Presenting a live 90-minute webinar with interactive Q&A

Perfecting Security Interests in Deposit

Accounts, Securities Accounts and
Other Investment Property
Establishing Control Under the UCC with Special Types of Collateral

THURSDAY, APRIL 27, 2017

1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific

Today’s faculty features:

Sandra M. Rocks, Counsel, Cleary Gottlieb Steen & Hamilton, New York

Edwin E. Smith, Partner, Morgan, Lewis & Bockius, New York and Boston

Steven O. Weise, Partner, Proskauer Rose, Los Angeles

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

Sandra Rocks
Cleary Gottlieb Steen & Hamilton LLP
Edwin E. Smith
Morgan, Lewis & Bockius LLP
Steve Weise
April 2017 Proskauer Rose LLP
Topics – UCC framework
• Choice of law
• Creation of security interest
• Perfection, effect of perfection or nonperfection,
and priority of security interest
• Secured party duties and exercise of remedies
• Comparison of security interests in deposit accounts
and security interests in securities accounts
• Legal opinions

6
Topics – control agreements
• Drafting and negotiating control agreements
• Deposit accounts
• Securities accounts / security entitlements
• Control agreement provisions
• Related to UCC provisions / requirements
• Commonly negotiated business terms
• Considerations in representing indenture trustees
and collateral agents
• Considerations in representing banks and securities
intermediaries

7
Choice of law
• Investment property
• Certificated securities
• Uncertificated securities
• Securities accounts
• Securities intermediary’s jurisdiction
• Hague Securities Convention
• Deposit accounts
8
Exclusion from Article 9
• UCC § 9-109(d)(13) excludes from Article 9 a security
interest in a deposit account in a consumer transaction
• UCC § 9-102(a)(26) consumer transaction:
• individual as pledgor
• purpose of the borrowing
• size of transaction not relevant
• In excluded transactions, non-UCC law applies to choice of
law, creation, perfection, and priority of collateral
assignment (common law ‘dominion and control’ and
exclusion of debtor)

9
What is a ‘security’ – shares?
• ‘Security’: share or similar equity interest
issued by:
• Corporation/business trust/ statutory
trust
• ‘Similar entity’

10
What is a ‘security’ – other interests?
• Not a ‘security’:
• Partnership interest
• LLC interest
• Series LLC interest?
• Exceptions to exclusion of LLC and partnership interests:
• Override exclusion by ‘opting in’ (UCC § 8-103)
• Held as a security entitlement
• Registered investment company / publicly traded
• Debt (if a ‘security’)
• Highland Capital Management LP v. Schneider (N.Y. 2007)
• 2010 Revisions – UCC § 8-102, Comment 13
• PEB Commentary

11
Deposit account v. securities account
– does it matter?
• Requirements for control agreement
• Description of the account
• Choice of law
• Available perfection methods
• Protected purchaser / ‘takes free’ rules
• Transaction excluded from Article 9
• Credit risk
• In re Gem Refrigerator Co., 512 B.R. 194 (Bankr. E.D.
Pa. 2014)

12
What is an ‘account’?
• No definition in the UCC for the ‘account’
element of a ‘securities account’ or ‘deposit
account’
• Reliance on the books and records of the
securities intermediary or bank, whether or
not designated by it as an ‘account’
• Except, in the case of a deposit account, a
certificate of deposit that qualifies as an
instrument. See UCC § 9-102(a)(29)

13
What is a ‘deposit account’?
• Debt of a bank to its customer
• Includes certificates of deposit (CDs) that are not
represented by an instrument
• Can include some certificated CDs (In re Perez (Bankr. D.
N.J. 2010))
• CDARS program
• CDs held in a securities account
• Not a deposit account
• Monticello Banking Company v. Flener (In re
Alexander), 2011 WL 9961118, 2011 U.S. App. LEXIS
26350 (6th Cir. 2011) [part of decision on collateral
description issues discussed below]

14
What is a ‘securities account’/security
‘entitlement’?
• Custodial arrangement for holding customer assets
• Security entitlement – bundle of rights wit respect to asset
that a securities intermediary has agreed to hold for its
customer and is a financial assets or securities
intermediary has agreed to treat as a financial asset
• Credited or accepted for credit to the customer's
securities account
• Intermediary obligated to credit to the account
• Securities account – a collection of security entitlements
• May also include other rights of the customer against
the intermediary

15
In what ‘capacity’ is the bank or
securities intermediary acting?
• Example:
• Bank is the depositary bank for Customer.
• Bank is also the agent on a syndicated loan facility to
Customer.
• Under a security agreement authenticated by Customer,
Customer has granted to Bank, as agent for the benefit of
the syndicate lenders, a security interest in all of Customer’s
customers deposit accounts maintained at Bank.
• Is a control agreement required for the Bank, as agent for the
benefit of the syndicate lenders, to have a security interest in
the deposit accounts perfected by control?
• See Comment 1 to UCC § 9-104 (2010)

16
Treatment of ‘financial assets’
• Securities account
• ‘Financial assets’ other than securities. See UCC §
8-102(a)(9)(iii); Article 8, Prefatory Note, III.C.1.
• ‘Cash’
• Duty to maintain under UCC § 8-504.
• Question about ‘cash balance’ credited to a
securities account if no election to treat ‘cash’ as a
financial asset.
• Investment in U.S. treasuries or money market
shares
• Use of deposit account
17
Choice of law – deposit account
• Local law of the bank’s jurisdiction governs perfection, the
effect of perfection or nonperfection, and priority of a
security interest in a deposit account at that bank (UCC §
9-304)
• Bank’s jurisdiction is determined as provided in UCC § 9-
304(b)
• Can select bank’s jurisdiction in the control agreement
• If not in a control agreement, UCC § 9-304(b) provides
rules
• No ‘reasonable relationship’ requirement ((see UCC § 1-
301 (former UCC § 1-103)

18
Choice of law – securities
• Certificated security
• Local law of the jurisdiction where certificated security
is located governs perfection, the effect of perfection or
nonperfection, + priority (UCC § 9-305(a)(1))
• Uncertificated Security
• Local law of the issuer’s jurisdiction (as specified in UCC
§ 8-110(d)) governs perfection, the effect of perfection
or nonperfection, + priority (UCC § 9-305(a)(2))
• Perfection by filing
• Location of debtor (UCC § 9-305(c)(1))

19
Choice of law – securities account
/security entitlement
• Local law of securities intermediary’s jurisdiction governs
perfection, the effect of perfection or nonperfection, and
priority (UCC § 9-305(a)(3))
• Securities intermediary’s jurisdiction is determined as
provided in UCC § 8-110(e)
• Can establish by control agreement
• If not in a control agreement, UCC § 8-110(e) provides
rules
• Perfection by filing – location of debtor (UCC § 9-
305(c)(1))
• Effect of Hague Securities Convention (discussed earlier)

20
Creation of security interest
• Usual requirements (UCC § 9-203):
• Debtor has rights in the collateral
• Value (UCC § 1-204 (Former UCC § 1-201(44)))
• Security agreement evidenced by an
authenticated record
• Legally sufficient description of collateral
• Exceptions to requirement for authenticated record
(UCC § 9-203(b)(3)(C) - (D))
• Control
• Possession of certificated security

21
Description or indication of
investment property as collateral
• UCC § 9-108 description is sufficient, whether or not it is specific, if it
reasonably identifies what is described
• UCC § 9-108(b) examples of reasonable description
(including by UCC type)
• UCC § 9-108(d) description of a security entitlement, securities
account, or commodity account is sufficient if it describes:
• by those terms or as investment property, or
• the underlying financial asset or commodity contract
• UCC § 9-108(e) consumer transaction rule
• Monticello Banking Company v. Flener (In re Alexander), 2011 WL 9961118,
2011 U.S. App. LEXIS 26350 (6th Cir. 2011)
• Must use UCC § 9-108(d) language
• Decision widely criticized

22
Perfection and priority by ‘control’
• Control as a method of perfection
• Alternative to filing for securities, security
entitlement, and securities account as
original collateral
• Only method of perfection for a deposit
account as original collateral
• Control as establishing non-temporal
priority over a security interest not
perfected by control

23
Other benefits of control
• Requirement for protected purchaser
status
• Control allows secured party to exercise
remedies without court involvement

24
Security agreement v. control
agreement
• Security agreement
• Between debtor and secured party
• Grants security interest and describes the collateral and secured obligations
• Specifies defaults and remedies (with loan agreement)
• Choice of law for creation of security interest
• Control agreement
• Among debtor, secured party and depositary bank / securities intermediary where
account is maintained
• Gives secured party right to direct the bank / securities intermediary as to the
account
• Deals with priority as between secured party and bank / intermediary
• Choice of law for perfection/priority/effect of perfection or nonperfection of
security interest
• Practice pointer: keep them separate

25
Meaning of ‘control’ – general
• ‘Control’ means the ability of secured party to
direct transfer or disposition of funds / assets
without further consent or action of debtor
• Control exists even if debtor retains right to
make substitutions, originate instructions or
otherwise deal with collateral (UCC §§ 9-104(b),
8-106(f))
• Traditional ‘blocked’ account agreement may
not suffice

26
Control – certificated security
• UCC § 8-106(b) ‘purchaser’ (including a secured
party) has control of a certificated security in
registered form if:
• Certificated security is ‘delivered’ to the purchaser
(possession) and
• Certificate is either:
• Indorsed to the purchaser or in blank by an
effective indorsement or
• Registered in the name of the purchaser (upon
original issue or registration of transfer by the
issuer)

27
Control – uncertificated security
• UCC § 8-106(c) ‘purchaser’ (including a
secured party) has control of an
uncertificated security if:
• Uncertificated security is ‘delivered’ to the
purchaser (registered in purchaser’s
name) or
• Issuer has agreed that it will comply with
instructions originated by the purchaser
without further consent by the registered
owner
28
Control – securities account/
security entitlement
• UCC § 8-106(d) purchaser (including a secured party) has control
of security entitlement if:
• Purchaser becomes the entitlement holder
• Securities intermediary has agreed that it will comply with
entitlement orders originated by purchaser without further
consent by entitlement holder or
• Another person has control of the security entitlement on
behalf of purchaser or, having previously acquired control of
the security entitlement, acknowledges that it has control on
behalf of purchaser
• UCC § 8-106(e) if security interest in a security entitlement is
granted by entitlement holder to entitlement holder’s own
securities intermediary, securities intermediary has control

29
Control – deposit account
• UCC § 9-104(a) secured party has control of deposit
account if:
• Secured party is the bank with which the deposit
account is maintained
• Debtor, secured party and bank have agreed in an
authenticated record that bank will comply with
instructions originated by secured party directing
disposition of the funds in the deposit account
without further consent by debtor or
• Secured party becomes the bank’s customer with
respect to the deposit account

30
Type of agreement
• Securities account
• Oral agreement? (see UCC § 8-113)
• Deposit account
• Authenticated record

31
Bank/intermediary’s rights
• Bank not required to:
• Enter into control agreement
• Confirm existence of control agreement (UCC § 9-342)
• Securities intermediary not required to:
• Enter into control agreement
• Confirm existence of control agreement (UCC § 8-
106(g))
• Securities intermediary may not enter into control
agreement without consent of entitlement holder (UCC §
8-106(g))

32
Who are the parties?
• Securities account/security entitlement
• Agreement of only the securities
intermediary?
• Deposit account
• Three-party agreement in a single
agreement?

33
Control – securities account /
security entitlement
• Who is the securities intermediary?
• Referring and clearing brokers
• National Consumer Cooperative Bank v.
Morgan Stanley & Co. (M.D. Pa. 2010)
• Fifth Third Bank v. Lincoln Financial
Securities Corp. (WD Ky 2009)
• Practice pointer: If can’t determine who is
the intermediary, have all sign the control
agreement

34
Key control agreement provision –
deposit accounts
• ‘The bank agrees to comply with
instructions originated by the secured
party, without the debtor’s further
consent.’

35
Key control agreement provision –
security entitlement/account
• ‘Intermediary agrees to comply with all
entitlement orders originated by
secured party, without debtor’s further
consent.’

36
Effect of other provisions on present
‘control’ – general
• Watch for provisions that amount to a
debtor ‘consent’ right

37
Effect of other provisions on present
‘control’ – conditions
• Example: The control agreement states that
the secured party may not give an
entitlement order or instruction to the
securities intermediary or bank unless the
secured party certifies to the securities
intermediary or bank that the debtor is in
default.
• See Comment 7 to UCC § 8-106 and
Comment 3 to UCC § 9-104

38
Effect of other provisions on present
‘control’ – conditions
• Example: The control agreement states
that the junior secured party may not
give an entitlement order or instruction
to the securities intermediary or bank
unless the senior secured party
consents.
• See Comment 7 to UCC § 8-106
39
Effect of other provisions on present
‘control’ – debtor default
• Confirmation from debtor as to:
• Occurrence of a default
• Amount that can be withdrawn

40
Effect of other provisions on present
‘control’ – interpleader
• Contractual interpleader rights?
• Compare to statutory interpleader
rights

41
Effect of other provisions on present
‘control’ – termination
• Debtor’s right to terminate the
agreement before bank is required to
act on secured party’s instructions
• Provide that upon termination by
debtor funds or financial assets
transferred to secured party

42
Effect of other provisions on present
‘control’ – delays
• Delays before bank required to act?

43
Priority – general rules
• Perfection by control has priority over
perfection by other means
• First to obtain control has priority
• Depositary bank or securities
intermediary as secured party will have
priority even if it obtains control later in
time (See UCC §§ 9-327(3) and 9-328(3))

44
Other bank rights
• UCC § 9-340 depositary bank rights:
• Right of set off
• Right of recoupment

45
Subordination issues
• Fees and expenses of the securities
intermediary or bank
• Reversals of provisional credits/returned
items
• New advances by the securities intermediary
or bank
• Margin
• Indemnities from account holder

46
Control agreement: subordination
• ‘Bank/intermediary subordinates in favor
of secured party any security interest,
lien or right of setoff or recoupment
bank may now or in future have against
the account.’
• Absent agreement to the contrary, the
bank or intermediary can exercise its
subordinated remedies
47
Investment property: protected
purchaser and ‘takes free’
• Applies to secured parties
• ‘Purchaser’/‘purchase’ (UCC § 1-201(b)(29), (30))
• UCC § 8-303(a) protected purchaser
• Gives value (UCC § 1-204 (Former UCC § 1-201(44)))
• Does not have notice of any adverse claim to the
security (certificated or uncertificated)
• Obtains control of the security
• Analogous protection for securities accounts /
security entitlements
• UCC §§ 8-502, 8-503, 8-510
48
Deposit accounts: transferee of funds

• Transferee ‘takes free’ of security

interest in deposit account, unless
transferee acts in ‘collusion’ with debtor
to violate rights of secured party
• UCC § 9-332(b)

49
Deposit account control agreement:
choice of law
• ‘The bank’s jurisdiction for purposes of Part 3 of
Article 9 of the UCC is [specify].’
• If this provision is not included, § 9-304(b)
determines applicable law
• Review for purposes of (i) selecting US
jurisdiction and (ii) law covered in perfection by
control and control priority opinion
• Also amend choice of law provisions of the
account agreement and other agreements
between bank and customer governing or relating
to the account?

50
Securities account control agreement:
choice of law
• ‘The intermediary’s jurisdiction for purposes of Part
3 of Article 9 of the UCC is [specify].’
• If this provision is not included 8-110 determines
applicable law
• Review for purposes of (i) selecting US
jurisdiction and (ii) law covered in perfection by
control and control priority opinion
• Also amend choice of law provisions of the
account agreement and other agreements
between intermediary and customer governing or
relating to the account?

51
Control agreement: status of account
• ‘Intermediary maintains securities account [identify] for
debtor.’
• ‘All property credited to the account and all other rights of
debtor against Intermediary arising out of the account,
including any free credit balances, will be treated as financial
assets under Article 8 of the [jurisdiction] UCC.’
• Securities intermediaries that are banks often will not agree
to treat cash as a financial asset, unless they are acting
through their trust department
• Confirming what is in the account or value of the account (or
not) (Fifth Third Bank v. Lincoln Financial Securities Corp. (WD Ky
2009))
• Monitoring account and transactions

52
Control agreement: other control
agreements
• ‘Intermediary does not know of any adverse claim to
the account, except for claims and interests of
[parties to the control agreement].’
• ‘Bank represents and warrants that no third party
has a right to give instructions with respect to the
account.’
• ‘Bank will not agree with any third party that bank
will comply with instructions originated by the third
party.’
• No third party has control (or priority) or will obtain
control

53
Control agreement: status and
transfer issues
• Status of bank as a ‘bank’/securities
intermediary as a ‘securities
intermediary’ for UCC purposes?
• Successor and renumbered accounts
• Assignee or successor to secured party

54
Control agreement: indemnity +
duties
• Indemnification and expense
reimbursement of bank/securities
intermediary
• Exculpation, standards of care
• Time in which bank / intermediary is
required to act on secured party
instructions (‘outside time’)

55
Control agreement: miscellaneous
• Secured party access to statements, on-
line info
• Monitoring of debtor activity re account
• Notice of claims made by third parties to
account

56
Sweep investments
• Example:
• Secured party has a control agreement with depositary bank
and debtor over debtor’s deposit account maintained with
bank
• Funds in the deposit account are swept each evening into an
investment vehicle maintained by bank and deposited to the
deposit account the next morning with the overnight return.
• Does secured party have control over debtor’s interest in the
funds in the investment vehicle when the funds are in the
investment vehicle rather than the deposit account?
• See ABA BLS Sweep Investment Form.
http://apps.americanbar.org/dch/committee.cfm?com=CL710
060

57
Repledge
• Securities account
• Right of secured party to repledge. UCC §
UCC 207(c)(3); but see UCC § 8-504(a)
• Control during the period of repledge. See
UCC § 9-314(c)
• Deposit account
• Debtor/creditor relationship
58
Insolvency of the secured party
• ‘Pledgor access rights’
• ISDA IA Seg. working group project
• Automatic stay v. ‘safe harbors’
• Secured party as broker-dealer being
liquidated under SIPA
• Sec. Investor Prot. Corp. v. Lehman Bros.
Inc., 433 B.R. 127 (Bankr. S.D.N.Y. 2010)

59
Insolvency of the securities
intermediary or bank
• Broker dealer under SIPA
• Treatment of ‘cash’ and securities
• Federally insured bank under FDIA
• Treatment of securities
• Treatment of ‘cash’
• Allocation of credit risk between the
secured party and the debtor
60
Secured party remedies
• Without control of collateral secured party
may have difficulty effecting a transfer or
liquidation of collateral or exercising other
remedies following default
• UCC § 9-607 determines the rights between
secured party and debtor in the exercise of
secured party remedies, but not the duties
of an account debtor, bank or other person
obligated on the collateral (Comments 6 and
7 to UCC § 9-607)
61
Legal Opinions
• Choice of law
• Creation
• Perfection
• By filing
• By possession
• By control
• Control priority
• Protected purchaser (certificated or uncertificated security) and
‘takes free’ (security entitlement / securities account)
• TriBar report

62
Control – Deposit Account
• In re Hawaiian Telecom Communications,
Inc. (Bankr. D. Hawaii 2009)
• FTC v. Transcontinental Warranty, Inc.
(N.D. Ill. 2009)
• Full Throttle Films, Inc. v. National Mobile
Television, Inc. (Cal. App. 2010)
• In re Perez (Bankr. D. N.J. 2010)
63
Resources
• Model Deposit Accounts Control Agreement,
Inserts and Reports
• http://apps.americanbar.org/dch/committee.
cfm?com=CL710060
• Securities Account Control Agreement
• Annotated agreement (included with course
materials)
• Legal Opinion Resource Center
• http://apps.americanbar.org/buslaw/tribar/
64
Thank You
Sandra Rocks
Cleary Gottlieb Steen & Hamilton LLP
srocks@cgsh.com

Edwin E. Smith
Morgan, Lewis & Bockius LLP
edwin.smith@morganlewis.com

Steven O. Weise
Proskauer Rose LLP
sweise@proskauer.com

65