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UCC & Corporate Due Diligence

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Is there adequate “control” language in the control agreement?

UCC, Due Diligence, Revised Article 9

We continue our examination of control agreements for pledged securities accounts with guest blogger Bennett Cohen of the law firm Cohen, Salk & Huvard, P.C. For more background on control agreements, see our introductory post here.

Is there adequate “control” language in the control agreement?

Some control agreements we reviewed failed to contain the necessary language required for the Lender to be deemed in “control” of the Securities Account under the Code, and thus perfected.  The control provision is probably the most essential provision needed in the control agreement, although there are a number of other important provisions described in this article.

Under Sections 9-106 and 8-106 of the Code, with respect to a Securities Account, “control” is achieved by the Lender when either (a) with the consent of the Pledgor, a Broker has agreed (in the control agreement) that it will comply with entitlement orders (i.e., instructions to transfer or redeem securities or other financial assets in the Securities Account) from the Lender without further consent from the Pledgor, or (b) the Securities Account is titled in the Lender’s name.

For illustration, the following are sample “control” provisions taken from control agreements used by several national brokerage houses: (1) “The Securities Intermediary will comply with all entitlement orders originated by the Lender without further action or consent by Account Holder or any other person,” and (2) “Broker will comply with all notifications it receives directing it to transfer or redeem any property in the Account (each an “Entitlement Order”) originated by Lender without further consent by Customer.”[1]

As permitted under the Code, many control agreements vest “control” in the Securities Account in the Lender, while at the same time permitting the Pledgor to continue to trade in the securities account until the Lender notifies the Broker that the Lender is taking exclusive control of the Securities Account and that no further trading by Pledgor will be permitted.

[1] It should be noted that Official Comment 7 to Code Section 8-106 recognizes that the Broker’s obligation to act on the Lender’s instructions need not be unconditional so long as further consent of the Pledgor (account owner) is not required. For example, Official Comment 7 itemizes the following factual situations that will not be deemed to cause a Lender to lose its “control” over a Securities Account (none of which require the further consent of the Pledgor): (i) permitting the Pledgor to trade in the account, (ii) permitting both a senior lender and a junior lender to both have control over the Securities Account, wherein the junior lender’s instructions to the Broker require the senior lender’s consent, and (iii) the Broker agrees to act on the Lender’s instructions provided the Lender has delivered a statement to the Broker that the Pledgor is in default.

Next week we’ll continue our guest blog series with attorney Bennett Cohen on the topic of control agreements for pledged securities accounts. Looking for more educational resources? Visit the First Corporate Solutions resource library to download documents related to corporate transactions, UCC filing, lien searching and more!