor had knowledge of the insolvency of the debtor at the time of the
transaction or payment.
In conclusion, we are of the view that the deemed presumption for gratuitous
contracts in the Civil Code would not apply to a transfer of Eligible Collateral
280 Article 2847, CCQ.
281 See Banque Nationale du Canada v. Soracchi. REJB 2000-16669 (C.A.) (Soracchi). Also Compagnie Montreal
Trust du Canada v. Bergeron, J.E. 2000-1297 (C.S.). See also Baudouin & Jobin, Les Obligations, 5th ed.,
Cowansville, Qc.: Yvon Blais, 1998 at pg. 717 cited with approval in Soracchi.
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because this transfer would not be considered to be a payment made in the
context of a gratuitous contract. For the deemed presumption in Article 1632 to
apply, there must be knowledge by the advantaged creditor of the debtor's
insolvency or impending insolvency and, even in such a case, it may be possible
to rebut the presumption of fraudulent intent. Therefore, if the Clearing Member
were not aware of the insolvent state of the debtor at the time that the security
agreements were entered into and when a transfer of Eligible Collateral took
place, the deemed presumption of fraudulent intent in Article 1632 should not
apply at all and a Paulian action would not likely be successful. Even if the
Clearing Member did have such knowledge when a transfer of Eligible Collateral
was made, as mentioned above, it will likely be possible for it to rebut the
presumption of fraudulent intent upon proof of good faith and that the transfer
was made in the interests of the debtor in that it permitted it to carry on business
and for the Transactions not to be terminated prematurely.
While we view the risk of a transfer of Eligible Collateral being set aside in a
Paulian action as being quite small, the risk cannot be predicted with certainty
since knowledge by the Clearing Member of the debtor's insolvency may trigger
the presumption of fraudulent intent set out in the Civil Code and rebutting the
presumption will depend upon the factual context of the transfer. In any case
where the debtor is insolvent, this issue will be of some concern.
Miscellaneous
18. Would the parties' agreement on governing law of each Covered
Base Agreement and CDA and submission to jurisdiction be
upheld in Ontario and Quebec, and what would be the
consequences if they were not?
(a) Choice of Law
Subject to the following qualifications, an Ontario or Quebec court would respect
the parties' choice of governing law. It would apply the chosen law to determine
the validity of the agreement (insofar as contractual matters are concerned) and
its interpretation.
An Ontario and Quebec court will apply its own procedural laws
notwithstanding the choice of a different governing law. For example, certain
matters with respect to the realization of the Collateral may be characterized as
procedural matters and subject to the PPSA or Quebec Civil Code.
An Ontario court will not apply a foreign law that is against public policy in the
province and similarly a Quebec court will not apply a foreign law that is against
public order as understood in international relations.
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A court will apply laws of mandatory application or, as it is expressed in Quebec,
laws that apply by reason of their particular object.
An Ontario court will not apply a foreign law if its application would cause a
party to breach a law in the place of performance of the obligation.
(b) Submission to Jurisdiction
The parties' submissions to the jurisdiction of courts outside of Ontario or
Quebec would be recognized by court in Ontario and Quebec. Note, however,
that if proceedings were to be taken with respect to Collateral situated in Ontario
or Quebec, it may as a practical matter be preferable to take proceedings in an
Ontario or Quebec court in the first instance, thereby avoiding the need to first
take proceedings in a foreign court and then further proceedings to have a
foreign judgment recognized and enforced in the province. There is some
question as to whether a Canadian court will recognize and enforce a nonmonetary order of a foreign court with respect to Canadian property and,
therefore, it may require the issue to be relitigated.
19. Are there any other local law considerations that you would
recommend the Clearing Member to consider in connection with
taking and realizing upon the Eligible Collateral from the
Covered Customer?
Other than those described above, there are no other local law considerations. In
this regard, we have not considered any tax, securities or other regulatory law
issues.
20. Are there any other circumstances you can foresee that might
affect the Clearing Member's ability to enforce its security
interest in Ontario and Quebec?
No.
RELIANCE
This memorandum of law is intended solely for the benefit of ISDA and the FIA
and their members. No other party may rely on it without our prior written
consent. Without limiting the foregoing, ISDA, the FIA and their members may
provide a copy of this opinion to (i) any competent regulatory authority or
supervisory body including the UK Financial Services Authority and the German
Bundesanstalt fur Finanzdienstleistungsaufsicht and (ii) their advisors; however
this opinion is not addressed to such regulatory authorities or advisors and may
not be relied upon by them.
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STIKEMAN ELLIOTT
We assume no obligation to any person or entity to make any investigations as to
or inform them of any change in law arising subsequent to the date of this
opinion that might affect the opinions expressed in it.
STIKEMAN ELLIOTT LLP
Contacts:
Margaret Grottenthaler (Toronto)
Sterling Dietze (Montreal)
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APPENDIX A
SEPTEMBER 2012
APPENDIX A - CERTAIN DERIVATIVES TRANSACTIONS
Basis Swap. A transaction in which one party pays periodic amounts of a given
currency based on a floating rate and the other party pays periodic amounts of
the same currency based on another floating rate, with both rates reset
periodically; all calculations are based on a notional amount of the given
currency.
Bond Forward. A transaction in which one party agrees to pay an agreed price
for a specified amount of a bond of an issuer or a basket of bonds of several
issuers at a future date and the other party agrees to pay a price for the same
amount of the same bond to be set on a specified date in the future. The payment
calculation is based on the amount of the bond and can be physically-settled
(where delivery occurs in exchange for payment) or cash-settled (where
settlement occurs based on the difference between the agreed forward price and
the prevailing market price at the time of settlement).
Bond Option. A transaction in which one party grants to the other party (in
consideration for a premium payment) the right, but not the obligation, to
purchase (in the case of a call) or sell (in the case of a put) a specified amount of a
bond of an issuer, such as Kingdom of Sweden or Unilever N.V., at a specified
strike price. The bond option can be settled by physical delivery of the bonds in
exchange for the strike price or may be cash settled based on the difference
between the market price of the bonds on the exercise date and the strike price.
Bullion Option. A transaction in which one party grants to the other party (in
purchase (in the case of a call) or sell (in the case of a put) a specified number of
Ounces of Bullion at a specified strike price. The option may be settled by
physical delivery of Bullion in exchange for the strike price or may be cash
settled based on the difference between the market price of Bullion on the
exercise date and the strike price.
Bullion Swap. A transaction in which one party pays periodic amounts of a given
currency based on a fixed price or a fixed rate and the other party pays periodic
amounts of the same currency or a different currency calculated by reference to a
Bullion reference price (for example, Gold-COMEX on the COMEX Division of
the New York Mercantile Exchange) or another method specified by the parties.
Bullion swaps include cap, collar or floor transactions in respect of Bullion.
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STIKEMAN ELLIOTT
Bullion Trade. A transaction in which one party agrees to buy from or sell to the
other party a specified number of Ounces of Bullion at a specified price for
settlement either on a "spot" or two-day basis or on a specified future date. A
Bullion Trade may be settled by physical delivery of Bullion in exchange for a
specified price or may be cash settled based on the difference between the market
price of Bullion on the settlement date and the specified price.
For purposes of Bullion Trades, Bullion Options and Bullion Swaps, "Bullion"
means gold, silver, platinum or palladium and "Ounce" means, in the case of
gold, a fine troy ounce, and in the case of silver, platinum and palladium, a troy
ounce (or in the case of reference prices not expressed in Ounces, the relevant
Units of gold, silver, platinum or palladium).
Buy/Sell-Back Transaction. A transaction in which one party purchases a
security (in consideration for a cash payment) and agrees to sell back that
security (or in some cases an equivalent security) to the other party (in
consideration for the original cash payment plus a premium).
Cap Transaction. A transaction in which one party pays a single or periodic fixed
amount and the other party pays periodic amounts of the same currency based
on the excess, if any, of a specified floating rate (in the case of an interest rate
cap), rate or index (in the case of an economic statistic cap) or commodity price
(in the case of a commodity cap) in each case that is reset periodically over a
specified per annum rate (in the case of an interest rate cap), rate or index (in the
case of an economic statistic cap) or commodity price (in the case of a commodity
cap).
Collar Transaction. A collar is a combination of a cap and a floor where one party
is the floating rate, floating index or floating commodity price payer on the cap
and the other party is the floating rate, floating index or floating commodity
price payer on the floor.
Commodity Forward. A transaction in which one party agrees to purchase a
specified quantity of a commodity at a future date at an agreed fixed or floating
price, and the other party agrees to deliver such quantity in exchange for
payment at such price on a specified date in the future.
Commodity Index Transaction. A transaction, structured in the form of a swap,
cap, collar, floor, option or some combination thereof, between two parties in
which the underlying value of the transaction is based on a rate or index based
on the price of one or more commodities.
Commodity Option. A transaction in which one party grants to the other party
(in consideration for a premium payment) the right, but not the obligation, to
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STIKEMAN ELLIOTT
purchase (in the case of a call) or sell (in the case of a put) a specified quantity of
a commodity at a specified strike price. The option can be settled either by
physically delivering the quantity of the commodity in exchange for the strike
price or by cash settling the option, in which case the seller of the option would
pay to the buyer the difference between the market price of that quantity of the
commodity on the exercise date and the strike price.
Commodity Swap. A transaction in which one party pays periodic amounts of a
given currency based on a fixed price and the other party pays periodic amounts
of the same currency based on the price of a commodity, such as natural gas or
gold, or a futures contract on a commodity (e.g., West Texas Intermediate Light
Sweet Crude Oil on the New York Mercantile Exchange); all calculations are
based on a notional quantity of the commodity.
Contingent Credit Default Swap. A Credit Default Swap Transaction under
which the calculation amounts applicable to one or both parties may vary over
time by reference to the mark-to-market value of a hypothetical swap
transaction.
Credit Default Swap Option. A transaction in which one party grants to the other
party (in consideration for a premium payment) the right, but not the obligation,
to enter into a Credit Default Swap.
Credit Default Swap. A transaction in which one party pays either a single fixed
amount or periodic fixed amounts or floating amounts determined by reference
to a specified notional amount, and the other party (the credit protection seller)
pays either a fixed amount or an amount determined by reference to the value of
one or more loans, debt securities or other financial instruments (each a
"Reference Obligation") issued, guaranteed or otherwise entered into by a third
party (the "Reference Entity") upon the occurrence of one or more specified
credit events with respect to the Reference Entity (for example, bankruptcy or
payment default). The amount payable by the credit protection seller is typically
determined based upon the market value of one or more debt securities or other
debt instruments issued, guaranteed or otherwise entered into by the Reference
Entity. A Credit Default Swap may also be physically settled by payment of a
specified fixed amount by one party against delivery of specified obligations
("Deliverable Obligations") by the other party. A Credit Default Swap may also
refer to a "basket" (typically ten or less) or a "portfolio" (eleven or more) of
Reference Entities or may be an index transaction consisting of a series of
component Credit Default Swaps.
Credit Derivative Transaction on Asset-Backed Securities. A Credit Default Swap
for which the Reference Obligation is a cash or synthetic asset-backed security.
Such a transaction may, but need not necessarily, include "pay as you go"
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settlements, meaning that the credit protection seller makes payments relating to
interest shortfalls, principal shortfalls and write-downs arising on the Reference
Obligation and the credit protection buyer makes additional fixed payments of
reimbursements of such shortfalls or write-downs.
Credit Spread Transaction. A transaction involving either a forward or an option
where the value of the transaction is calculated based on the credit spread
implicit in the price of the underlying instrument.
Cross Currency Rate Swap. A transaction in which one party pays periodic
amounts in one currency based on a specified fixed rate (or a floating rate that is
reset periodically) and the other party pays periodic amounts in another
currency based on a floating rate that is reset periodically. All calculations are
determined on predetermined notional amounts of the two currencies; often such
swaps will involve initial and or final exchanges of amounts corresponding to
the notional amounts.
Currency Option. A transaction in which one party grants to the other party (in
purchase (in the case of a call) or sell (in the case of a put) a specified amount of a
given currency at a specified strike price.
Currency Swap. A transaction in which one party pays fixed periodic amounts of
one currency and the other party pays fixed periodic amounts of another
currency. Payments are calculated on a notional amount. Such swaps may
involve initial and or final payments that correspond to the notional amount.
Economic Statistic Transaction. A transaction in which one party pays an amount
or periodic amounts of a given currency by reference to interest rates or other
factors and the other party pays or may pay an amount or periodic amounts of a
currency based on a specified rate or index pertaining to statistical data on
economic conditions, which may include economic growth, retail sales, inflation,
consumer prices, consumer sentiment, unemployment and housing.
Emissions Allowance Transaction. A transaction in which one party agrees to
buy from or sell to the other party a specified quantity of emissions allowances
or reductions at a specified price for settlement either on a "spot" basis or on a
specified future date. An Emissions Allowance Transaction may also constitute a
swap of emissions allowances or reductions or an option whereby one party
grants to the other party (in consideration for a premium payment) the right, but
not the obligation, to receive a payment equal to the amount by which the
specified quantity of emissions allowances or reductions exceeds or is less than a
specified strike. An Emissions Allowance Transaction may be physically settled
by delivery of emissions allowances or reductions in exchange for a specified
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STIKEMAN ELLIOTT
price, differing vintage years or differing emissions products or may be cash
settled based on the difference between the market price of emissions allowances
or reductions on the settlement date and the specified price.
Equity Forward. A transaction in which one party agrees to pay an agreed price
for a specified quantity of shares of an issuer, a basket of shares of several issuers
or an equity index at a future date and the other party agrees to pay a price for
the same quantity and shares to be set on a specified date in the future. The
payment calculation is based on the number of shares and can be physicallysettled (where delivery occurs in exchange for payment) or cash-settled (where
settlement occurs based on the difference between the agreed forward price and
the prevailing market price at the time of settlement).
Equity Index Option. A transaction in which one party grants to the other party
receive a payment equal to the amount by which an equity index either exceeds
(in the case of a call) or is less than (in the case of a put) a specified strike price.
Equity Option. A transaction in which one party grants to the other party (in
purchase (in the case of a call) or sell (in the case of a put) a specified number of
shares of an issuer or a basket of shares of several issuers at a specified strike
price. The share option may be settled by physical delivery of the shares in
exchange for the strike price or may be cash settled based on the difference
between the market price of the shares on the exercise date and the strike price.
Equity Swap. A transaction in which one party pays periodic amounts of a given
currency based on a fixed price or a fixed or floating rate and the other party
pays periodic amounts of the same currency or a different currency based on the
performance of a share of an issuer, a basket of shares of several issuers or an
equity index, such as the Standard and Poor's 500 Index.
Floor Transaction. A transaction in which one party pays a single or periodic
amount and the other party pays periodic amounts of the same currency based
on the excess, if any, of a specified per annum rate (in the case of an interest rate
floor), rate or index level (in the case of an economic statistic floor) or commodity
price (in the case of a commodity floor) over a specified floating rate (in the case
of an interest rate floor), rate or index level (in the case of an economic statistic
floor) or commodity price (in the case of a commodity floor).
Foreign Exchange Transaction. A deliverable or non-deliverable transaction
providing for the purchase of one currency with another currency providing for
settlement either on a "spot" or two-day basis or a specified future date.
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Forward Rate Transaction. A transaction in which one party agrees to pay a fixed
rate for a defined period and the other party agrees to pay a rate to be set on a
specified date in the future. The payment calculation is based on a notional
amount and is settled based, among other things, on the difference between the
agreed forward rate and the prevailing market rate at the time of settlement.
Freight Transaction. A transaction in which one party pays an amount or
periodic amounts of a given currency based on a fixed price and the other party
pays an amount or periodic amounts of the same currency based on the price of
chartering a ship to transport wet or dry freight from one port to another; all
calculations are based either on a notional quantity of freight or, in the case
of time charter transactions, on a notional number of days.
Fund Option Transaction: A transaction in which one party grants to the other
party (for an agreed payment or other consideration) the right, but not the
obligation, to receive a payment based on the redemption value of a specified
amount of an interest issued to or held by an investor in a fund, pooled
investment vehicle or any other interest identified as such in the relevant
Confirmation (a "Fund Interest"), whether i) a single class of Fund Interest of a
Single Reference Fund or ii) a basket of Fund Interests in relation to a specified
strike price. The Fund Option Transactions will generally be cash settled (where
settlement occurs based on the excess of such redemption value over such
specified strike price (in the case of a call) or the excess of such specified strike
price over such redemption value (in the case of a put) as measured on the
valuation date or dates relating to the exercise date).
Fund Forward Transaction: A transaction in which one party agrees to pay an
agreed price for the redemption value of a specified amount of i) a single class of
Fund Interest of a Single Reference Fund or ii) a basket of Fund Interests at a
future date and the other party agrees to pay a price for the redemption value of
the same amount of the same Fund Interests to be set on a specified date in the
future. The payment calculation is based on the amount of the redemption value
relating to such Fund Interest and generally cash-settled (where settlement
occurs based on the difference between the agreed forward price and the
redemption value measured as of the applicable valuation date or dates).
Fund Swap Transaction: A transaction a transaction in which one party pays
periodic amounts of a given currency based on a fixed price or a fixed rate and
the other party pays periodic amounts of the same currency based on the
redemption value of i) a single class of Fund Interest of a Single Reference Fund
or ii) a basket of Fund Interests.
Interest Rate Option. A transaction in which one party grants to the other party
receive a payment equal to the amount by which an interest rate either exceeds
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STIKEMAN ELLIOTT
(in the case of a call option) or is less than (in the case of a put option) a specified
strike rate.
Interest Rate Swap. A transaction in which one party pays periodic amounts of a
given currency based on a specified fixed rate and the other party pays periodic
amounts of the same currency based on a specified floating rate that is reset
periodically, such as the London inter-bank offered rate; all calculations are
based on a notional amount of the given currency.
Longevity/Mortality Transaction. (a) A transaction employing a derivative
instrument, such as a forward, a swap or an option, that is valued according to
expected variation in a reference index of observed demographic trends, as
exhibited by a specified population, relating to aging, morbidity, and
mortality/longevity, or (b) A transaction that references the payment profile
underlying a specific portfolio of longevity- or mortality- contingent obligations,
e.g. a pool of pension liabilities or life insurance policies (either the actual claims
payments or a synthetic basket referencing the profile of claims payments).
Physical Commodity Transaction. A transaction which provides for the purchase
of an amount of a commodity, such as oil including oil products, coal, electricity
or gas, at a fixed or floating price for actual delivery on one or more dates.
Property Index Derivative Transaction. A transaction, often structured in the
form of a forward, option or total return swap, between two parties in which the
underlying value of the transaction is based on a rate or index based on
residential or commercial property prices for a specified local, regional or
national area.
Repurchase Transaction. A transaction in which one party agrees to sell
securities to the other party and such party has the right to repurchase those
securities (or in some cases equivalent securities) from such other party at a
future date.
Securities Lending Transaction. A transaction in which one party transfers
securities to a party acting as the borrower in exchange for a payment or a series
of payments from the borrower and the borrower's obligation to replace the
securities at a defined date with identical securities.
Swap Deliverable Contingent Credit Default Swap. A Contingent Credit Default
Swap under which one of the Deliverable Obligations is a claim against the
Reference Entity under an ISDA Master Agreement with respect to which an
Early Termination Date (as defined therein) has occurred.
Swap Option. A transaction in which one party grants to the other party the right
(in consideration for a premium payment), but not the obligation, to enter into a
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STIKEMAN ELLIOTT
swap with certain specified terms. In some cases the swap option may be settled
with a cash payment equal to the market value of the underlying swap at the
time of the exercise.
Total Return Swap. A transaction in which one party pays either a single amount
or periodic amounts based on the total return on one or more loans, debt
securities or other financial instruments (each a "Reference Obligation") issued,
guaranteed or otherwise entered into by a third party (the "Reference Entity"),
calculated by reference to interest, dividend and fee payments and any
appreciation in the market value of each Reference Obligation, and the other
party pays either a single amount or periodic amounts determined by reference
to a specified notional amount and any depreciation in the market value of each
Reference Obligation.
A total return swap may (but need not) provide for acceleration of its
termination date upon the occurrence of one or more specified events with
respect to a Reference Entity or a Reference Obligation with a termination
payment made by one party to the other calculated by reference to the value of
the Reference Obligation.
Weather Index Transaction. A transaction, structured in the form of a swap, cap,
collar, floor, option or some combination thereof, between two parties in which
the underlying value of the transaction is based on a rate or index pertaining to
weather conditions, which may include measurements of heating, cooling,
precipitation and wind.
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APPENDIX B - CERTAIN COUNTERPARTY TYPES 282
Description
Covered by
opinion
Legal form(s) 283
Bank/Credit Institution. A legal entity, which may
be organized as a corporation, partnership or in
some other form, that conducts commercial
banking activities, that is, whose core business
typically involves (a) taking deposits from private
individuals and/or corporate entities and
(b) making loans to private individual and/or
corporate borrowers. This type of entity is
sometimes referred to as a "commercial bank" or,
if its business also includes investment banking
and trading activities, a "universal bank". (If the
entity only conducts investment banking and
trading activities, then it falls within the
"Investment Firm/Broker Dealer" category below.)
This type of entity is referred to as a "credit
institution" in European Community (EC)
legislation. This category may include specialised
types of bank, such as a mortgage savings bank
(provided that the relevant entity accepts deposits
and makes loans), or such an entity may be
considered in the local jurisdiction to constitute a
separate category of legal entity (as in the case of a
building society in the United Kingdom (UK)).
Yes
Canadian domestic banks
are bodies corporate. They
use the word "Bank" or
"Banque" in their name.
They are governed by the
Bank Act (Canada).
However, to
the extent
incorporated
provincially
in a
province
other than
Ontario or
Quebec the
governing
legislation
of the entity
should be
reviewed to
determine if
insolvency
winding-up
or
restructuring
is possible
under that
provincial
legislation
Other covered credit
institutions are:
- trust and/or loan
companies incorporated
under Canadian federal law
(the Trust and Loan
Companies Act) or the laws
of any of the provinces of
Canada.
-a credit union central or
credit union (which is a cooperative credit institution
or financial services cooperative) incorporated
under Canadian federal law
(the Cooperative Credit
Association Act) or the laws
of any of the provinces of
Canada
In these definitions, the term "legal entity" means an entity with legal personality other than a
private individual.
283
If appropriate, please indicate, as discussed in the instruction letter, any naming convention or rule
that would help a reader of the opinion to identify and classify the entity.
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STIKEMAN ELLIOTT
Description
Covered by
opinion
Legal form(s) 283
Central Bank. A legal entity that performs the
function of a central bank for a Sovereign or for an
area of monetary union (as in the case of the
European Central Bank in respect of the euro
zone).
No
The Bank of Canada. It is a
body corporate governed by
the Bank of Canada Act
(Canada).
Corporation. A legal entity that is organized as a
corporation or company rather than a partnership,
is engaged in industrial and/or commercial
activities and does not fall within one of the other
categories in this Appendix B.
Yes
A domestic business
corporation is one
incorporated under the
Canada Business
Corporations Act, the
Canada Corporations Act or
the business corporations
legislation of a province of
Canada. Identifying
terminology in the name is
"Corporation", "Corp.",
"Limited", "Ltd.",
"Limitee", "Ltee.",
"Incorporated",
"Incorporee", "Inc."
Railway corporations are
excluded for the scope of the
opinion.
Hedge Fund/Proprietary Trader. A legal entity,
which may be organized as a corporation,
partnership or in some other legal form, the
principal business of which is to deal in and/or
manage securities and/or other financial
instruments and/or otherwise to carry on an
investment business predominantly or exclusively
as principal for its own account.
Yes
Such funds are partnerships,
corporations or trusts
Insurance Company. A legal entity, which may be
organised as a corporation, partnership or in some
other legal form (for example, a friendly society or
industrial & provident society in the UK), that is
licensed to carry on insurance business, and is
typically subject to a special regulatory regime and
a special insolvency regime in order to protect the
Yes
Canadian domestic
insurance companies are
bodies corporate. They may
be incorporated under
federal legislation (the
Insurance Companies Act
(Canada) or provincial
6049925 v21
STIKEMAN ELLIOTT
Description
Covered by
opinion
Legal form(s)283
legislation. The corporate
name would typically use
the word "Insurance",
"Assurance", "Assurances",
"Reassurance",
"Reinsurance" or "Lifeco",
but might also be "Society",
"Life", "Re", "Casualty",
"Indemnity" "Guarantee",
"Guaranty", "Surety",
"Underwriters".
interests of policyholders.
International Organization. An organization of
Sovereigns established by treaty entered into
between the Sovereigns, including the
International Bank for Reconstruction and
Development (the World Bank), regional
development banks and similar organizations
established by treaty.
No
Investment Firm/Broker Dealer. A legal entity,
which may be organized as a corporation,
partnership or in some other form, that does not
conduct commercial banking activities but deals in
and/or manages securities and/or other financial
instruments as an agent for third parties. It may
also conduct such activities as principal (but if it
does so exclusively as principal, then it most likely
falls within the "Hedge Fund/Proprietary Trader"
category above.) Its business normally includes
holding securities and/or other financial
instruments for third parties and operating related
cash accounts. This type of entity is referred to as a
"broker-dealer" in US legislation and as an
"investment firm" in EC legislation.
Yes
An investment firm (a
broker or broker dealer)
would typically be
incorporated under the
Canada Business
Corporations Act or the
business corporations
legislation of province (not
the Canada Corporations
Act). See Corporation,
above. They would not
normally be partnerships or
in any other legal form.
Investment Fund. A legal entity or an arrangement
without legal personality (for example, a common
law trust) established to provide investors with a
share in profits or income arising from property
acquired, held, managed or disposed of by the
manager(s) of the legal entity or arrangement or a
right to payment determined by reference to such
profits or income. This type of entity or
Yes
An investment fund
organized as a corporation
(see Corporation above),
limited partnership (LP) or
trust.
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STIKEMAN ELLIOTT
Description
Covered by
opinion
Legal form(s) 283
arrangement is referred to as a "collective
investment scheme" in EC legislation. It may be
regulated or unregulated. It is typically
administered by one or more persons (who may be
private individuals and/or corporate entities) who
have various rights and obligations governed by
general law and/or, typically in the case of
regulated Investment Funds, financial services
legislation. Where the arrangement does not have
separate legal personality, one or more
representatives of the Investment Fund (for
example, a trustee of a unit trust) contract on
behalf of the Investment Fund, are owed the rights
and owe the obligations provided for in the
contract and are entitled to be indemnified out of
the assets comprised in the arrangement.
Local Authority. A legal entity established to
administer the functions of local government in a
particular region within a Sovereign or State of a
Federal Sovereign, for example, a city, county,
borough or similar area.
No
Partnership. A legal entity or form of arrangement
without legal personality that is (a) organised as a
general, limited or some other form of partnership
and (b) does not fall within one of the other
categories in this Appendix B. If it does not have
legal personality, it may nonetheless be treated as
though it were a legal person for certain purposes
(for example, for insolvency purposes) and not for
other purposes (for example, tax or personal
liability).
Yes
6049925 v21
Ordinary (general) or
limited partnerships formed
under provincial law. A
limited partnership may use
the term "limited
partnership" or LP in its
name.
STIKEMAN ELLIOTT
Description
Covered by
opinion
Pension Fund. A legal entity or an arrangement
without legal personality (for example, a common
law trust) established to provide pension benefits
to a specific class of beneficiaries, normally
sponsored by an employer or group of employers.
It is typically administered by one or more persons
(who may be private individuals and/or corporate
entities) who have various rights and obligations
governed by pensions legislation. Where the
arrangement does not have separate legal
personality, one or more representatives of the
Pension Fund (for example, a trustee of a pension
scheme in the form of a common law trust)
contract on behalf of the Pension Fund and are
owed the rights and owe the obligations provided
for in the contract and are entitled to be
indemnified out of the assets comprised in the
arrangement.
Yes if
governed by
the Ontario
or federal
law, namely
governed by
the Ontario
Pension
Benefits Act
or the
Pension
Benefits
Standards
Act
(Canada)
Private Business Trusts. A form of arrangement
without legal personality that is organized by
declaration or deed of trust, to carry on business,
other than an Investment Fund. One or more
trustees in their capacity as trustees of the Trust,
are owed the rights and owe the obligations
provided for in the contract and are entitled to be
indemnified out of the trust assets.
Yes
Sovereign. A sovereign nation state recognized
internationally as such, typically acting through a
direct agency or instrumentality of the central
government without separate legal personality, for
example, the ministry of finance, treasury or
national debt office. This category does not include
a State of a Federal Sovereign or other political
sub-division of a sovereign nation state if the
sub-division has separate legal personality (for
example, a Local Authority) and it does not
include any legal entity owned by a sovereign
nation state (see "Sovereign-owned Entity").
No
6049925 v21
Legal form(s) 283
Corporate entities or trusts.
Includes Ontario Teachers
Pension Plan Board,
OMERS Corporation,
Healthcare of Ontario
Pension Plan Board
(formerly Hospitals of
Ontario Pension Plan
Board), Canadian Pension
Plan Investment Board
(CPPIB) and Public Sector
Pension Investment Board
(PSPIB).
Does not include other
public sector plans governed
by special Act or Quebec
pension plans
As defined where trust is
stated in its constituting
document to be governed by
the laws of the province of
Ontario or Quebec.
STIKEMAN ELLIOTT
Description
Covered by
opinion
Sovereign Wealth Fund. A legal entity, often
created by a special statute and normally wholly
owned by a Sovereign, established to manage
assets of or on behalf of the Sovereign, which may
or may not hold those assets in its own name. Such
an entity is often referred to as an "investment
authority". For certain Sovereigns, this function is
performed by the Central Bank, however for
purposes of this Appendix B the term "Sovereign
Wealth Fund" excludes a Central Bank.
No
Sovereign-Owned Entity. A legal entity wholly or
majority-owned by a Sovereign, other than a
Central Bank, or by a State of a Federal Sovereign,
which may or may not benefit from any immunity
enjoyed by the Sovereign or State of a Federal
Sovereign from legal proceedings or execution
against its assets. This category may include
entities active entirely in the private sector without
any specific public duties or public sector mission
as well as statutory bodies with public duties (for
example, a statutory body charged with regulatory
responsibility over a sector of the domestic
economy). This category does not include local
governmental authorities (see "Local Authority").
No
State of a Federal Sovereign. The principal
political sub-division of a federal Sovereign, such
as Australia (for example, Queensland), Canada
(for example, Ontario), Germany (for example,
Nordrhein-Westfalen) or the United States of
America (for example, Pennsylvania). This
category does not include a Local Authority.
No
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Legal form(s) 283
STIKEMAN ELLIOTT
APPENDIX C - APPLICATION OF INSOLVENCY REGIMES
BIA
WURA
CCAA
CDIC
Act
Provincial
Receiver
BIA
Receiver
Corp.plan
Ai
Not if CBCA;
Others
theoretically
possible but not
likely
Al
X
Al
Al
Al
Al
X
Only
corporate
general
partners
X
Ai
Ai
Only corporate
general
partners
Banks
X
Al
X
Ai
X
X
Insurance Companies —
Canadian or Provincial
X
Al
X
X
X
X
If federal X;
if prov.
unclear but
not likely
Unclear but
not likely if
CPA
members;
possibly if
not CPA
members
If federal I;
Not
presently if
prov.
Unclear but
very unlikely
X
X
X
Unclear but
not likely if
CPA
members;
possibly if not
CPA
members
Ai
Depends on
governing
legislation
Corporations other than
Banks, Insurance
Companies, Credit
Institutions, Pension
Funds
Partnerships (including
Investment Fund, Hedge
Fund/Proprietary
Trader)
Credit Institutions that
are trust/ loan/ savings
corporations
X
Al
Unclear but
very unlikely
Unclear but
very unlikely
Credit Institutions that
are Credit Unions
(federal or provincial)
Ai
Ai
(possibly if nonCPA members)
Bank of Canada
X
X
X
X
X
X
Pension Plan if CPPIB,
PSPIB
X
X
X
X
X
X
X
Unclear
but not
likely
X
X
X
Al
Ai
X
Al
X
Al
X
Ai
Ai
X
Unclear
X
Unclear
X
Al
Al
X
Pension Plan (not CPPIB,
PSPIB)284
Income Trusts *
Trusts (other than
Investment Trusts and
Pension Plans), including
Investment Funds
organized as trusts
As noted in the memorandum, pension plan trusts are likely to be wound up by the trustee either
voluntarily or under the supervision of the regulator.
publicly traded.
284
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APPENDIX D - DESCRIPTION OF CANADIAN INSOLVENCY REGIMES
Canadian insolvency regimes can be divided into two general categories. The
first category is liquidation regimes. These include:
(2)
the bankruptcy provisions of the BIA,
(3)
the liquidation provisions of the WURA,
(4)
the receivership provisions of the CDIC Act,
(5)
court administered receivership,
in the case of Pension Plans, winding-up under the supervision of the
(6)
regulator, and
in the case of Pension Plan and other trusts such as Investment Funds,
(7)
voluntary winding-up by the trustee or plan administrator. 285
The primary purpose of liquidation regimes is for the insolvency representative,
whether the trustee in bankruptcy, the liquidator, the court appointed receiver,
administrator or trustee, to realize all of the assets of the insolvent entity for the
benefit of its creditors.
The second category is reorganization regimes. These include:
(1)
the proposal provisions of the BIA,
(2)
the reorganization provisions of the CDIC Act,
(3)
the arrangement provisions of the CCAA, and
(4)
a corporate plan of arrangement under the relevant corporate legislation.
BIA Bankruptcy. This is a voluntary or involuntary proceeding where a trustee
in bankruptcy is appointed to liquidate the assets of the debtor for the benefit of
creditors. The debtor's assets vest by operation of law in the trustee.
By its terms the BIA applies to almost any type of legal entity, including
individuals, partnerships, associations and corporations. The BIA defines
" corporations" to include any company incorporated or authorized to do
business by or under a federal or provincial Act or any incorporated company
285 This is not strictly speaking an insolvency regime, but it is likely the manner in which an insolvent trust
would be dealt with.
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that has an office in or carries on business in Canada. However, excluded from
the definition of "corporations" are banks, savings banks, insurance companies,
trust companies, loan companies and railway companies. 286 Holding companies
of such entities are subject to the BIA. The BIA expressly applies to non-Canadian
corporations with assets in Canada. 287
The BIA applies to "income trusts" (including publicly listed investment funds).
An "income trust" is a trust that has assets in Canada and the units of which are
traded on a prescribed stock exchange or a trust all of the units of which are held
by an entity that trades on a prescribed stock exchange. A prescribed stock
exchange is one that is regulated by an Act of Parliament or the legislature of a
province.
It is not clear whether the BIA applies to trusts that are not income trusts. Its
application to trusts is an open question. It may be that the trustee in its capacity
as trustee could become subject to the BIA, but there are impediments to this
analysis because the BIA generally excludes property held in trust from the
scheme of distribution. In any event, if the trustee is a financial institution it
likely could not be subject to the BIA even if it sought to apply solely in its
capacity as trustee and with respect to the assets held in trust. For the purpose of
analyzing netting rights, parties should assume that the BIA might apply to a
trust, such as an Investment Fund, Trust or Pension Plan that does not have a
Canadian trust company as trustee.
WURA Liquidation. A liquidator appointed by order of the court takes control
of the debtor's assets to deal with in accordance with the court order for the
purpose of liquidating the assets for the benefit of creditors.
Banks, other Credit Institutions, Insurance Companies, incorporated under
Canadian law or carrying on operations in Canada are potentially subject to the
WURA. Although the WURA also applies to other types of "trading
companies" 288 (except corporations incorporated under the Canada Business
BIA, s.2.
BIA. s.2. "insolvent person".
288 The WURA defines a "trading company" as: any company, except a railway or telegraph company,
carrying on business similar to that carried on by apothecaries, auctioneers, bankers, brokers, brickmakers,
builders, carpenters, carriers, cattle or sheep salesmen, coach proprietors, dyers, fullers, keepers of inns,
taverns, hotels, saloons or coffee houses, lime burners, livery stable keepers, market gardeners, millers,
miners, packers, printers, quarrymen, sharebrokers, ship-owners, ship-wrights, stockbrokers, stock-jobbers,
victuallers, warehousemen, wharfingers, persons using the trade of merchandise by way of bargaining,
exchange, bartering, commission, consignment or otherwise, in gross or by retail, or by persons who, either
for themselves, or as agents or factors for others, seek their living by buying and selling or buying and
letting for hire goods or commodities, or by the manufacture, workmanship or the conversion of goods or
commodities or trees.
286
287
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Corporations Act)289, Corporations that are not financial institutions are normally
liquidated under the BIA. Trusts and Partnerships are not subject to the WURA,
although the trustee or partner may be.
The liquidator of a company being wound-up under the WURA can also take
advantage of the BIA proposal provisions if the entity is a Corporation of a type
that could be subject to the BIA. 290
BIA Proposal. The purpose of the proposal provisions of the BIA is to allow the
insolvent entity time to develop a plan for the continued operation of the
business which involves the compromise of the existing claims of its creditors.
The proposal provisions potentially apply to the same types of entities that the
BIA bankruptcy provisions potentially apply to.
CCAA. The purpose of the proposal provisions of the BIA and the arrangement
provisions of the CCAA is to allow the insolvent entity time to develop a plan for
the continued operation of the business which involves the compromise of the
existing claims of its creditors. For larger corporations it is the preferred
procedure over BIA proposal. It is also occasionally used to effect an orderly
liquidation of an entity.
The CCAA applies to corporations with aggregate claims against it of over
5 million CAD. Banks, insurance companies, railways and federal loan and trust
corporations are expressly excluded from the application of the CCAA.
Provincial loan and trust corporations are not expressly excluded, and there is
some uncertainty as to whether the CCAA could apply to such entities.
The CCAA applies to "income trusts" (including publicly traded mutual funds).
An "income trust" is a trust that has assets in Canada and the units of which are
traded on a prescribed stock exchange or a trust all of the units of which are held
by an entity that trades on a prescribed stock exchange. A prescribed stock
exchange is one that is regulated by an Act of Parliament or the legislature of a
province.
It is not clear whether the CCAA applies to trusts that are not income trusts. Its
application to trusts is an open question. A corporate trustee in its capacity as
trustee could become subject to the CCAA 291, but the CCAA is intended to apply
to corporations. In any event, if the trustee is a financial institution it likely could
The Canada Business Corporations Act, R.S.C. 1985, c.C-44, s.3(3), specifically provides that corporations
governed by it are not to be wound-up under the WURA.
290 BIA, s.50.
291 As occurred with respect to the restructuring of many of the issuer trusts of Canadian asset backed
commercial paper market.
289
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not be subject to the CCAA even if it sought to apply solely in its capacity as
trustee and with respect to the assets held in trust. For the purpose of analyzing
netting rights, parties should assume that the CCAA might apply to a trust, such
as an Investment Fund, Trust or Pension Plan that does not have a Canadian
trust company or individuals as trustees.
CDIC Act Receivership or Restructuring. Prior to the involvement of Canada
Deposit Insurance Corporation (CDIC), the Superintendent of Financial
Institutions may take control of a deposit taking institution's assets. 292 After
taking control, the Superintendent might also, as a further step, take over the
management of the business and affairs of the institution. 293 The Superintendent
is not given any extraordinary powers that could, in our view, allow him to alter
the contractual arrangements of the financial institution.
In certain circumstances, CDIC can obtain an order vesting the shares and
subordinated debt of such institutions in it in order to attempt a sale of the
institution, an amalgamation or any other transaction to restructure a substantial
part of the institution's business. 294 The purpose of the CDIC Act reorganization
provisions is to place CDIC in control of a federal deposit taking institution
(namely banks and deposit taking federal loan and trust corporations) for the
purpose of restructuring its affairs at a shareholder level. Under this regime, the
rights of creditors are delayed in order to facilitate the restructuring, but are not
compromised. A receivership with CDIC as receiver is also possible. An entity
might also be restructured under the WURA. We have discussed the WURA
under the liquidation heading and the CDIC Act under the restructuring
heading.
Court Administered Receivership. Generally, court administered receivership is
an alternative regime to the BIA. Unlike the BIA and the WURA, no particular
statute governs a court-administered receivership. In Ontario, a judge is given
jurisdiction by provincial statute to appoint a receiver whenever it appears
convenient to do so on whatever terms the judge determines to be appropriate.
The receiver's function is to realize upon all of the assets of the debtor for the
benefit of all creditors. Through the court order, the judge (most often upon the
application of a major secured creditor) designs the procedure and rules for the
particular receivership. The terms of such orders tend to be fairly standard, but
are also constantly and gradually evolving. Recent amendments to the BIA
292 The statutory authority for the Superintendent's intervention depends upon the type of entity involved.
The Bank Act (Canada), S.C. 1991, c.46, s.538 confers the authority with respect to banks. The Trust and Loan
Companies Act (Canada), S.C. 1991, c.45, s.510 confers the authority with respect to federal trust or loan
companies.
293 Bank Act, s.538; Trust and Loan Companies Act, s.514.
294 CDIC Act, s.39.19.
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provide for the appointment of a national receiver. Although there is no
provincial law in Quebec with respect to the appointment of a receiver in the
context of an insolvency, the BIA appointed receiver would have jurisdiction
with respect to assets and entities located in Quebec. A national receiver is also
appointed by court order and the terms of the order would be similar to the
receiver appointed under provincial law.
There is no restriction on the type of entity that could be subject to a receivership
order. The Courts of Justice Act (Ontario) do not specify and, therefore, do not
limit, the types of entities over which a judge has jurisdiction to appoint a
receiver. As far as we are aware, there is no precedent supporting the jurisdiction
of a judge to appoint a receiver of a financial institution. Liquidation under the
WURA and now under the CDIC Act is a very similar proceeding to court
administered receivership and, therefore, there is no need to resort to this
procedure for such institutions. With respect to banks and other federal deposittaking institutions, the federal deposit insurer, CDIC, has the power to control
the liquidation and it is highly unlikely that it would cede this power to a courtappointed receiver. Also, receiverships are typically orchestrated by a major
secured creditor, which financial institutions do not have given that they do not
grant blanket security to secured creditors. 295
Corporate Plan. Corporate Plans of Arrangement are governed by corporate
statutes, such as the Canada Business Corporations Act and the Ontario Business
Corporations Act (Corporate Plan). 296 A corporate plan procedure is relevant only
to corporations that are governed by a corporations statute that provides for the
plan of arrangement procedure. This would include most Canadian business
corporations, but does not include banks, insurance companies and other
federally incorporated financial institutions. The Corporate Plan proceeding is
not an insolvency proceeding and is most often used outside of an insolvency
context to restructure the equity and/ or debt securities of a corporation. This
proceeding also involves voting on the plan by classes of security holders and
court sanction following a fairness hearing. Notwithstanding that most business
corporation statutes require the applicant corporation to be solvent, it has been
employed where corporations are on the verge of insolvency or insolvent to
restructure debt security holders. Rarely has this procedure affected other
The BIA now provides for the appointment of a national receiver under the BIA. In the past
appointments were made under provincial law only.
296 These statutes apply regardless of the province in which the matter is being litigated. Each province has
its own business corporation legislation, all of which provide for plans of arrangement and some of which
expressly provide for the arrangement of creditors.
295
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STIKEMAN ELLIOTT
creditor classes, although a recent decision allowed it to be extended to term
lenders. 297
PCSA. The PCSA is not an insolvency statute, but is overriding legislation that,
in part, ensures the enforceability of termination and netting rights in
agreements between financial institutions.
297
See the Abitibi case discussed in more detail in Question I.B.1 (Qualification 1).
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APPENDIX E - DEFINITION OF ELIGIBLE FINANCIAL CONTRACT
ELIGIBLE FINANCIAL CONTRACT REGULATIONS [BANKRUPTCY AND
INSOLVENCY ACT/ CANADA DEPOSIT INSURANCE CORPORATION
ACT/ PAYMENT CLEARING AND SETTLEMENT ACT/ WINDING UP AND
RESTRUCTURING ACT/ COMPANIES' CREDITORS ARRANGEMENT ACT]
1. The following definitions apply in these Regulations.
"derivatives agreement" means a financial agreement whose obligations are derived
from, referenced to, or based on, one or more underlying reference items such as interest
rates, indices, currencies, commodities, securities or other ownership interests, credit or
guarantee obligations, debt securities, climatic variables, bandwidth, freight rates,
emission rights, real property indices and inflation or other macroeconomic data and
includes
(a) a contract for differences or a swap, including a total return swap, price return
swap, default swap or basis swap;
(b) a futures agreement;
(c) a cap, collar, floor or spread;
(d) an option; and
(e) a spot or forward (contrat derive).
"financial intermediary" means
(a) a clearing agency; or
(b) a person, including a broker, bank or trust company, that in the ordinary
course of business maintains securities accounts or futures accounts for others.
(intermediaire financier).
2. The following kinds of financial agreements are prescribed for the purpose of the
definition "eligible financial contract" in [refers to relevant section in relevant Act]:
(a) a derivatives agreement, whether settled by payment or delivery, that
(i) trades on a futures or options exchange or board, or other regulated
market, or
(ii) is the subject of recurrent dealings in the derivatives markets or in the
over-the-counter securities or commodities markets;
(b) an agreement to
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STIKEMAN ELLIOTT
(i) borrow or lend securities or commodities, including an agreement to
transfer securities or commodities under which the borrower may repay the
loan with other securities or commodities, cash or cash equivalents,
(ii) clear or settle securities, futures, options or derivatives transactions, or
(iii) act as a depository for securities;
(c) a repurchase, reverse repurchase or buy-sellback agreement with respect to
securities or commodities;
(d) a margin loan in so far as it is in respect of a securities account or futures
account maintained by a financial intermediary;
(e) any combination of agreements referred to in any of paragraphs (a) to (d);
(f) a master agreement in so far as it is in respect of an agreement referred to in
any of paragraphs (a) to (e);
(g) a master agreement in so far as it is in respect of a master agreement referred
to in paragraph (f);
(h) a guarantee of, or an indemnity or reimbursement obligation with respect to,
the liabilities under an agreement referred to in any of paragraphs (a) to (g); and
(i) an agreement relating to financial collateral, including any form of security or
security interest in collateral and a title transfer credit support agreement, with
respect to an agreement referred to in any of paragraphs (a) to (h).
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APPENDIX F - PENSION ENTITY WINDING-UP
Ontario Pension Benefits Act (Ontario PBA)
There is nothing in the Ontario PBA that expressly imposes any stay on
termination of contracts pursuant to their terms, or netting of transaction values
or on liquidating credit support when a wind-up is commenced. Nor is there
anything that expressly gives the regulator the power to impose any such
requirement.
If the regulator purported to exercise such a power, section 13 of the PCSA
might provide a basis upon which to challenge his action. See the analysis of
section 13 above. The trustees of the pension entity (or the entity itself if in
corporate form) would be a "financial institution" or a "customer". However,
there is uncertainty as to whether section 13 applies because of the fact that the
pension statute is not strictly speaking an "insolvency" law. 298
In any event, we do not believe that the Ontario regulator would have any
power to prevent a party from exercising its termination rights to the extent they
are triggered and we believe any attempt to do so could be successfully
challenged in our view simply on the basis that he does not have the statutory
jurisdiction to take such action.
Federal Pension Benefits Standards Act (Federal PBSA)
There is nothing in the Federal PBSA that expressly imposes any stay on
termination of contracts pursuant to their terms, or netting of transaction values
or on liquidating collateral when a wind-up is commenced. Nor is there anything
that expressly gives the regulator the power to impose any such requirement.
The federal Superintendent of Financial Institutions (the pension regulator) does
have wide remedial powers of a general nature. Section 11 of the Federal PBSA
provides that the Superintendent can give directions to plan administrators "or
any person" in respect of a pension plan who is about to commit an act or pursue
a course of conduct that is contrary to safe and sound financial or business
practices. The Superintendent can direct the person to refrain from committing
the act or to perform a remedial act. We do not believe that this general power
would give the Superintendent jurisdiction to order a party to a Transaction with
the trustee/administrator of the plan to refrain from terminating its
agreement. 299
There may also be constitutional limitations to applying the PCSA to a provincial winding-up process.
Given that the Superintendent of Financial Institutions is also the regulator that requires financial
institutions to have robust termination and netting rights under such contracts, it would be surprising if it
tried to undermine those same rights by attempting to use the section 11 power to prevent a third party
institutions from exercising them.
298
299
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Superintendent's directions to administrators
11. (1) If, in the opinion of the Superintendent, an administrator,
an employer or any person is, in respect of a pension plan,
committing or about to commit an act, or pursuing or about to
pursue any course of conduct, that is contrary to safe and sound
financial or business practices, the Superintendent may direct
the administrator, employer or other person to
(a) cease or refrain from committing the act or pursuing
the course of conduct; and
(b) perform such acts as in the opinion of the
Superintendent are necessary to remedy the situation.
Directions in the case of non-compliance
(2) If, in the opinion of the Superintendent, a pension plan does
not comply with this Act or the regulations or is not being
administered in accordance with this Act, the regulations or the
plan, the Superintendent may direct the administrator, the
employer or any person to
(a) cease or refrain from committing the act or pursuing
the course of conduct that constitutes the noncompliance; and
(b) perform such acts as in the opinion of the
Superintendent are necessary to remedy the situation.
Opportunity for representations
(3) Subject to subsection (4), no direction shall be issued under
subsection (1) or (2) unless the Superintendent gives the
administrator, employer or other person a reasonable
opportunity to make written representations.
Temporary direction
(4) If, in the opinion of the Superintendent, the length of time
required for representations to be made under subsection (3)
might be prejudicial to the interests of the members, former
members or any other persons entitled to pension benefits or
refunds under the pension plan, the Superintendent may make a
temporary direction with respect to the matters referred to in
subsection (1) or (2) that has effect for a period of not more than
fifteen days.
Continued effect
(5) A temporary direction under subsection (4) continues to
have effect after the expiry of the fifteen day period referred to in
that subsection if no representations are made to the
Superintendent within that period or, if representations have
been made, the Superintendent notifies the administrator,
employer or other person that the Superintendent is not satisfied
that there are sufficient grounds for revoking the direction.
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If the Superintendent purported to exercise a stay power with respect to
the termination rights, section 13 of the PCSA might provide a basis upon which
to challenge his action. As with Ontario PBA plans, there is uncertainty as to
whether section 13 applies because of the fact that the Federal PBSA is not strictly
an "insolvency" law. 300
In any event, do not believe that the Superintendent has any power to prevent a
party from exercising its termination rights and we believe any attempt to do so
could be successfully challenged in our view simply on the basis that he does not
have the statutory jurisdiction to take such action.
CPPIB and PSPIB
The analysis with respect to the federal public sector plans (CPPIB and PSBIB) is
somewhat different because of the fact that they cannot be wound up without an
Act of Parliament.
In light of the statutory immunity provisions it is somewhat odd that both
pension entities are specifically defined as a "financial institution" for purposes
of section 13 of the PCSA. If a court appointed a receiver to manage and
reorganize an entity (as opposed to winding it up), this restructuring procedure
may not be caught by the statutory immunities. However, receivership seems an
unlikely possibility for these entities. We suspect that when they were included
in the list of financial institutions in section 13, the legislators did not have the
statutory immunities in mind. In any event, with respect to these entities there is
a specific netting law, even though it may not ever come into play in practice. If
the government were to pass legislation for the winding up it would have to
specifically repeal the PCSA in so far as it applies to these entities or specifically
override it.
Given the statutory immunity from insolvency proceedings, there are no
insolvency laws currently in place that could interfere with the enforceability of a
termination right. CPPIB and PSPIB cannot be subject to an insolvency type
proceeding unless Parliament takes the very significant step of passing
legislation.
Although unlike the Ontario case, there is no constitutional impediment to the PCSA taking priority over
the provincial regime.
300
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APPENDIX G - INSOLVENCY PROCEEDING STAYS
Likelihood of
Stay on
Realization of
Collateral
Length of Stay on Realization
of Collateral (without
statutory exemption)
Likelihood of
Stay on Set-off
Statutory Exemption
for Financial
Collateral for
Eligible Financial
Contracts
BIA
Bankruptcy
Unlikely for
securities or cash
collateral
Up to 6 months
No stay likely
Yes
BIA Proposal
Automatic stay
Up to 6 months plus possibility
that plan may stay permanently
(subject to new default ) or
otherwise compromise rights
No stay likely
Yes
WURA
Unlikely for
securities or cash
collateral
Up to 6 months (may be longer
in restructuring proceedings)
No stay
Yes, subject to bridge
institution provisions
if preceded by CDIC
Act receivership
proceeding
CCAA
Automatic stay
No limit; plus possibility that
plan or court order may stay
permanently (subject to new
default) or otherwise
compromise rights
No stay
(temporary
only)
Yes
CDIC
Automatic stay
No limit; if proceeding is a
liquidation, Superintendent
may realize on secured party's
behalf
Automatic stay
Yes, but subject to the
bridge bank
provisions
Receivership
Unlikely
No limit
Unlikely
No, unless PCSA
applies
Corporate
Plan
Unlikely
No limit
Unlikely
No
Voluntary
Wind-up
No stay
N/A
No stay
No
Windup by
pension
regulator
No stay
N/A
No stay
No unless PCSA
applies
CPPIB,
PSPIB and
Bank of
Canada
No stay
N/A
No stay
No
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APPENDIX H - SUMMARY OF CONFLICT OF LAWS RULES
Validity, Perfection and Priority of Security Interests
Manner of Holding
Characterization for
PPSA/CCQ
Purposes
Governing Law Validity of Security
Interest
Governing LawPerfection/
Publication and
Priority301
Cash not held in a
"securities account"
Ont. Intangible;
Que. Incorpreal
Movable Property
Place where debtor is
located (Ont) or
domiciled (Que) at
time of
attachment/creation
Place where debtor
is located (Ont) or
domiciled (Que) at
time of
attachment/creation
account where
intermediary and account
holder have not agreed
that it is not a financial
asset
Investment Property
Securities
intermediary's
jurisdiction at the
time of attachment/
creation
Securities
intermediary's
jurisdiction if
perfecting by
control
account where
intermediary and account
holder have agreed that it
is not a financial asset
Intangible
Place where debtor is
located at time of
attachment/ creation
Place where debtor
is located
Directly held bearer or
registered securities
Investment Property
(Ont.)
Place where
certificate is located
at time of
attachment/ creation
Place where
certificate is located
if perfecting by
delivery or control
Issuer's jurisdiction
at time of
Financial Assets (Que. attachment/creation
Issuer's jurisdiction
if perfecting by
delivery or control
Financial Assets
(Que.)
Directly held
uncertificated/ demateriali
zed securities
Investment Property (Ont.)
Indirectly held securities
Investment Property
(Ont.)
Financial Assets
(Que.)
Futures Contracts and
301
Ont. Intangibles if
Clearing Member is
Securities
intermediary's
jurisdiction at the
time of attachment/
creation
Securities
intermediary's
jurisdiction if
perfecting by
control
Ont. Intangible - see
Intangible - see
This is always location/ domicile of debtor if means of perfection is registration.
6049925 v21
STIKEMAN ELLIOTT
Futures Accounts
not a Canadian
registered FCM
Ont. Futures
Contracts and
Futures Accounts if
Clearing Member is
a Canadian
registered FCM
below
below
Future - futures
intermediary's
location at time of
attachments
Future - futures
Ont. Debtor's
location at time of
attachment
Ont. Debtor's
location at time of
attachment
Que. Debtor's
domicile at time of
creation
Que. Debtor's
domicile at time of
creation
intermediary's
location at relevant
time
Quebec: Likely same
rule as for
subsequent item
Intangibles, including
contractual rights with
respect to Futures
Transactions and Covered
Derivative Contract and
payment rights under
them
Ont. Intangibles
Que. Incorporeal
Movable Property
2
6049925 v21

STIKEMAN ELLIOTT MEMORANDUM OF LAW FOR THE

Transcription

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