Copyright 2008, Blake, Cassels & Graydon LLP
Originally published in Blakes Bulletin on Financial Services, October 2008
With the recent elimination of Canadian withholding tax, there are more institutions lending into Canada that do not have a physical presence in the country. Where their security package includes shares pledged by a Canadian debtor or shares of a Canadian issuer, the question arises as to where the certificates should be held for safekeeping. The answer gets complicated where the pledge is governed by the laws of a province that has passed a Securities Transfer Act.
The majority of Canadian provinces have passed a Securities Transfer Act or equivalent legislation (each, an STA), and it is anticipated that the outstanding provinces and territories will soon follow suit. In a nutshell, an STA and the accompanying amendments to a jurisdiction's Personal Property Security Act (each, a PPSA) serve to facilitate/modernize the taking of security over Investment Property and to bring Canadian law into conformity with Article 8 of the UCC.
Under the new conflicts provisions of a PPSA, the validity of a security interest in a certificated security is governed by the law of the jurisdiction where the certificate is located at the time the security interest attaches (s. 7.1(1)). Such conflicts provisions go on to provide that the perfection, the effect of perfection or of non-perfection and the priority of a security interest in a certificated security shall be governed by the law of the jurisdiction where the certificate is located at any time (s. 7.1(2)). However, the law of the jurisdiction in which the debtor is located (i.e., its chief executive office), governs the perfection of a security interest in a certificated security by registration (s. 7.1(5)).
When taking a security interest in a certificated security in Canada, it is common practice to both:
(a) register against the debtor in the province where it is located, and
(b) take possession of the share certificate at closing in the province whose law governs the pledge.
Accordingly, the validity and perfection of such security interest will always remain a matter of Canadian law. However, where the share certificates are subsequently delivered to the secured party in another jurisdiction, the laws of such foreign jurisdiction will govern the effect of perfection or of non-perfection and the priority of such security interest.
As a result one must consider whether, under the laws of such foreign jurisdiction, it is possible for a competing (and, where contrary to a negative pledge, fraudulent) security interest in such shares to gain priority over the interest of a possessory pledgee. Presumably this would have to have to occur through some sort of public registration or issuer notification. If such steps cannot defeat a possessory interest, then a secured party should be comfortable maintaining possession in such foreign jurisdiction. Of course, where local registration is easy and inexpensive (e.g., in any U.S. state), a possessory pledgee may wish to take such additional step out of an abundance of caution.
As a practical matter, any insolvency proceeding with respect to a Canadian pledgor would likely occur in Canada. Assuming that it had effected a registration, a Canadian court would recognize a possessory pledgee as a secured creditor. In determining the priority of its security interest, however, the Canadian court would look to the laws of the jurisdiction in which the share certificates are located, which law would have to be proven before the court. It would, of course, be possible for a possessory pledgee to repatriate the share certificates to Canada in an attempt to reintroduce Canadian law to the priority analysis. However, it is unclear whether such a step would be effective in the face of a stay order or where priority is determined as at a prior point in time.
In summary, the effect of any extra-territorial delivery of share certificates pledged under the laws of an STA jurisdiction requires some extra-territorial analysis. While a burdensome exercise, it should be a familiar one for a secured party that has taken delivery of share certificates pledged under a laws of a U.S. state. In the event that a secured party cannot get comfortable with its local law conclusion, prudence dictates that it retain a custodian (typically a trust company) to maintain possession of the share certificates in Canada. Given the additional cost and time involved, this should be viewed as a measure of last resort.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
