New York State Bar Association International Section Seasonal Meeting 2014, Vienna, Austria

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1 New York State Bar Association International Section Seasonal Meeting 2014, Vienna, Austria How Can a Company Grant Security in Shares of its Subsidiaries under the draft UNCITRAL Model Law on Secured Transactions? By Spyridon V. Bazinas, Senior Legal Officer, UNCITRAL secretariat 1 1. Introduction Non-intermediated securities ( NIS ) are regularly used in commercial finance transactions security, in particular by small- and medium-size enterprises. Yet, they are not covered in the Unidroit Convention on Substantive Rules for Intermediated Securities, the Convention on the Law Applicable to Certain Rights in Respect of Securities held with an Intermediary or the UNCITRAL Legislative Guide on Secured Transactions. Thus, at its 47 th session in 2014, the Commission decided that the draft UNCITRAL Model Law on Secured Transactions (the draft Model Law ) currently being prepared by Working Group VI (Security Interests) should address security rights in NIS Terminology Securities means essentially shares or similar rights of participation in an issuer that: (a) is one of a class or series, or by its terms is divisible into a class or series, of shares, participations or obligations; and (b) is, or is of a type, dealt in or traded on securities exchanges or financial markets, or is a medium for investment in the area in which it is issued or dealt in or traded. Intermediated securities means securities credited to a securities account or rights or interests in securities resulting from the credit of securities to a securities account. Non-intermediated securities means securities other than intermediated securities. Certificated non-intermediated securities means non-intermediated securities represented by a written (paper or electronic) certificate. 1 The views expressed are the personal views of the author and do not necessarily reflect the views of the United Nations or UNCITRAL. 2 The remarks in this paper are based on the draft Model Law contained in documents A/CN.9/WG.VI/WP.61 and Add. 1-3 (that will become available under This draft will be discussed at the 26 th session of Working Group VI (Vienna, 8-12 December 2014).

2 Uncertificated non-intermediated securities means non-intermediated securities not represented by a written certificate. Control agreement means an agreement among the issuer of uncertificated nonintermediated securities, the grantor and the secured creditor, evidenced by a signed writing, according to which the issuer has agreed to follow instructions from the secured creditor with respect to the securities to which the agreement relates without further consent from the grantor. 3. Scope The draft Model Law covers security rights in NIS. The concept of security right is defined in a functional way to include all transactions that serve security functions, irrespective of the formulation used by the parties. As a result, transfers of NIS for security purposes are covered but not outright transfers of NIS. However, to achieve certainty with respect to the rights of competing claimants, the draft Model law addresses all priority conflicts, including priority conflicts between a security right in NIS and the right of a transferee of the same NIS. NIS covered are those defined above. The draft Model Law covers security related issues. Thus, it does not cover but leaves to the other applicable laws issues such as the following: (a) the way in which NIS are created and issued; (b) the rights of the holders of NIS; (c) the way in which the issue of NIS is recorded; and (d) the way in which NIS are transferred (i.e. delivery of the certificate to the transferee in the case of certificated NIS in bearer form, delivery and endorsement of the certificate in the case of certificated NIS issued to a named holder, or registration of the NIS in the name of the transferee in the books of the issuer in the case of uncertificated NIS). 4. Creation of a security right in NIS The draft Model Law does not include an asset-specific rule with respect to the creation of a security right in NIS. Thus, the general rule of the draft Model Law that is applicable to security rights in all types of asset applies to the creation of a security right in NIS. Under this general rule, a security right is created by an agreement between the grantor and the secured creditor that: (a) provides for the creation of a security right, regardless of the form of the transaction or the terminology used by the parties; (b) identifies the secured creditor and the grantor; (c) describes the secured obligation; (d) describes the encumbered assets in a manner that reasonably allows their identification; and (e) indicates the maximum monetary amount for which the security right may be enforced (if a State decides to include this requirement in its law). The agreement must be in writing, except if certificated NIS are involved and the agreement is accompanied by a transfer of the possession of the certificate to the secured creditor.

3 5. Third-party effectiveness of a security right in NIS An asset-specific rule is included in the draft Model Law to deal with the thirdparty effectiveness of a security right in NIS, which differentiates between certificated and uncertificated NIS. Under this rule, a security right in certificated NIS is effective against third parties, if it has been created and: (a) the certificate is delivered to the secured creditor; (b) a notice with respect to the security right has been registered in the security rights registry; or (c) the certificate has been endorsed in a manner indicating the intention to create and make effective against third parties a security right. A security right in uncertificated NIS is effective against third parties, if it has been created and: (a) a notice with respect to the security right has been registered in the security rights registry; (b) the security right has been noted or the name of the secured creditor as the holder of the securities has been entered into the books maintained for that purpose by or on behalf of the issuer; or (c) a control agreement has been entered into by the grantor, the secured creditor and the issuer of the NIS. 6. Priority of a security right in NIS The draft Model Law also includes asset-specific rules addressing the priority of a security right in NIS. One rules deals with priority among security rights in NIS and another rule deals with priority between a security right and the right of a transferee of the same NIS. Priority rules determine the order of priority based on the way in which a security right was made effective against third parties, which are different depending on the way in which a security right was made effective against third parties. With respect to security rights in certificated NIS, the order of priority is as follows: endorsement of the certificate beats any other method; and delivery of the certificate beats registration of a notice in the security rights registry. With respect to security rights in uncertificated NIS, the order of priority is as follows: a control agreement beats registration of a notice in the security rights registry; in the case of several control agreements, the first in time beats all others; and notation of the security right in the books of the issuer beats any other method. Where there is a priority conflict between a security right in NIS and the right of a transferee of the NIS, the transferee acquires them subject to the security right, except if: (a) the secured creditor authorized the transfer free of the security right; or (b) at the time of the transfer, the transferee had no knowledge that the transfer violated the right of the secured creditor. There is a rule intended to preserve rights of transferees under other law relating to the transfer of securities. And there is an alternative to this rule providing that a security right in NIS is subordinate to any superior rights acquired by a transferee of the securities under other law relating to the transfer of securities.

4 7. Enforcement of a security right in NIS The draft Model Law does not include asset-specific rules for the enforcement of security rights in NIS. So, the general rules and the asset-specific rules applicable to receivables apply to NIS. As a result, in the case of default, the secured creditor may enforce the security right by resorting to court or to self-help remedies foreseen in the draft Model Law. The remedies of a secured creditor generally involve repossession and sale of the encumbered asset (or a suggestion by the secured creditor to retain it), and distribution of the sale proceeds. Judicial enforcement is generally subject to the enforcement rules under civil procedure law. Extra-judicial enforcement is subject to the provisions of the draft Model Law. For example, for the secured creditor to take possession of certificated NIS extrajudicially, all the following conditions must be met: extra-judicial enforcement must be foreseen in the security agreement; the secured creditor must give notice of extra-judicialenforcement to the debtor, the third-party grantor, the person in possession of the asset and any person with a right in the asset (e.g. registered secured creditors); and the person in possession of the NIS must not object at the time of repossession. Then, the secured creditor may dispose of the NIS in good faith and in a commercially reasonable manner; and then return any surplus to the grantor or, in the case of any dispute, deposit it in a public deposit fund. In the case of receivables form NIS, the secured creditor has generally the right to collect the receivables or otherwise enforce the security right. 8. Law applicable to a security right in NIS The draft Model Law also includes asset-specific applicable law rules with respect to security rights in NIS that differentiate between certificated and uncertificated NIS. Generally, the law applicable to a security right in certificated NIS is the law of the location of the certificate with the exception of enforcement which is referred to the law of the place of enforcement), while the law applicable to a security right in uncertificated NIS is the law of the State under which the issuer is constituted. Under the draft Model Law, the relevant time for determining the location of the certificate or the issuer, for creation issues, is the time of the putative creation of the security right and, for third-party effectiveness and priority issues, is the time when the issue arises. 9. Coordination with other law Further NIS-specific rules may be required to avoid conflicts with other law, such as the European Union Collateral Directive (2002/47/EC), as amended by Directive 2009/44/EC (the Financial Collateral Directive ). For example, an NIS-specific provision or other adjustment to the chapter on enforcement may be necessary to ensure that the draft Model Law is consistent with article 4 of the Financial Collateral Directive. Such NIS-specific or other provision may need to clarify that: (a) a security right in NIS

5 may be enforced by collection, set-off, a proposal for the acquisition of the securities by the secured creditor in full or partial satisfaction of the secured obligation or by a sale or other disposition of the NIS; and (b) subject to contrary agreement of the parties, a secured creditor may enforce its security right in NIS without giving any notice of its intention to enforce.