Effective September 12, 1997, New Jersey joined numerous other states across the country in amending Articles 8 and 9 of the Uniform Commercial Code to more clearly set forth the rules for creation and perfection of security interests in uncertificated securities.
These new rules will hopefully remove the confusion which has previously surrounded the creation and perfection of security interests in uncertificated securities, the records of which are maintained by securities intermediaries. This Update will, in question and answer format, summarize important aspects of the new law and suggest actions lenders should take in order to create and perfect security interests in uncertificated securities pledged by obligors.
What is an uncertificated security? An uncertificated security is defined in the new law as an obligation of an issuer or a share, participation or other interest in an issuer or in property or an enterprise of an issuer which is not represented by a certificate.
What is a security entitlement?
A security entitlement means the rights and property interest of an entitlement holder with respect to a securities account held by a securities intermediary (e.g., a broker such as Merrill Lynch, Paine Webber, etc.). The entitlement holder (typically, the record owner of the account and the pledgor) will acquire a security entitlement once the securities intermediary indicates by book entry that a financial asset (i.e., the security itself) has been credited to that party's account.
How are security interests in uncertificated securities and security entitlements perfected under the new rules?
The new rules clearly state that a security interest in an uncertificated security or security entitlement is perfected when the s ecured party has "control" over the uncertificated security or the security entitlement or when a financing statement has been filed encumbering the security or the security entitlement.
What does it mean for a secured party to have "control" over an uncertificated security or a security entitlement?
A secured party has control if the uncertificated security is delivered (i.e., registered in secured party's name) to the secured party or if the securities intermediary has agreed that it will comply with instructions originated by the secured party without further consent of the obligor. A secured party has control over a security entitlement if the secured party becomes the entitlement h older or the securities intermediary has agreed it will comply with the instructions originated by the secured party without further consent of the obligor. To assure compliance with the new law, the lender should either cause itself to become the entitlement holder ( a step often objected to by the obligor) or enter into a "control" agreement with the securities intermediary whereby the securities intermediary agrees to comply with any directives of the lender without obtaining the consent of the obligor.
Is filing of a financing statement a permissible means of perfecting a security interest in uncertificated securities or a security entitlement?
Yes. However, as will be hereafter discussed, perfection by "control" is the preferred means.
Does the new law impose any requirements on the contents of financing statements?
The new law requires that the financing statement describe th e obligor's collateral by specifically using the term "uncertificated security" or by setting forth a specific description of the collateral.
Is there an advantage to perfecting a security interest by "control" rather than by "filing"?
Yes. Obtaining perfection by filing a financing statement will not give priority against third parties with control. In other words, if Creditor A perfects by filing but Creditor B perfects by an agreement as described above with the securities intermediary, Creditor B will have priority over Creditor A. Therefore, perfecting by "control" is the preferred method of perfection.
Will the new law affect those security interests presently held in uncertificated securities and security entitlements?
The new law may require a lender to take certain actions to continue its perfected security interest in an uncertificated security. If a security interest in an uncertificated security is perfected prior to the adoption of the new law, but the action by which the security interest was perfected would not suffice to perfect a security interest under the new law, the security interest will remain perfected for four months after the effective date of the law. If appropriate action to perfect under the new law is taken within the four-month period, the security interest will continue to be perfected thereafter. If this "outstanding" security interest can be perfected by filing under the new law, a financing statement signed by the lender instead of the obligor may be filed to continue the perfection. However, perfection by filing of a financing statement is subject to being "primed" by another creditor which perfects by use of a "control" agreement with a securities intermediary. As long as any security interest previously perfected was perfected by a method permissible under the new law, the security interest will continue to be perfected under the new law.
The new law does not prescribe rules for the continuation of a perfected security interest in security entitlements, thereby creating uncertainty as to whether a four-month safe harbor (such as the one described above) exists if the method used to perfect the security entitlement prior to the adoption of the new law w ould not be acceptable under the new law. As a result, it may be prudent to perfect the security interest in the security entitlement in accordance with the new law's requirements prior to the expiration of the four-month period. It is not clear, however whether such action will "save" the perfection.
If the lender has "control" over the uncertificated security or security entitlement at the time of the passage of the new law, will the lender have properly perfected its security interest?
Not necessarily. If the securities account is in the name of the lender or if the securities intermediary has agreed with the lender that it will comply with the lender's directives without further consent from the obligor, then perfection has likely been achieved by "control" for purposes of the new laws. However, two methods of perfection often used under the old Article 8 may not achieve perfection under the new law. If, under the old law, perfection was achieved merely by notice to the financial intermediary of the security interest, the lender will have to take further action to achieve control under the new law. Similarly, even if a securities intermediary has signed an agreement with the lender acknowledging the lender's security interest in the securities account, but the lender does not have an immediate right to give entitlement orders without the obligor's consent, the lender will not have achieved control under the new law.
If a lender has filed a financing statement encumbering uncertificated securities or security entitlements prior to the adoption of the new law, will the lender have properly perfected its security interest under the terms of the new law?
Not necessarily. As discussed above, the new law requires specific descriptions of the collateral. If the previously filed financing statements do not meet these requirements, the lender has 4 months to cure the filing and then perfection will continue, subject, however, to the priority risks discussed above.
Are certificated securities affected by the new law?
The new law does not affect how a security interest in certificated securities is perfected. As has always been true under Article 9 of the Uniform Commercial Code, perfection of certificated securities is achieved by possession. Thus, lenders must continue to maintain possession of the certificates and obtain a signed blank stock power for each certificate.
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The revisions to Articles 8 and 9 of the New Jersey Uniform Commercial Code should prove to be a very helpful step towards bringing long overdue clarity to the procedures for creating and perfecting a security interest in uncertificated securities and security accounts. Lenders should review their existing loan portfolios to assure their existing perfection procedures conform to the new rules.
