An interesting case on securities accounts from the United States Bankruptcy Court for the Eastern District of Pennsylvania addressed the issue of whether a creditor’s perfected security interest in a securities account remained perfected in sub-accounts that were created post-closing.  In re GEM Refrigerator Co., 512 B.R. 194 (Bankr. E.D. Pa.  2014).

The debtor in this case owned a securities account at its broker (in this case, Charles Schwab) and pledged the securities account to its lender to secure repayment of a loan.  In order to perfect its security interest in the securities account, the lender required delivery of a control agreement identifying the account.  The lender also filed a financing statement that described “investment property” among the collateral.  At some point after the closing of the loan, the debtor created three “sub-accounts” relating to the securities account and transferred collateral into the sub-accounts.  The parties did not amend the control agreement or the financing statement to expressly identify the sub-accounts as being a part of the lender’s collateral.  The debtor subsequently filed bankruptcy and the parties disputed whether the lender held a perfected security interest in the sub-accounts.

The debtor’s bankruptcy trustee argued that the lender was not perfected in the sub-accounts or the collateral on deposit therein because the sub-accounts were separate from the primary securities account and were not expressly identified in the control agreement.  The trustee also asserted that the sub-accounts constituted deposit accounts, not security accounts.  Thus, the trustee argued, because deposit accounts must be perfected by control pursuant to a control agreement and cannot be perfected by filing a financing statement, the lender’s financing statement filed at the loan closing did not perfect the lender’s security interest in the sub-accounts.  The trustee’s argument that the sub-accounts constituted deposit accounts, rather than securities accounts, was based in part on the use of the sub-accounts to hold cash and not exclusively to hold securities.

After examining the differences between a deposit account and a securities account, the court found the lender held a perfected security interest in the sub-accounts.  The court reasoned that the sub-accounts in this case constituted securities accounts and that a securities account does not become a deposit account just because the account contains some cash.  Although the sub-accounts were not described in the parties’ control agreement, the court held on the facts of the case that the lender was nevertheless perfected in the sub-accounts.  Based on its finding that the sub-accounts were securities accounts, the court determined that the sub-accounts were included within the scope of “investment property” as defined under the UCC and thus were within the description of “investment property” in the lender’s financing statement.  Accordingly, while the control agreement was not dispositive to maintain perfection in the sub-accounts, the collateral described in the lender’s financing statement included the sub-accounts.

The case demonstrates several important considerations that relate to obtaining and maintaining a perfected security interest in certain banking or brokerage accounts.  As the court noted in its opinion, if a lender’s security interest in a securities account or a deposit account is perfected based on a control agreement, then it would be prudent to amend the control agreement if sub-accounts are subsequently created to ensure continued perfection in the sub-accounts.  In this case, had the court found that the sub-accounts constituted deposit accounts instead of securities accounts, the lender’s financing statement would not have applied to the deposit account and would not have “saved” perfection of the lender’s security interest.  Amending the control agreement could have avoided a loss of perfection if the sub-accounts at issue were characterized as deposit accounts.  It is also important to note that perfection of a security interest in a securities account by “control” will have priority over a security interest that is perfected only by filing.  Thus, amending a control agreement to address changes in a securities account could also continue not only a creditor’s perfection in the account, but also its priority over another creditor who obtains control over the account.  The case also reflects the potential usefulness of filing a financing statement to provide “belts and suspenders” protection with a control agreement.

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