New Regime in Quebec for Security on Bank Deposits and Other Monetary Claims

In our December 3, 2014 legal update, we reported on the tabling of a bill in Quebec to amend the Civil Code of Québec (the “CCQ”) in respect of hypothecs on bank deposits and other monetary claims as well as hypothecs granted in favour of multiple creditors. The bill was assented to on April 21, 2015. On that date, the amendments to the CCQ providing for the grant of security in favour of a representative (agent) on behalf of multiple creditors came into force. Security can now be granted to an agent in substantially the same manner as in the common law provinces of Canada and the United States.

This update outlines in greater detail the new regime applicable to monetary claims, with particular emphasis on security on bank deposits or cash collateral. This new regime will come into force on January 1, 2016. The new rules add to the existing provisions of the CCQ, without setting them aside, but the effect of the existing provisions is also changed. A creditor intending to obtain security on monetary claims will gain an advantage under the new regime.

Essentially, the new regime allows for the grant of a hypothec with delivery (i.e. a pledge) on a monetary claim, which in general had not been possible previously.

The new regime is based on the provisions of Article 9 of the Uniform Commercial Code (“UCC”) in effect in the United States relating to security on deposit accounts. It is to be noted, however, that the relevant provisions of the UCC are limited to deposit accounts maintained with banks and do not extend to cash collateral that is not a bank deposit.

This update covers, in successive order, the notion of a monetary claim, the creation and perfection of a pledge on such a claim, the ranking and exercise of rights in respect of such pledge, the conflict of laws rules (determination of the applicable law) and the transitional rules. We will conclude with certain practical considerations going forward.

  1. What is a monetary claim?

Essentially, a monetary claim is a claim for the payment of a sum of money. A deposit of money made at a financial institution that takes deposits from the public (such as a bank, a financial services cooperative or a credit union) is a monetary claim. For ease of reference, we will use the expression “bank deposit” to refer to such a deposit of money. A cash amount that is remitted to secure the performance of an obligation is also a monetary claim. Examples of a monetary claim also include a security deposit made by a tenant to a landlord or by a bidder in the context of a call for tenders. The notion of a monetary claim obviously extends well beyond these examples. A loan, a balance of sale, and amounts due for services rendered are also considered to be monetary claims.

The new rules for pledges on monetary claims do not extend, however, to negotiable instruments, securities or security entitlements within the meaning of the Act respecting the transfer of securities and the establishment of security entitlements.[1] Other rules set forth in the CCQ already allow for the pledge of a negotiable instrument, a security or a security entitlement.

  1. Creation and Perfection of the Pledge by Control

The requirement that the property be physically delivered for the creation of a pledge is met for a monetary claim by the pledgee obtaining “control” of the claim. Control automatically makes the pledge effective against third parties and there is no requirement to register the pledge in the Quebec register of personal and movable real rights (the “RPMRR”). The methods of obtaining control vary depending on whether the monetary claim is pledged in a bilateral or tripartite relationship.

There is a bilateral relationship where the creditor of a monetary claim pledges the claim in favour of the person who is the debtor of that claim. For example, the client of a bank (creditor of the claim) and the bank itself (debtor of the claim) are in a bilateral relationship if the client pledges the bank deposit in favour of the bank. A bilateral relationship also exists where a party to a contract transfers an amount in cash to another party to secure an obligation due to the other party under a contract. In a bilateral relationship, the pledgee obtains control by the mere fact that the creditor of the claim (the grantor of the pledge) consents to the claim securing the performance of an obligation due to the pledgee.

In a tripartite relationship (i.e. when the pledged claim is owing by a third party and not by the pledgee), there are two ways to obtain control of the claim.

The first method is to enter into a control agreement. Only two categories of monetary claims may be the subject of a pledge by control agreement: a bank deposit or a security deposit. In the first case, the client of the bank grants security in favour of a creditor (other than the bank) charging the credit balance of a bank account held with such bank. In the second case, a party to a contract transfers to a third party (for example a trust company or a notary) an amount in cash to secure the performance of an obligation due to its counterparty under the contract.

A control agreement is an agreement among the grantor of the pledge (creditor of the claim), the pledgee and the third party (debtor of the claim), pursuant to which the third party agrees to comply with the pledgee’s instructions with respect to the disposition of the bank deposit or security deposit, without any additional consent required on the part of the grantor (creditor of the claim). It is to be further noted that the third party (for example, the depositary bank) is never required to enter into a control agreement.

Another method of obtaining control in the context of a tripartite relationship applies in respect of bank deposits: the prospective pledgee obtains control by becoming the holder of the bank account in which the deposits are credited. The creditor may thus replace the grantor as the holder of the account thereby obtain control (in which case, the prior consent of the depositary bank will of course be necessary).

Obtaining control by means of a control agreement is similar to obtaining control by means of becoming the holder of the account in that both methods allow the pledgee to exercise the rights relating to the deposits credited to the account. The difference between the two methods lies in the fact that, in the first case, the grantor remains the account holder, whereas, in the second case, the pledgee becomes the account holder.

Neither the consent required to obtain control in a bilateral relationship nor the control agreement required to obtain control in a tripartite relationship need be in writing. It is therefore clear that article 2689 CCQ, which requires that a deed of hypothec specify the amount for which it is granted, does not apply to a pledge of a monetary claim. No doubt that the parties will nevertheless generally put their agreement in writing so as to clearly set out their intentions. However, such agreement will not be a deed that creates a hypothec.

  1. Priority of Rank

The pledge of a monetary claim will rank ahead of a hypothec without delivery (i.e. a non-possessory security) that charges the same claim and was registered prior to the pledge. Take the example of a borrower that grants a hypothec on all of its present and future property in favour of a lender. If the borrower has a bank account with a bank other than the lender, the lender’s hypothec may charge the credit balance in such account. If the lender’s hypothec has been made effective against third parties (i.e. perfected), merely by registration at the RPMRR, such hypothec will rank after any pledge granted by the borrower in favour of the bank on the credit balance of its account even if control by the bank was obtained after the registration of the lender’s hypothec.

The new regime also addresses conflicts between different pledges of the same monetary claim. The CCQ provides for several new rules, which are based on the analogous provisions of the UCC. In practice, the most important of these rules is the following: a pledge obtained in a bilateral relationship has priority over a pledge on the same monetary claim where control was obtained by means of a control agreement in a tripartite relationship.

The following example illustrates this priority rule: A (grantor) grants to C (creditor) security over all present and future credit balances held in its account with bank B. A control agreement is entered into between A, B and C. Subsequently, A grants to B security on all credit balances in the same account. B and C both have control, but B ranks ahead of C even though its pledge was granted after C’s security.

As a result of this rule, creditor C will generally seek to obtain from bank B a subordination and priority of rank in favour of C’s pledge, except in respect of amounts that may be due to bank B for the operation of the account or in respect of credits to the account that are subsequently cancelled.[2] This is common practice in the United States.

It should also be noted that, like any other security, the pledge will remain subject to any prior ranking rights that may arise as a matter of law, includingthe deemed trust arising under Section 227(4.1) of the Income Tax Act (Canada) in respect of certain unpaid claims owing to the Crown in right of Canada.

  1. Exercise of Rights

The CCQ provides that the holder of a hypothec on a claim has the right to collect it. This right may be exercised even if the grantor is not in default. Moreover, the exercise of such collection right is not a recourse that is subject to the rules of the CCQ relating to the realization of hypothecary rights.

In a bilateral relationship, the pledgee of a monetary claim may collect the claim merely by operating setoff between what the pledgee owes to the holder of the monetary claim and the debt that is secured by the pledge. Setoff is in essence a means of obtaining payment.

In a tripartite relationship involving a control agreement, the agreement will provide for the pledgee’s right to demand payment of the claim from the depositary bank or other third party that is the debtor of the monetary claim. If the pledgee has initially permitted the holder of the account to continue to give instructions in respect of the credit balance in the account (i.e. by making withdrawals), the pledgee may cancel such authorization at any time. There is no particular notification, registration or other formality required to so cancel such authorization.[3]

A pledgee of a monetary claim has a clear advantage over a hypothecary creditor who holds a non-possessory hypothec on all claims of the grantor and has given the grantor authorization to collect its claims until such authorization is withdrawn. In the latter case, the CCQ requires that such authorization be registered at the RPMRR and notified to the grantor as well as to the account debtors of the claims.[4]

  1. Conflict of Laws (Applicable Law)

The conflict of laws rules in Québec currently provide that the law applicable to the validity, perfection and rank of security on a claim is generally governed by the law of the place of the domicile of the grantor.[5] Under the new regime, special conflict of laws rules will determine the law applicable to such issues in respect of bank deposits or cash collateral (i.e. security deposits). All other monetary claims will continue to be subject to the existing general rule for security on claims (the law of the place of the domicile of the grantor).

These new special conflict of laws rules are a function of various factual scenarios and are aligned with the existing conflict of laws rules that apply to security on securities entitlements as well as the UCC conflict rules relating to security on bank deposits. The rule that will, in practice, most often determine the applicable law is the following: the law governing the validity, perfection, and rank of security on a bank deposit or a security deposit (cash collateral) will be the law chosen by the parties in the agreement governing the deposit as being the law applicable to such matters, or, if there is no such law designated, then the law chosen by the parties as being the law applicable to the agreement governing the bank deposit or security deposit. For example, if the parties to a bank account (the client and the bank) merely specify in their agreement relating to the account that Québec law will govern their relationship, then the validity, perfection and rank of a pledge or any security on the credit balance in such account will be governed by Québec law. If the law so chosen by the parties were to point to a jurisdiction that does not recognize control as a method of perfection of security in a deposit account, it follows that a Québec court would not be able to recognize any security obtained by means of control of such account.

  1. Transitional Rules

The regime outlined above will come into force on January 1, 2016, and may give rise to an inversion of rank of then existing security relating to monetary claims, since the priority presently given in respect of a non-possessory hypothec registered before any other hypothec will no longer apply in respect of a subsequent hypothec that is a pledge perfected by control. Accordingly, a bank that on January 1, 2016 holds a pledge of a credit balance in an account held by such bank will rank ahead of a non-possessory hypothec previously granted in favour of another creditor by the holder of the account.

In addition, the new regime will automatically give effect to control that may have been given prior to January 1, 2016 in the manner provided under the new rules, even though such control was not at that time a means to obtain and perfect security on a monetary claim. It follows that existing bilateral or tripartite agreements regarding bank deposits will automatically have the effect of conferring a pledge on January 1, 2016, to the extent that such agreements satisfy the requirements for control as set out under the new rules.

  1. Practical Considerations

As of January 1, 2016, the consent of the grantor to a monetary claim securing the performance of an obligation will be sufficient for the pledgee to obtain control of such monetary claim in a bilateral relationship (i.e. where the pledgee is also the debtor of the monetary claim that is being pledged – for example, a bank, if the pledge charges a bank deposit maintained by the grantor with such bank). Such intention is likely to be clearly established by then existing agreements providing for a hypothec on a bank deposits, but may not be so in other circumstances. The mere fact that a party to a contract may hold a set-off right does not necessarily mean that the other party intended to grant security on the monetary claim that may be subject to such set-off right.

Going forward as of January 1, 2016, for a creditor to obtain control of a bank deposit or a security deposit in a tripartite relationship, where the deposit in question is owed by a third party, the parties must enter into a control agreement. Such agreements are already commonly entered into in respect of securities accounts, and are also used (currently without any priority afforded by control) in respect of collection accounts in certain asset-based loan transactions. It will soon become standard practice in Quebec to negotiate control agreements for bank deposits held with third party financial institutions.

In order to avail themselves of the benefits of the new regime, banks, financial institutions and other creditors that wish to hold security on bank deposits or other monetary claims may want to review, and as the case may be, revise their documentation or practices so as to ensure that control of a monetary claim is properly obtained, or automatically maintained, depending on the circumstances.

[1] R.S.Q., c. T-11.002

[2] As an example, consider a cheque deposited in the account and returned unpaid for insufficient funds.

[3] Control is not affected by the fact that the holder of the monetary claim maintains the right to give instructions with respect to such claim, i.e. by continuing to make withdrawals and deposits in the account that is subject to the pledge.

[4] Art. 2745 CCQ

[5] Art. 3105 CCQ