Perfection by control

     A secured party may perfect a security interest in deposit accounts, investment property, letter-of-credit rights, and electronic chattel paper through control of those types of collateral.  U.C.C. 9-314(a).   A secured party may also perfect a security interest in investment property or electronic chattel paper by filing a financing statement, but, with limited exceptions, a secured party may perfect a security interest in deposit accounts or letter-of-credit rights only by control.  U.C.C. 9-312(a), (b). Section 9-115 of former Article 9 had borrowed the concept of control from U.C.C. Article 8, an article dealing with investment securities (such as stocks and bonds).  Official Comment 1 to U.C.C. 8-106 says this about the concept of control:   "Obtaining 'control' means that the purchaser has taken whatever steps are necessary, given the manner in which the securities are held, to place itself in a position where it can have the securities sold, without further action by the owner."  Building upon section 9-115 of former Article 9, revised Article 9 has expanded the function of "control" to apply to the additional types of collateral identified above.   For these types of collateral, control serves to put the secured party in a position to realize on collateral without any further action of the debtor.  In addition, control perfects a security interest in these types of collateral. 

     Here we discuss the concept of control as it relates to deposit accounts and as it relates to one form of investment property, a securities entitlement.  We do not discuss control of letter-of-credit rights, control of electronic chattel paper, or control of other types of investment property. 

     We start with deposit accounts, familiar to anyone who has a checking account at a bank.  (Remember, however, that Article 9 does not apply to an assignment of a deposit account in a consumer transaction, except to the extent that the deposit account includes proceeds of the disposition of collateral.  U.C.C. 9-109(d)(13).)  A secured party may obtain control over a deposit account through one of three mechanisms described in U.C.C. 9-104:  (1) if the secured party is the bank in which the deposit account is maintained; (2) if the secured party is authorized by the debtor and the bank to dispose of the funds in the account without further consent by the debtor; or, (3) if the secured party has become a customer with respect to the deposit account (e.g. has been added as signatory to the account).  If the secured party has obtained such control pursuant to a security agreement with the debtor, then the secured party has an enforceable security interest against the deposit account as long as the two remaining requirements for attachment of a security interest (value given by the secured party and the debtor having rights in the collateral) have also been satisfied.  U.C.C. 9-203(b).  Control also perfects the security interest from the time the secured party obtains control until such control is lost.  U.C.C. 9-314(b). Thus, control serves much the same function as possession of tangible personal property.  Possession of tangible personal property pursuant to a security agreement is sufficient both to create a security interest (if the secured party also has given value and the debtor has rights in the collateral) and to perfect the security interest.  See Commentary.Perfection by possession. 

     A secured party may obtain control over most types of investment property by the mechanisms articulated in U.C.C. 8-106.  U.C.C. 9-106.   A thorough discussion of the nature of investment property and the vocabulary and concepts introduced in U.C.C. 8-106 is beyond the scope of these materials.  However, we offer the following example to introduce some of the vocabulary and concepts.   Consider Investor Diego.  Several years ago he inherited $100,000.  He decided to invest that money in the stock market.  He opened an account with E-Trade, an online investment service, transferred funds to E-Trade through an electronic transfer from his bank, and instructed E-Trade to purchase on his behalf stock in Exxon, corporate bonds issued by General Motors, and shares in a mutual fund and to credit his E-Trade account with the securities so purchased.  This system of acquisition of securities (in which E-Trade actually holds the positions in the securities purchased but credits its customers with their respective portions of those positions) is known as the "indirect holding system," supplementing the older and more cumbersome direct holding system in which a purchaser of a security would be issued a certificate in her name (a "certificated security") or would be registered on the books of the issuer as the holder of the security, but without the issuance of a certificate ("uncertificated security").  In the parlance of Articles 8 and 9, E-Trade is a "securities intermediary," Diego's property interest in the stock, bonds and mutual fund shares credited to his account each are "securities entitlements," Diego is "an entitlement holder," and the securities entitlements individually, and the account, are "investment property."  

     Suppose that Diego later needs capital to start a business.  Even though he might liquidate some or all of his securities entitlements, he prefers a loan for both tax and psychological reasons.  The lender may take a security interest in any of the securities entitlements or in the entire account.  It may do so in a traditional way, through an authenticated record describing the securities entitlements as collateral, or it may do so by obtaining control of the securities entitlements pursuant to a security agreement.  U.C.C. 9-203(b).  It may obtain control either by being substituted as entitlement holder on the books of E-Trade or by the agreement of E-Trade to honor orders for disposition of the entitlements originated by the lender without the further consent of Diego.  U.C.C. 9-106, U.C.C. 8-106(d).  Control of the securities entitlements also perfects the security interest.  U.C.C. 9-314(a), (c).  Alternatively, the lender could perfect the security interest in the entitlements by filing a financing statement.  U.C.C. 9-312(a).