STIKEMAN ELLIOTT. Ontario Law, Quebec Law and Canadian Federal Law STIKEMAN ELLIOTT LLP. October 9, 2013

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1 MEMORANDUM OF LAW FOR THE INTERNATIONAL SWAPS AND DERIVATIVES ASSOCIATION, INC. AND THE FUTURES INDUSTRY ASSOCIATION on the Enforceability of the Liquidation, Setoff, Netting and Credit Support Provisions of Certain Futures Account Agreements and a Cleared Derivatives Addendum upon a Customer's Default or Insolvency, and Enforceability of Certain Offset Provisions Applicable Prior to a Customer's Default or Insolvency Ontario Law, Quebec Law and Canadian Federal Law October 9, 2013 STIKEMAN ELLIOTT LLP 5300 Commerce Court West, 199 Bay Street, Toronto, Canada M5L 1B9 1

2 TABLE OF CONTENTS PART 1- INTRODUCTION AND BASIC ASSUMPTIONS 1 I. INTRODUCTION 1 II. ASSUMPTIONS FOR COVERED BASE AGREEMENTS AND CDA 3 PART 2 - FURTHER ASSUMPTIONS AND OPINIONS 7 I. NETTING UNDER A COVERED BASE AGREEMENT AND CDA 7 II. NETTING FOR MULTIBRANCH PARTIES 34 III. COLLATERAL UNDER A COVERED BASE AGREEMENT AND CDA 36 APPENDIX A - CERTAIN DERIVATIVES TRANSACTIONS 1 APPENDIX B - CERTAIN COUNTERPARTY TYPES 1 APPENDIX C - APPLICATION OF INSOLVENCY REGIMES 7 APPENDIX D - DESCRIPTION OF CANADIAN INSOLVENCY REGIMES 1 APPENDIX E - DEFINITION OF ELIGIBLE FINANCIAL CONTRACT 7 APPENDIX F - PENSION ENTITY WINDING-UP 9 APPENDIX G - INSOLVENCY PROCEEDING STAYS 12 APPENDIX H - SUMMARY OF CONFLICT OF LAWS RULES 1

3 TO: RE: International Swaps and Derivatives Association, Inc. (ISDA) and the Futures Industry Association (FIA) Enforceability of the Liquidation, Setoff, Netting and Credit Support Provisions of Certain Futures Account Agreements and a Cleared Derivatives Addendum upon a Customer's Default or Insolvency, and Enforceability of Certain Offset Provisions Applicable Prior to a Customer's Default or Insolvency DATE: October 9, 2013 PART 1 - INTRODUCTION AND BASIC ASSUMPTIONS I. Introduction This legal opinion (this opinion) examines the treatment under the laws of the Provinces of Ontario and Quebec and the federal laws of Canada of the liquidation, set-off, netting and credit support provisions of: (A) certain Covered Base Agreements (as defined below), entered into by an entity that is registered with the United States Commodity Futures Trading Commission (the CFTC) as a futures commission merchant and is a member of one or more CFTC-registered derivatives clearing organizations (FCM) (each such FCM, a Clearing Member) and such Clearing Member's Covered Customer (as defined below), setting forth the right of such Clearing Member, upon the occurrence of an event giving rise to any right of such Clearing Member to liquidate all Futures Transactions (as defined below), to liquidate such transactions and to determine amounts owing with respect to them, to exercise remedies in respect of Futures Payment Rights (as defined below) and rights of netting and setoff with respect to obligations arising from Futures Transactions and to apply Futures Credit Support (as defined below) transferred by a Covered Customer in connection with such Futures Transactions; and (B) an addendum for Cleared Derivatives Transactions (a CDA), entered into by a Clearing Member and such Clearing Member's Covered Customer, setting forth the right of such Clearing Member, upon the occurrence of an event giving rise to any right of such Clearing Member to liquidate either (i) all Cleared Derivatives Transactions (as defined below)or (ii) any Cleared Derivatives Transactions affected by a Tax Liquidation Event (as defined in the form of Cleared Derivatives Addendum published by the FIA and ISDA), under a Covered Base Agreement, to liquidate such transactions and to determine amounts owing with respect to such transactions, to exercise remedies in respect of Cleared Derivatives Payment Rights (as defined below) and rights of netting

4 and setoff with respect to obligations arising from Cleared Derivatives Transactions, to apply Cleared Derivatives Credit Support (as defined below) transferred by a Covered Customer in connection with such transactions and to offset obligations arising from Cleared Derivatives Transactions against Cleared Derivatives Credit Support transferred to the Covered Customer. 1 This opinion addresses only the laws of the Province of Ontario, the Province of Quebec and the federal laws of Canada that apply in these Provinces as of the date of this opinion. 2 The Canadian insolvency laws addressed in this opinion are the Bankruptcy and Insolvency Act (Canada) (BIA) 3 (both with respect to bankruptcy (BIA Bankruptcy) and restructuring proposals (BIA Proposal)), the Winding-up and Restructuring Act (Canada) (WURA) 4, the Canada Deposit Insurance Corporation Act (Canada) (CDIC Act) 5, the Companies' Creditors Arrangement Act (Canada) (CCAA) 6, and national court administered receivership under the BIA (Receivership) (together Insolvency Laws). These Insolvency Laws and proceedings under them are generally the only federal insolvency laws and proceedings that apply to Canadian entities.? This memorandum also considers the application of the Payment Clearing and Settlement Act (Canada) 8 (PCSA) to the termination and close-out netting provisions of the Agreement. Where this opinion addresses Canadian insolvency proceedings it refers to proceedings under these Insolvency Laws. 1 This opinion does not address or constitute advice with respect to compliance with, or the effects of (including any unenforceability as a result of a failure to comply with), any other body of law or regulation other than as explicitly set forth in this opinion, including but not limited to (i) any Canadian federal or provincial commodities, securities or derivatives laws, rules or regulations, (ii) the rules and regulations of any self-regulatory organization, exchange or clearing organization of which a Clearing Member may be a member, (iii) Canadian federal or provincial tax laws, rules or regulations, (iv) laws applicable to individuals, including but not limited to those related to capacity, competency, marriage, divorce or death or (v) any laws, regulations, or insolvency proceedings not governed by Ontario, Quebec or Canadian federal law. In addition, this opinion does not address or constitute advice with respect to bankruptcy, insolvency or insurance matters other than those expressly addressed in it. 2 There are some very material differences in the laws of the different provinces as they apply to the subjects discussed in this opinion. Therefore, in considering these issues in any case where a party might be potentially litigating in another Canadian jurisdiction, or where the private international law rules would direct you to that jurisdiction, specific advice should be sought. 3 S.C. 1992, c.27 as amended, including by S.C. 2007, c R.S.C. 1985, c.w-11, as amended by S.C. 1996, c.6, ss R.S.C. 1985, c.c-3, as amended. 6 R.S.C. 1985, c.c There are proceedings in various corporate statutes that provide for (1) a restructuring of a company at the shareholder and sometimes at a creditor level, or (2) a winding-up of a company. Occasionally these proceedings can involve insolvent corporations. Although they are not strictly insolvency proceedings, they are also discussed in this memorandum because of their potential application to an insolvent entity. 8 S.C. 1996, c.6. 2

5 The chart at Appendix C illustrates in chart form which insolvency proceedings apply to the Covered Customer types addressed in this opinion. Appendix D provides a description of each insolvency proceeding. IL Assumptions For Covered Base Agreements and CDA Our opinion is based on the following assumptions: (i) (ii) (iii) (a) Covered Base Agreements Pursuant to a futures customer account agreement (a Covered Base Agreement) entered into between a Clearing Member and a customer located in Ontario or Quebec that is an entity type specified on Appendix B as being covered by this opinion (a Covered Customer), the Clearing Member agrees to carry one or more accounts on behalf of that Covered Customer (each, an Account) and to execute, carry and clear transactions for the purchase or sale of commodities for future delivery on, or subject to the rules of derivatives clearing organization (a DCO) registered as such under the United States Commodity Exchange Act (the CEA) or traded on, or subject to the rules of, a board of trade outside the United States (such contracts executed on a contract market designated pursuant to Section 5 of the CEA and cleared by a U.S.-registered DCO, "U.S. Futures, such as contracted, traded on or subject to the rules of, a board of trade outside the United States, an options thereon, "Foreign Futures" and, collectively Futures) and/or options on U.S. Futures subject to Part 33 of the rules of the CFTC (such contracts, Options, and collectively with Futures, Futures Transactions). With respect to Foreign Futures, the Clearing Member acts for the Covered Customer by carrying Foreign Futures on the Covered Customer's behalf with, and guaranteeing the Covered Customer's performance to, clearing members ("Foreign Clearing Members") of the relevant foreign clearinghouses, which Foreign Clearing Members may frequently be affiliates of the Clearing Member, and the Foreign Clearing Members will, in turn, enter into back-to-back futures transactions cleared by foreign clearinghouses. Each Covered Base Agreement is governed by New York law and is legal, valid and binding and enforceable in accordance with its terms under New York law. Each party has the capacity to enter into each Covered Base Agreement and has properly authorized, executed and delivered the Covered Base Agreement. Pursuant to a Covered Base Agreement, the Covered Customer agrees to transfer, as applicable, initial margin and variation margin payments as the Clearing Member may require in respect of the Covered Customer's Futures Transactions. Also, pursuant to the Covered Base Agreement, the 3

6 Covered Customer grants a security interest to the Clearing Member in all of the Covered Customer's rights in the following property, whether at the time of the grant or thereafter existing: (A) "Futures Credit Support" including: (1) with respect to U.S. Futures and Options, its Account and all assets credited thereto, including assets held by a DCO, as well as other property of the Covered Customer held in respect of Futures Transactions by or for the Clearing Member, the DCO or any agent acting for the Clearing Member, the DCO or the Covered Customer; (2) with respect to Foreign Futures, its Account and all assets credited thereto, including assets held by a Foreign Clearing Member or foreign clearinghouse, as well as other property of the Covered Customer held in respect of Futures Transactions by or for, or for the Account and due from the Clearing Member, any Foreign Clearing Member, any foreign clearinghouse or others, or any agent action for the Clearing Member, any Foreign Clearing Member, any foreign clearinghouse or others; and (B) "Futures Payment Rights", including: (1) with respect to U.S. Futures and Options, its Futures Transactions and all rights to payment thereunder (whether constituting obligations of the Clearing Member or a DCO); (2) with respect to Foreign Futures, its Futures Transactions and all rights to payment thereunder (whether constituting obligations of the Clearing Member, a Foreign Clearing Member or a foreign clearinghouse). The security interest secures all obligations of the Covered Customer to the Clearing Member under the Covered Base Agreement. (iv) A Covered Base Agreement contains one or more events of default (whether or not described therein as "events of default") (each, an Event of Default) the effect of which is to give the Clearing Member the right to 4

7 liquidate the Futures Transactions held in the Covered Customer's Account (Futures Liquidation Rights). Among such Events of Default are defaults predicated on (A) a Covered Customer's filing under applicable bankruptcy or similar insolvency laws, (B) the filing of a petition for the commencement of involuntary proceedings in respect of the Covered Customer under applicable bankruptcy or similar insolvency laws which filing results in a judgment of insolvency or bankruptcy or an order for relief and (C) the appointment in respect of the Covered Customer or substantially all of its assets of an administrator, conservator, receiver or similar official, including the possession and control of the property of the Covered Customer by such an official pursuant to seizure orders.. The terms of the Covered Base Agreement provide the Clearing Member with the right as a secured party to exercise remedies in respect of Futures Payment Rights and to net and set off amounts owing under Futures Transactions on account of their liquidation and termination (collectively, Futures Netting Rights). (v) The Covered Base Agreement includes a provision the effect of which is to permit the Clearing Member, upon the occurrence of an Event of Default in respect of a Covered Customer, to dispose of or realize on all Futures Credit Support posted by the Covered Customer to the Clearing Member in respect of Futures Transactions and net or apply the foregoing or the liquidation value thereof to any obligations the Covered Customer owes to the Clearing Member under the Covered Base Agreement. We refer to the foregoing collectively as Futures Credit Support Rights. A futures account agreement that does not alone satisfy the above requirements is nevertheless a "Covered Base Agreement" to the extent it is paired with a CDA that supplies any of the otherwise unsatisfied requirements. (i) (b) The CDA In addition to entering into a Covered Base Agreement with the Covered Customer, the Clearing Member and the Covered Customer execute a CDA. The CDA supplements a Covered Base Agreement with respect to, among other things, the liquidation, set-off and netting of "Cleared Derivatives Transactions" carried in the Covered Customer's account holding Cleared Derivatives Transactions (the Cleared Derivatives Account), as well as the application of collateral related to those Cleared Derivatives Transactions. "Cleared Derivatives Transactions" are swaps, forwards, options, or similar transactions (but excluding Futures Transactions executed on or subject to the rules of a U.S. designated contract market or on a foreign board of trade and subject to regulation in that jurisdiction) that are (a) entered into by a Covered Customer in the 5

8 over-the-counter market, or (b) executed or traded by such Covered Customer on or subject to the rules or protocols of any multilateral or other trading facility, system or platform, including any communication network or auction facility permitted under applicable law or any designated contract market and, in either case, subsequently submitted to and accepted for clearing by a DCO and subject to the CFTC's Part 22 rules. To the extent that a security-based swap is, in accordance with applicable law, carried by an FCM in a cleared swaps customer account (as defined in the CFTC's Part 22 rules), such security-based swap constitutes a Cleared Derivatives Transaction. A list of example types of Cleared Derivatives Transactions appears in Appendix A. (ii) Each CDA is governed by New York law and is legal, valid and binding and enforceable in accordance with its term under New York law. Each party has the capacity to enter into each CDA and has properly authorized, executed and delivered the CDA. (iii) Pursuant to a CDA, Cleared Derivatives Transactions become incorporated into the related Covered Base Agreement, which incorporation is accomplished by considering references to "Contracts," "Futures," "Futures Contracts" and similar terms in such Covered Base Agreement to include references to the Cleared Derivatives Transactions. Through this incorporation, the Covered Customer grants a security interest to the Clearing Member in all of the Covered Customer's rights in the following property, whether at the time of the grant or thereafter existing: (A) its Cleared Derivatives Account and all assets credited thereto, including assets held by a DCO, and (2) other property of the Covered Customer held in respect of Cleared Derivatives Transactions by or for the Clearing Member, the DCO and any agent acting for the Clearing Member, the DCO or the Covered Customer (collectively, Cleared Derivatives Credit Support); and (B) its Cleared Derivatives Transactions and all rights to payment thereunder (whether constitution obligations of the Clearing Member or a DCO) (collectively, Cleared Derivatives Payment Rights). (iv) Pursuant to the CDA, following the occurrence of an Event of Default, the Clearing Member is entitled to set off or apply any margin transferred to the Covered Customer under Cleared Derivatives Transactions (Customer 6

9 Received Margin) against obligations to the Covered Customer under the CDA. (v) (vi) The Clearing Member is entitled, upon the occurrence of an Event of Default, to designate a date and thereupon cause the liquidation of a Covered Customer's Cleared Derivatives Transactions (such rights, the Cleared Derivatives Liquidation Rights). The Clearing Member is entitled to exercise its remedies as a secured party in respect of Cleared Derivatives Payment Rights and to net amounts owing in respect of liquidated Cleared Derivatives Transactions. Upon the liquidation of a Covered Customer's Cleared Derivatives Transactions, the CDA provides the Clearing Member with rights to (a) dispose of or realize on all Cleared Derivatives Credit Support posted by the Covered Customer to the Clearing Member in respect of Cleared Derivatives Transactions and set off or apply the foregoing or the liquidation value thereof to any obligations the Covered Customer owes to Clearing Member under the CDA and (b) apply the value of any Customer Received Margin against any obligations owed to the Covered Customer under the CDA (such rights, the Cleared Derivatives Credit Support Rights). The FIA-ISDA Cleared Derivatives Addendum in the foreign published jointly by the FIA and ISDA satisfies the above requirements. A CDA that does not alone satisfy the above requirements is nevertheless a "CDA" to the extent it is paired with a Covered Base Agreement that supplies any of the otherwise unsatisfied requirements. In addition, a single document that satisfies the above requirements for a Covered Base Agreement and a CDA is both a "Covered Base Agreement" and a "CDA." Any reference to a "Question" in this memorandum refers to a Question in the same section of the memorandum unless otherwise indicated. PART 2 - FURTHER ASSUMPTIONS AND OPINIONS I. Netting Under a Covered Base Agreement and CDA A. Assumptions 1. On the basis of the terms and conditions of a Covered Base Agreement and CDA and other relevant factors, and acting in a manner consistent with the intentions stated in the Covered Base Agreement and CDA, the parties over time enter into a number of Futures Transactions and Cleared 7

10 Derivatives Transactions (Covered Transactions) that are intended to be governed by the Covered Base Agreement and CDA. The Covered Transactions entered into include any or all of the transactions described in Appendix A. 2. Some of the Covered Transactions provide for an exchange of cash by both parties and others provide for the physical delivery of shares, bonds or commodities in exchange for cash. 3. After entering into these Covered Transactions and prior to the maturity thereof, the Covered Customer, which is organized in Canada, becomes the subject of a voluntary or involuntary case under the insolvency laws of Canada and, subsequent to the commencement of the insolvency, either the Covered Customer or an insolvency official seeks to assume the profitable Covered Transactions for the Covered Customer and reject the unprofitable Covered Transactions for the Covered Customer or otherwise prevent the exercise of close-out rights by the Clearing Member. B. Issues 1. Are the provisions of the Covered Base Agreement and CDA permitting the Clearing Member to terminate all the Covered Transactions upon the insolvency of the Covered Customer enforceable under the laws of Ontario and Quebec? The provisions of the Covered Base Agreement and CDA permitting the Clearing Member to terminate all the Covered Transactions upon the insolvency of the Covered Customer are enforceable under the laws of these jurisdictions, subject to the following provisos and qualifications. Provisos Proviso 1 - Covered Transactions Must be EFCs Between the Parties In the context of an insolvency proceeding, the above opinion applies to Covered Transactions as long as they are "eligible financial contracts" between the Clearing Member and the Covered Customer as defined under the relevant Insolvency Law. Under certain Insolvency Laws (namely CCAA, BIA Proposal, WURA, CDIC Act, Receivership), either automatically or by court order, the non-insolvent party may not exercise a right to terminate any contract or accelerate obligations under a contract by reason of the insolvency of the other party or commencement of the insolvency proceeding with respect to it. 8

11 Under certain of these insolvency proceedings (CCAA, BIA Proposal and WURA) there is a safe-harbour provision that permits a party to rely on contractual termination rights in an eligible financial contract notwithstanding the automatic or any court ordered stay (the EFC safe-harbour). Mutuality of obligations is a requirement for relying on the EFC safe-harbour. Mutuality exists between the DCO and the Covered Customer through the agency of the Clearing Member so as to permit reliance by the DCO (or its agent) on the EFC safeharbour with respect to the Covered Transactions that have been novated to the DCO. Futures Transactions are eligible financial contracts as they are expressly covered by the definition ("a derivative agreement [which includes a futures agreement or an option] that... trades on a futures or options exchange or board, or other regulated market"). Cleared Derivatives Transactions would be eligible financial contracts assuming they met the general criteria for being an eligible financial contract, which definition is set out in Appendix E. Any of the Cleared Derivatives Transaction types set out in Appendix A are potentially eligible financial contracts. The definition is very general. Cleared Derivatives Transactions that are "derivatives agreements that are the subject of recurrent dealings in the derivatives markets or in the over-the-counter securities or commodities markets" are eligible financial contracts. A transaction which is sufficiently standardized to be cleared would be subject of recurrent dealings in such markets. The definition of "derivative agreement" encompasses the concept of a "financial" agreement. We believe that the intention of the definition is not to require evidence in individual cases that transactions have a "financial" element in the particular context if the transaction is one of the listed types of contracts, such as a swap, future, option, spot or forward, and if it relates to an underlying interest that is specifically listed. In other words, such contracts should be, by definition, "financial" agreements. This approach to the definition meets the purpose of the legislation, which is to provide certain and express protection for termination, netting and collateral enforcement rights for the types of contracts that are the subject of recurrent dealings in derivatives, securities and commodities markets. If this interpretation is not correct, then we believe that Transactions that provide for cash settlement or Transactions that involve an element of financial risk management or speculation would be found to be "financial" agreements. Also, if the analysis of the Ontario Court of Appeal in Re Androscoggin Energy LLC 9 is 9 (2005), 8 C.B.R. (5th) 11. 9

12 applied, the presence of termination and netting rights is a key indication of the financial nature of the contract. Covered Derivatives Transactions of the types listed in Appendix A would in our view meet the criteria for an eligible financial contract. The CDA and Covered Base Agreement are eligible financial contracts to the extent that the Covered Transactions are themselves eligible financial contracts as an eligible financial contract includes a master agreement in so far as it is in respect of, among others, a derivative agreement. Also included in the definition is "an indemnity or reimbursement obligation with respect to the liabilities under" such an agreement. To the extent that the Covered Customer has an obligation to indemnify the Clearing Member with respect to the Clearing Member's liability to the DCO for the Covered Customer's Covered Transactions novated to the DCO, that indemnity obligation is itself a safe-harboured transaction and, consequently, the right to accelerate the obligation is covered by the EFC safe-harbour. 10 We are assuming that the proper interpretation of the CDA and any Covered Base Agreement under the relevant governing law would recognize that the nature of the Customer's obligations to the Clearing Member is to indemnify the Clearing Member for its obligations to the DCO. Consequently, although mutuality of obligations is a requirement for reliance on the EFC safe-harbour, the required mutuality exists between the Clearing Member and the Covered Customer in this respect even though it may not exist between the Clearing Member and the Covered Customer with respect to the Cleared Derivative Transaction itself or to Covered Transactions that have been novated to the DCO. Although there is no express statutory safe-harbour, there is a practice in Receivership proceedings of providing the same exemption for eligible financial concerts as part of the court order. There is also an EFC safe-harbour in the CDIC Act (which applies to CDIC insured deposit taking institutions), but it subject to certain additional qualifications and provisos where a bridge institution is to be incorporated (see below). 10 The measurement of that liability may be determined by a calculation of gains and losses determined through the Clearing Member entering into Close-out Transactions, Risk-Reducing Transactions and Mitigation Transactions that are entered into in order to liquidate Cleared Derivatives Transactions and which themselves give rise to a liability of the Clearing Member to the DCO. As noted below, however, there may be impediments to entering into such Transactions as agent of an insolvent Customer directly for the account of the Customer. 10

13 A more detailed description of the treatment of termination rights in insolvency proceedings is set out in the following paragraphs. BIABankruptcy In our view, the provision allowing the Clearing Member to terminate would be enforceable against a trustee in bankruptcy under the BIA. 11 There is no statutory provision that provides for a stay on termination rights in a BIA bankruptcy procedure. Consequently, the principle that the trustee in bankruptcy obtains no greater rights under a contract than had the insolvent party will operate. In fact, the trustee in bankruptcy may have fewer rights. As stated in a Canadian bankruptcy text:... But when bankruptcy occurs the rights of the trustee are not in all respects the same as those of the debtor before his bankruptcy or insolvency. The rights which the trustee acquires are only those rights which remain in the insolvent party. The trustee's rights are not those of the party if it had not become insolvent. 12 So where a contract contains a clause to the effect that rights are terminated or obligations accelerated upon insolvency, the trustee in bankruptcy will, assuming all contractual preconditions to termination are met, be subject to that contractual provision. 13 On the same basis, a contractual right to rescind contracts that may be settled by physical delivery is also enforceable provided that title has not passed to the Customer. The BIA provides for an automatic stay of "proceedings" for the recovery of claims that are provable in the liquidation upon the commencement of a liquidation proceeding. 14 The automatic stay of proceedings provided for in the BIA does not, in our view, prevent the termination of Covered Transactions by the Clearing Member. We have three reasons for this view. First, the purpose of liquidation proceedings is for all creditors to value their claims and seek redress 11 There is now an exception to this principle for contracts with individuals. There is an automatic stay on termination or acceleration in that case, although subject to a safe-harbour for eligible financial contracts (BIA, s.84.2). 12 Duncan, Bankruptcy in Canada, at See Re Diamond Truck Co. Ltd., [1942] 3 D.L.R. 738, at 743 (Que. C.A.); Re Durnford Elk Shoes Ltd. (1916), 11 O.W.N. 59 (C.A.) lv. to app. refd. 11 O.W.N. 105; Laing Construction Equipment Limited v. Casson (1975), 19 C.B.R. (N.S.) 89 (B.C.C.A.); Garrett v. Richardson & Sons Ltd., [1942] 2 D.L.R. 182 (Ont. C.A.); Merrill Lynch Royal Securities Ltd. v. Blum (1983), 23 B.L.R. 260 (Ont. H.C.J.); Fridman, The Law of Contract 2nd ed. (Toronto: Carswell, 1986) at BIA, s.69.3(1). 11

14 for those claims solely within the insolvency proceedings. The termination and close-out netting mechanisms are simply mechanisms to value claims of or against the Clearing Member. There is no intention that the insolvent party will continue in business following the proceedings and therefore, no purpose would be served by preventing the Clearing Member from terminating and valuing its claim. Secondly, the case law supports the right of contracting parties to terminate agreements after the commencement of insolvency proceedings. Thirdly, it would be surprising if the court were to prevent termination in the liquidation context, when it is clearly permitted by the BIA in the reorganization context. Also, where the PCSA applies (see Proviso 2 below), the Clearing Member will also be able to rely on the express statutory termination right included in section 13 as described below. BIA Proposal The BIA proposal provisions expressly address the issue of termination of derivatives transactions. 15 The BIA provides that the filing of a proposal or notice of intention to file a proposal to effect a creditor reorganization prevents a party from terminating contracts or accelerating obligations under contracts for the reason only that the other party (1) is insolvent, or (2) has filed a proposal or notice of intention to file a proposa1. 16 A party is permitted to terminate contracts by reason of any other default, either before or after the filing of the proposal or notice. Eligible financial contracts, however, are expressly exempted from the provision preventing termination because of insolvency or the filing of a proposal or notice of intention to file a proposa1. 17 In summary, the right of the Clearing Member to terminate all Covered Transactions is not adversely affected by the filing of a proposal or notice of intention to file a proposal to effect a creditor reorganization under the BIA. Also, where the PCSA applies (see Proviso 2 below), the Clearing Member will also be able to rely on the express statutory termination right included in section 13 as described below. CCAA The CCAA expressly recognizes the right of a party to terminate eligible financial contracts pursuant to the terms of a master agreement. Section 34(1) provides for 15 BIA, s BIA, s.65.1(1). 17 BIA, s.65.1(7). 12

15 an automatic stay on terminating or accelerating contracts by reason only that proceedings are commenced under the Act or that the company is insolvent. Section 34(7) provides an exemption from that automatic stay for eligible financial contracts: 34. (1) No person may terminate or amend, or claim an accelerated payment or forfeiture of the term under, any agreement, including a security agreement, with a debtor company by reason only that proceedings commenced under this Act or that the company is insolvent. (7) Subsection (1) does not apply (a) in respect of an eligible financial contract; or (b) to prevent a member of the Canadian Payments Association from ceasing to act as a clearing agent or group clearer for a company in accordance with the Canadian Payments Act and the by-laws and rules of that Association. Also, where the PCSA applies (see Proviso 2 below), the Clearing Member will also be able to rely on the express statutory termination right included in section 13 as described below. WURA Under the WURA there is express recognition of the right to terminate eligible financial contracts (1) Nothing in this Act or an order made under this Act prevents or prohibits the following actions from being taken in accordance with the provisions of an eligible financial contract: (a) the termination of the contract; Where the PCSA applies, however, the Clearing Member will also be able to rely on the express statutory termination right included in section 13 as described below. If the Covered Transactions have been transferred to a new bridge institution or CDIC has guaranteed the payment obligations under them under the procedures 18 WURA, s

16 in the CDIC Act, the Clearing Member will not be able to rely on the WURA safeharbour if the defaulting financial institution is made subject to a WURA order. 19 Receivership A court order appointing a receiver and manager will often prevent the termination of contracts. This type of order is generally intended to prevent utilities and other suppliers from terminating their arrangements with the debtor in a way which would prejudice the receiver and manager's opportunities to sell the business as a going concern. In theory, the order preventing termination may be drafted widely enough to capture any type of agreement. We believe that, even if an original order was drafted so widely as to capture Covered Transactions, a court would amend this order to exclude them upon a motion by the Clearing Member. A court administered receivership is, in essence, a liquidation proceeding, not a creditor reorganization proceeding, and consequently, a court would be reluctant to allow a situation that differs so markedly from that under either the BIA, CCAA or WURA. It is our view that the risk of a court order in a receivership preventing the termination is minimal. We would expect that, at most, there might be a period of delay until the court can hear and determine the Clearing Member's motion to exclude it from the general stay that might be granted by the order. Current practice in Ontario is to exempt eligible financial contracts from such a stay. Where the PCSA applies, the Clearing Member will also be able to rely on the express statutory termination right included in section 13 as described below. Voluntary Wind-up of Trusts If the Covered Customer is in the form of a trust and is voluntarily winding-up, then there is no applicable stay with respect to the termination rights. Proviso 2 - Application of Payment Clearing and Settlement Act If the EFC safe-harbour does not apply, then the Clearing Member may nevertheless be able to rely on certain provisions of the PCSA, which provides an additional stay exemption. This stay exemption 20 applies "[d]espite anything in any law relating to bankruptcy or insolvency or any order of a court made in respect of an administration of a reorganization, arrangement or receivership involving insolvency". This PCSA exemption applies to allow a party to a "netting agreement" to terminate the agreement. A "netting agreement" is defined as: 19 CDIC Act, s.39.18(2). 20 PCSA, s

17 "netting agreement" means an agreement between two or more financial institutions, between the Bank [of Canada] and one or more financial institutions or between a participant 21 and a customer to which the participant provides clearing services that is (a) an eligible financial contract; or (b) an agreement that provides for the netting or setoff or compensation of present or future obligations to make payments against the present or future rights to receive payments. [emphasis added] A Clearing Member for a DCO clearing futures, options on futures, or other over-the-counter derivatives transactions would be a "participant". There is no requirement for purposes of this provision that the DCO be licensed in this jurisdiction. Consequently termination rights in an eligible financial contract between a Clearing Member and a Covered Customer are protected by this provision. This means, for example, that this express safe-harbour would apply in Receivership (where there is no express safe-harbour). Further, termination rights in any other agreement between a participant and customer that provides for the netting or set-off or compensation 22 of present or future payment obligations is a netting agreement even if the obligations do not relate to an eligible financial contract. Because the Covered Base Agreement and CDA are agreements that provide for such netting and set-off of obligations between the Clearing Member and the Covered Customer, they would be an 21 A "participant" means a member of a clearing house or a party to an arrangement that establishes a clearing and settlement system (PCSA, s.2). A"clearing house" means "a corporation, association, partnership, agency or other entity that provides clearing or settlement services for a clearing and settlement system. It includes a securities and derivatives clearing house, as defined in subsection 13.1(3) [which means any designated DCOs], but does not include a stock exchange or the Bank [of Canada]". (PCSA, s.2). A "clearing and settlement system" means a system or arrangement for the clearing or settlement of payment obligations or payment messages in which: (a) there are at least three participants, at least one of which is a Canadian participant and at least one of which has its head office in a jurisdiction other than the jurisdiction where the head office of the clearing house is located; (b) clearing or settlement is all or partly in Canadian dollars; and (c) except in the case of a system or arrangement for the clearing or settlement of derivatives contracts, the payment obligations that arise from clearing within the system or arrangement are ultimately settled through adjustments to the account or accounts of one or more of the participants at the Bank. For greater certainty, it includes a system or arrangement for the clearing or settlement of securities transactions, derivatives contracts, foreign exchange transactions or other transactions if the system or arrangement also clears or settles payment obligations arising from those transactions. 22 "compensation" is the Quebec law equivalent of set-off. 15

18 eligible financial contract even if the mutual obligations netted are not themselves derivatives agreements between the parties. Qualification 1 - Agency Relationship In order to close out the transactions and determine the indemnity obligation of the Covered Customer to the Clearing Member, it is contemplated that the Clearing Member could enter into Offsetting Transactions or Risk-Reducing Transactions as agent and for the account of the Covered Customer. With respect to BIA proceedings, Quebec law provides that the agency relationship would be automatically revoked by the commencement of a "bankruptcy" proceeding, but it does not define bankruptcy proceeding so it could include not only proceedings under bankruptcy legislation but also other insolvency proceedings. 23 However, under Quebec law, whether such an agency relationship is irrevocable inside or outside of insolvency proceedings is determined by the governing law of the agency relationship and hence this automatic revocation would only apply if the agency relationship was governed by Quebec law. The agency relationship may be revocable by the insolvency representative if under its governing law it is not irrevocable. Consequently, for a Quebec Counterparty where the agency relationship is governed by Quebec law or whether it is not an irrevocable agency relationship under its governing law, it may be necessary to adopt a method of liquidating the Covered Transactions with the DCO in a manner that does not require entering into Transactions for the account of the Covered Customer. Under Ontario law, there is only very limited case law on the agency issue. An agency relationship that is expressed to be irrevocable, is granted for consideration, and is coupled with an interest cannot be revoked by the principal. This type of agency relationship will also survive the commencement of insolvency proceedings. 24 There is some support in Canadian common law case law for the position that an agency relationship that is for the protection of the agent would be considered to be coupled with an interest. 25 In other words, it is not necessarily the case that the agency power relates specifically to property over which the agent has rights (such as a security interest or option). This case law would support in our view the irrevocability of the Clearing Member's right to enter into Offsetting Transactions or Risk-Reducing Transactions as agent of the Covered Customer. However, it is not a definitive body of case law. Also, it 23 Art Civil Code of Quebec. It is silent with respect to other insolvency proceedings. 24 Cameron Harvey and Darcy MacPherson, Agency Law Primer, 4th ed (Toronto: Carswell, 2009). 25 Wilkinson v. Young, [1972] O.J. No. 1707, 25 D.L. R. (3d) 275 (Ont. H.C.J.); Mitchell v. Sykes [1883] O.J. No. 266 at para 21, 4 O.R. 501, Klymas v. Burkholder, [1976] O.J. No at para 27; Lear v. Klapstein [2000] 7 WWR 736 at para 40 to 42, 79 Alta LR (3d)

19 may also be the case that an Ontario court would consider the issue of whether or not the agency relationship is irrevocable to be governed by the law of the agency relationship and not Ontario law. Consequently, with respect to an Ontario Customer, if under the governing law of the Covered Base Agreement or CDA the agency relationship is revocable, it may be necessary to adopt a method of liquidating the Covered Transactions with the DCO in a manner that does not require entering into Transactions for the account of the Covered Customer. Further, given the limited case authority on this point in Ontario, this may also be a prudent course of action for any Customer potentially subject to insolvency proceedings in Ontario. Qualification 2 - CDIC Act Bridge Institution If the Covered Customer is a deposit taking institution whose deposits are insured by the Canadian Deposit Insurance Corporation, then there is a possibility of a stay preventing termination of the Covered Transactions by the Clearing Member. Where CDIC obtains a vesting order under the CDIC Act 26, the Act imposes a number of different limitations on the rights that can be exercised against the institution, including that no person may terminate or amend any agreement with the institution or claim an accelerated payment only because of (1) the institution's insolvency, (2) the making of the order, or (3) a default before the order was made in any performance of obligations under the agreement. 27 Subject to the bridge institution provisions discussed below, the CDIC Act provides that these provisions do not prevent termination in accordance with their terms of "eligible financial contracts". 28 The CDIC Act EFC safe-harbour provides for an exception to its effectiveness where an order to incorporate a bridge institution is made. 29 The CDIC Act permits CDIC to assign all of the eligible financial contracts between a member institution that is subject to a receivership order under the CDIC Act and its counterparty to a bridge institution. A bridge institution is an institution of the same type as the insolvent member institution (e.g. a bank) 26 CDIC Act, s CDIC Act, s.39.15(1)(d). Note that the CDIC Act differs from section 65.1(1) of the BIA in that under the CDIC Act a prior default, such as a payment default, cannot provide grounds for termination once an order is made, whereas under the BIA the pre-proceeding defaults can be relied on. The Governor in Council (essentially the federal cabinet), in making the order, has the power to provide that these provisions do not apply to the institution, but no such order has been made (s.39.15(1)) 28 CDIC Act, s.39.15(4). 29 S.C. 2009, c. 2, s. 245(7). 17

20 incorporated by a Cabinet order. The shares of a bridge institution would be owned by CDIC. 30 CDIC is required, to provide the financial assistance that a bridge institution needs in order to discharge its obligations as they become due. Where an order directing the incorporation of a bridge institution is made, there is (1) an automatic temporary stay that prevents reliance on the EFC safe-harbour and (2) the possibility of a permanent stay where the Agreement is assumed by a bridge institution or CDIC guarantees the payment obligations under the Agreement. These stays take precedence over the rights protections in the PCSA. 31 It is anticipated that an order incorporating a bridge institution would be made at or around the same time that the receivership order under the CDIC Act is made. The Temporary Stay The Jobs and Growth Act, 2012 (Canada) 32 passed on December 14, 2012 amended the CDIC Act to provide for a new temporary stay in the event that an order is made directing the incorporation of a bridge institution. 33 The stay prevents reliance on the member institution's insolvency, the making of the order appointing CDIC as receiver, the making of the order directing incorporation of the bridge institution, or the assignment of the eligible financial contract to or assumption of it by the bridge institution as grounds for accelerating or terminating any eligible financial contract. 34 This stay lasts from the time the order directing incorporation of the bridge institution is made until 5:00 p.m. on the following business day 35 (Ottawa time). During this period presumably CDIC will determine whether or not the bridge institution will assume the eligible financial contracts. This temporary stay does not apply to an eligible financial contract between the federal member institution and a clearing house that provides clearing and settlement services for a clearing and settlement system designated under section 4 of the PCSA or a securities and derivatives clearing house as defined under subsection 13.1(3) of the PCSA. 36 It does apply to DCOs that do not have either of these designations. Currently, no non-canadian DCOs have such designations. 30 The bridge institution is not a Crown agent corporation. 31 PCSA, s. 13(1.2). 32 S.C. 2012, c CDIC Act, s.39.15(7.01). 34 There is an exemption for certain designated clearing and settlement systems or designated securities and derivatives clearing houses; CDIC Act, s.39.15(7.02). 35 A business day is a day other than Saturday, Sunday or a day on which the clearing and settlement systems operated by the Canadian Payments Association are closed; CDIC Act, s.39.15(7.03). 36 CDIC Act, s.39.15(7.02). 18

21 The Conditional Stay After or during the operation of the temporary stay, a conditional stay may become effective. The counterparty of the member institution cannot rely on the eligible financial contracts exemption if CDIC undertakes to either guarantee unconditionally the payment of any amount due or that may become due in accordance with the provisions of the contract by the member institution or ensure that all obligations arising from the contract will be assumed by the bridge institution. We refer to this as the conditional stay as it is conditional on CDIC making these undertakings. The relevant section reads as follows: (7.1) If an order directing the incorporation of a bridge institution is made and the Corporation undertakes to unconditionally guarantee the payment of any amount due or that may become due by the federal member institution, in accordance with the provisions of the eligible financial contract, or to ensure that all obligations of the federal member institution arising from the eligible financial contract will be assumed by the bridge institution, the actions referred to in subsection (7) [ed. termination, netting and dealing with financial collateral for an eligible financial contract] are not to be taken by reason only of (a) the federal member institution's insolvency; (b) the making of an order or an order appointing the Corporation as receiver in respect of the federal member institution or the making of the order directing the incorporation of the bridge institution; or (c) the eligible financial contract being assigned to or assumed by the bridge institution. 37 After the temporary stay period, unless and until the CDIC undertakings referred to in the provision are made there is no impediment to relying on the EFC safe-harbour, The provision prevents reliance on the exemption only if the reason for termination of the agreements is one or more of the matters set out in (a) to (c) immediately above. It does not, for example, preclude relying on the 37 S.C. 2009, c. 2, s. 245(7). 19

22 exemption if there has been a performance Default, such as a failure to transfer collateral. The stay is a permanent stay once the contracts have been assigned to the bridge institution. A subsequent WURA proceeding with respect to the insolvent member institution cannot be relied on as a new Event of Default. CDIC is a federal Crown corporation that is an agent of Her Majesty in right of Canada so it is the federal Crown that ultimately stands behind the statutory obligation of CDIC to ensure that the bridge institution meets its financial obligations (where the eligible financial contracts are assumed by the bridge institution) or the CDIC guarantee of the payment obligations of the defaulting member institution (where the eligible financial contracts are not assigned to the bridge institution and the guarantee is provided). In summary, the right of the Clearing Member to terminate is not adversely affected by the making of an order to facilitate a restructuring of a federal deposit taking financial institution under the CDIC Act. If the federal institution is placed into receivership under the CDIC Act and if the government makes an order to incorporate a bridge institution, then a temporary one business day stay on relying on the eligible financial contracts exemption applies. If CDIC then makes either the guarantee undertaking or the undertaking to have the bridge institution assume the obligations, then there is a further stay preventing reliance on the EFC safe-harbour. The stay is a permanent stay once the contracts have been assigned to the bridge institution or the guarantee given (subject to a fresh default). The PCSA safe-harbour does not override the bridge institution stays under the CDIC Act. 38 Qualification 3 - Pension Plans Pension Entities that are insolvent may be wound-up under the supervision of the pension regulator. In our view the regulator has no jurisdiction to impose a stay preventing termination in such a context if there is a contractual provision that permits termination on the basis of such an order being made. More detail as to the procedure for winding-up a pension plan entity under Ontario law is provided in Appendix F. Qualification 4 - Corporate Plans of Arrangement 38 PCSA, s. 13(1.2). 20

23 With respect to Corporate Plans (applicable only to Covered Customers that are Corporations governed by a statute with a corporate plan of arrangement procedure), courts do not typically grant orders staying the termination of contracts. In particular, we are aware of only one case where any order has purported to stay the exercise of termination and liquidation rights relating to eligible financial contracts. We do not believe that a court before which the issue was fully argued would grant such a stay in the face of the generally applicable bankruptcy principles relating to executory contracts and the statutory recognition of termination and netting rights in other insolvency regimes. A case provides further support for the enforceability of close-out and netting or liquidation rights in a Corporate Plan context. 39 An application was brought before the courts in Alberta under the arrangement provisions of the Canada Business Corporations Act in which the applicant sought a stay of termination rights under what would have been classified as an "eligible financial contract" under the CCAA and other insolvency legislation. Parties to such contracts had contractual rights to terminate based on the Chapter 11 filing of the applicant's parent corporation or other credit events affecting the parent corporation, which was the applicant's credit support provider. The applicant argued that it was solvent and that it could remain so if a stay was granted to give it time to renegotiate credit support arrangements with its counterparties. The court rejected the application on the basis that it was not appropriate to interfere with the contractual rights of the parties and that the public policy against interfering with close-out and netting rights in the case of insolvent counterparties applied as well to solvent counterparties seeking to reorganize. However, in a similar later proceeding involving Abitibi-Consolidated Inc. the court took the unprecedented step of staying the termination of contracts with the applicant companies and made no exception for eligible financial contracts entered into with them. The Enron Canada case was not before the court. The proceeding was made in the context of a proposal to restructure, through a series of relatively complicated corporate steps, the outstanding bonds and term loans of the company. Abitibi, which was insolvent, determined to use the corporate proceeding to restructure not only its relationship with bondholders, but also with its term lenders in the belief that it would be a more expedited procedure than a CCAA proceeding. The court in the Abitibi proceeding made an interim order that looked very much like the type of order a court would make in a CCAA proceeding. Included in the order was a temporary stay (until the hearing date for approval of the arrangement) against any person (not just the bondholders and term lenders) 39 Re Enron Canada (2001), 31 C.B.R. (4th) 15 (Alta. Q.B.). 21

24 accelerating or terminating any contract with any of the Abitibi entities. Unlike the orders granted under the CCAA, however, there was no exemption for eligible financial contracts with the Abitibi entities. The Quebec Superior Court in its reasons associated with the order does not deal with eligible financial contracts except to note that the orders requested "exclude from their application swap or derivative transactions or eligible financial contracts". However, the order itself did not exclude all eligible financial contracts from the stay. It only excluded eligible financial contracts with persons "other than the Abitibi parties". The intention here was seemingly to not interfere with the operation of credit default transactions having Abitibi as a reference entity or other eligible financial contracts between third parties where termination may have been triggered by an Abitibi default. The very fact that the Abitibi order was made raises an issue for the exercise of termination rights under eligible financial contracts. It is important to note, however, that the court did not hear arguments from any affected parties regarding the application of the order to eligible financial contracts and it was not the focus of Abitibi's submissions to the court. The Enron Canada decision also was not before the court. Nor was the order subsequently challenged by any party to an eligible financial contract. The order became moot when Abitibi filed under the CCAA, it having become apparent that the corporate plan would not succeed. Given the circumstances, the precedential value of the order on this issue is not as great as that of the Enron Canada case. If, as this case suggests, the courts will allow the Corporate Plan proceeding to be used by an insolvent corporation as an alternative to a CCAA proceeding to deal not only with bondholder claims but also claims of ordinary creditors such as term lenders, then it makes sense to treat the commencement of such a proceeding, at least where creditors' claims are involved, in the same way as other bankruptcy Events of Default. Parties will be in a better position to challenge the type of stay order granted in Abitibi if they clearly have a contractual termination right in this circumstance. 2. Are the provisions of the Covered Base Agreement and CDA providing for the netting of termination values (and any cash collateral that is viewed as a title transfer (see discussion in Section III.a.(e) below), in determining a single lump-sum termination amount upon the insolvency of a Covered Customer enforceable under the law of Ontario and Quebec? The provisions of the Covered Base Agreement and CDA providing for the netting of termination values (and any cash collateral that is viewed as a title transfer) in determining a single lump-sum termination amount upon the 22

25 insolvency of a Covered Customer are enforceable under the law of this jurisdiction subject to the provisos and qualifications set out below. Proviso 1 - Covered Transactions Must be EFCs Between the Parties or PCSA applies The above opinion applies to Covered Transactions as long as (1) the PCSA applies (see below) or (2) they are eligible financial contracts between the Clearing Member and the Covered Customer. Calculating the net termination amount presupposes enforceability of the right to terminate, which is dependent on the Covered Transactions being eligible financial contracts or the PCSA applying. Consequently, the analysis in question 1 is relevant. Assuming termination is not stayed, then the right to net Covered Transactions based on the terms of the Covered Base Agreement or CDA will be enforceable without being subject to any stay if the Covered Transactions are eligible financial contracts or the PCSA applies. Under certain insolvency proceedings (CCAA, BIA proposal and WURA) the EFC safe-harbour permits a party to rely on contractual netting rights in an "eligible financial contract" notwithstanding the automatic or any court ordered stay. As noted above in the analysis of termination in Question 1, (1) mutuality of obligations is a requirement for relying on the EFC safe-harbour, (2) any of the Covered Transactions are potentially eligible financial contracts, and (3) included in the definition is "an indemnity or reimbursement obligation with respect to the liabilities under" such an agreement and the Covered Customer's obligation to indemnify the Clearing Member with respect to the Clearing Member's liability for the Covered Customer's Covered Transactions novated to the DCO is itself an eligible financial contract. Consequently, although mutuality of obligations is a requirement for reliance on the EFC safe-harbour, the required mutuality exists in this respect even though it may not exist with respect to the Cleared Derivatives Transaction itself or Covered Transactions that have been novated to the DCO. Although there is no express statutory safe-harbour, there is a practice in Receivership proceedings of providing the same safe-harbour as part of the court order. The CDIC Act does stay the exercise of rights of set-off in the context of a CDIC proceeding. The EFC safe-harbour in the CDIC Act (which applies to CDIC insured deposit taking institutions) exempts netting rights under an eligible financial contract from this stay, but this exemption is subject to the same qualifications and provisos described in answer to Question 1 where a bridge institution is to be incorporated. 23

26 With respect to the FCM structure, we note that under the FCM clearing model, the ultimate counterparties to a derivatives contract that has been novated through the clearing process, are (i) the FCM's customer and (ii) the DCO that has accepted the customer's derivative contract for clearing. In the context of a Covered Base Agreement and CDA, the Covered Customer will interact with the DCO via its clearing FCM (the Clearing Member), and the Clearing Member will be exposed to the Covered Customer: under applicable DCO rules, the Clearing Member must meet the Covered Customer's obligations to the DCO under the Futures Transactions and Cleared Derivatives Transactions it clears regardless of whether the Covered Customer itself performs. Thus, the DCO will have two potential sources of payment under a cleared derivatives contract the Covered Customer itself and the Clearing Member. The Clearing Member, however, does not guarantee the obligations of the DCO to the Covered Customer. We note also that following a Covered Customer's default, the Clearing Member (liable to the DCO for amounts owed by the Covered Customer under Futures Transactions and Cleared Derivatives Transactions it clears for the Covered Customer) would want to reduce its exposure by any amounts owing by the DCO to the Covered Customer. However, while the Clearing Member owes the DCO in its capacity as a principal (by virtue of its obligation to perform for its Covered Customer), the DCO, with respect to its derivatives contracts with the Covered Customer, owes not the Clearing Member (who serves only as an intermediary and one-way guarantor) but the Covered Customer. In some cases, amounts may be owed to and from different DCOs. As noted in answer to Question 1, an indemnity obligation with respect to a Covered Transaction is itself an eligible financial contract so to the extent termination and netting rights relate to that obligation as opposed to the direct rights or obligations under the Covered Transaction itself, it is not necessary to adopt a different approach for the FCM model. Also, section 13 of the PCSA should apply to characterize the Covered Base Agreement and CDA as a netting agreement even if the netted obligations between the parties are not directly with respect to the Covered Transactions. However, if the Covered Customer's claim against the FCM with respect to amounts paid by the DCO is in the nature of a proprietary claim, there may be a question as to whether that is the type of claim that can be set-off or netted pursuant to the EFC safe-harbours or the PCSA safe-harbour. It may be necessary to grant and perfect a security interest in the Covered Customer's right, title and interest in its (1) contractual rights under its Futures Transactions and Cleared Derivatives Transactions, including Futures Payment Rights and Cleared Derivatives Payment Rights and (2) its Futures Credit Support and Cleared Derivatives Credit Support held by and returned from DCOs. Such a security interest could be created and perfected under Ontario and Quebec law (see 24

27 Question III.B.3. and 5. below) and based on the PCSA the rights to deal with such collateral in a Canadian insolvency proceeding should be exempt from stay laws or orders (see Question III.B.17 below) (Subject to the bridge institution exception). The position is not quite as robust as for rights of set-off given the need to rely on perfection by registration and priority issues that can arise when relying on a security interest (see Question III.B.14. and 16.) A further description of the treatment of set-off rights in insolvency proceedings is set out in the following paragraphs. BIA Bankruptcy In our answers to Question 1 above we described the principle that the trustee in bankruptcy of an insolvent Covered Customer would have no greater rights than the insolvent person under an agreement. It follows from this principle that the calculation of the net termination amount will also be enforceable, and that the Clearing Member will be entitled to determine the amount payable either to or by the Covered Customer by netting the gains and losses on the Covered Transactions. We believe that a court would determine that under the Covered Base Agreement and CDA, one net amount was either owing or owed. This analysis is not dependent on an application of the law of set-off. The analysis applies to proceedings in both Ontario and Quebec. An alternative argument is available based on the express protections in the BIA for rights of set-off. The BIA incorporates provincial concepts of set-off and, consequently, the possibility of different outcomes depending on the province the BIA proceeding is commenced in. The BIA 40 provides that the "law of set-off" (or compensation) applies to all claims made by a trustee in bankruptcy in the same manner and to the same extent as if the insolvent party were bringing the suit. It is clear in Ontario that the "law of set-off" will include rights of set-off which exist by operation of law, namely legal set-off and equitable set-off. Although the relevant case law is limited, the "law of set-off" appears to also include the enforcement of contractual rights of set-off as well as rights of legal set-off and equitable set-off. 41 In our view, the relevant statutory provisions would be interpreted to include contractual rights of set-off even if these contractual rights of set-off were wider than the legal set-off, equitable set-offs or compensation that might otherwise be available. 4 BIA, s.97(3). 41 Re McMurtry & Co. Ltd., [1924] 1 D.L.R. 737; Re Berman (1979), 105 D.L.R. (3d) 380 (Ont. C.A.); Adatia v. A. Faber Ltd. (2004), 7 C.B.R. (5th) 165 (Ont. S.C.); Re Blue Range Resource Corp., (1999) 245 A.R. 154; Canada (Attorney General) v. Reliance Insurance Company (2009), 58 C.C.L.I. (4th) 220, 40 C.B.R. (5th) 292, 40 B.L.R. (4th)

28 The effect of set-off (or "compensation" as it is known under Quebec law) in a Quebec BIA bankruptcy proceeding is somewhat different. A bankruptcy court in Quebec will apply legal, judicial and conventional (contractual) "compensation" if the appropriate criteria are met. In the absence of contractual set-off, Quebec courts generally interpret "the law of set-off" to mean the rules of legal or judicial compensation only, as set out in the CCQ 42 which are not as broad as the principles of equitable set-off. 43 A Quebec court sitting in bankruptcy matters will not apply the rules of equitable set-off. Under the CCQ, the principles of judicial or legal compensation do not require that there be any connection between the debts, but only that the requirements of Article 1673 of the CCQ be fulfilled, namely that there coexist debts which are certain, liquid and exigible and which are either for a sum of money or some other fungible property identical in kind. Quebec courts have, on certain occasions, permitted compensation to be operated after the bankruptcy even if the debts are not liquid and exigible prior to the bankruptcy when the debts were capable of being quantified by the courts at the time of the bankruptcy and were certain prior to the bankruptcy. 44 There was some concern until recently that conventional compensation would not be applied by a Quebec bankruptcy court since it was not formally recognized by the CCQ provisions on compensation. However, a recent Supreme Court of Canada decision 45 recognized "conventional compensation" as operating in bankruptcy although, in the circumstances of the case, the court held that the terms of the conventional compensation gave rise to a "security interest". It may, however, be necessary to rely not on rights of "compensation", but on the general bankruptcy principle noted above. Where the PCSA applies, however, the Clearing Member will also be able to rely on the express statutory netting right included in section Articles 1672 and 1673 provide that debts are extinguished by compensation, up to the amount of the lesser debt, by the operation of law where the debts are certain, liquid and exigible and both debts are for a sum of money or a certain quantity of fungible property identical in kind. Upon termination, the remaining obligations of both parties to a Master Agreement are certain, liquid and exigible, and therefore, compensation will operate. 43 Structal (1982) Inc. v. Fernand Gilbert Ltee, J.E (C.A.); Re Nolisair International inc. (Syndic de). J.E (C.A.); e d'auteuill, Benoit, and Motokov Canada inc., REJB (C.A.); and Montreal Fast Print (Faillite de), J.E (C.A.); D.I.M.S. Construction inc. (Syndic de) c. Quebec (Procureur general), [2005] 2 R.C.S Hil-A-Don Ltd. (In re): Bank of Montreal c. Kwiat, (C.A., ), SOQUIJ AZ , [1975] C.A. 157; Syndicat d' epargne des epiciers du Quebec (In re): Laviolette c. Mercure, (C.A., ), SOQUIJ AZ , [1975] C.A. 599 (res.). 45 Caisse populaire Desjardins de l'est de Drummond v. Canada, 2009 SCC

29 BIA Proposal The BIA proposal provisions expressly provide for the calculation of a net termination value upon termination of eligible financial contracts. 46 The relevant provisions read as follows: 65.1(9) Despite subsections 69(1) and 69.1(1), the following actions are permitted in respect of an eligible financial contract that is entered into before the filing, in respect of an insolvent person of a notice of intention or, where no notice of intention is filed, a proposal, and that is terminated on or after that filing, but only in accordance with the provisions of that contract: (a) the netting or setting off or compensation of obligations between the insolvent person and the other parties to the eligible financial contract; and (10) If net termination values determined in accordance with an eligible financial contract referred to in subsection (9) are owed by the insolvent person to another party to the eligible financial contract, that other party is deemed, for the purposes of paragraphs 69(1)(a) and 69.1(1)(a), to be a creditor of the insolvent person with a claim provable in bankruptcy in respect of those net termination values. Section 2 defines "net termination value" to mean:... the net amount obtained after setting off the mutual obligations between the parties to an eligible financial contract in accordance with its provisions. It is our view that this provision would recognize the enforceability of a close-out netting provision under the Covered Base Agreements and CDA to the extent of the obligations and mutual obligations. If the Clearing Member is entitled to payment of the net termination amount from the Covered Customer, then it is treated as a creditor for that amount in the proposal process (subject to the discussion in Question 3, of conversion of amounts into foreign currencies). In the event that the Covered Customer subsequently becomes bankrupt, the Clearing Member would have a claim provable in bankruptcy for the net termination amount. 46 To the extent the Transactions are eligible financial contracts. See Question 1. 27

30 CCAA The CCAA gives express statutory recognition to the right to terminate and to determine a net termination value in a CCAA proceeding. "Net termination value" is defined as: the net amount obtained after setting off the mutual obligations between the parties to an eligible financial contract in accordance with its provisions. 47 In addition, the CCAA makes it clear that the non-insolvent party that is owed the net termination value is a creditor in the proceeding for that amount. 34. (8) The following actions are permitted in respect of an eligible financial contract that is entered into before proceedings under this Act are commenced in respect of the company and is terminated on or after that day, but only in accordance with the provisions of that contract: (a) the netting or setting off or compensation of obligations between the company and the other parties to the eligible financial contract; and (9) No order may be made under this Act if the order would have the effect of staying or restraining the actions permitted under subsection (8). (10) If net termination values determined in accordance with an eligible financial contract referred to in subsection (8) are owed by the company to another party to the eligible financial contract, that other party is deemed to be a creditor of the company with a claim against the company in respect of those net termination values. WURA The WURA provides that nothing in the WURA or the order of a court made under the WURA prevents the setting-off of obligations pursuant to the terms of the agreement between the parties. Section 22.1 states: 22.1 (1) Nothing in this Act or an order made under this Act prevents or prohibits the following actions from being taken in accordance with the provisions of an eligible financial contract: 47 CCAA, s.2. 28

31 (b) the netting or setting off or compensation of obligations between a company in respect of which winding-up proceedings under this Act are commenced and another party to the contract; and Net termination values (1.01) If the net termination values determined in accordance with the eligible financial contract referred to in subsection (1) are owed by the company to another party to the eligible financial contract, that other party is deemed to be a creditor of the company with a claim provable against the company in respect of the net termination values. "Net termination value" is defined to mean: the net amount obtained after setting off the mutual obligations between the parties to an eligible financial contract in accordance with its provisions.4 8 It is our view that this provision recognizes the enforceability of a netting provision. This analysis is subject to the CDIC Act provisions with respect to bridge institutions where the Covered Customer is a CDIC insured deposit taking financial institution. CDIC Act The CDIC Act provides that creditors of a federal member institution (or a provincial member institution in those cases where an agreement exists with the province for the application of the Act 19) are not entitled to exercise any right of set-off against the institution where an order has been made vesting in the CDIC the shares and subordinated debt of the institution. 50 However, the CDIC Act exempts from these provisions the setting-off of an amount payable under or in connection with eligible financial contracts WURA, s.22.1(2). 49 There are, as yet, no such agreements. 5 CDIC Act, s.39.15(1)(c.1). 51 CDIC Act, s.39.15(4). 29

32 39.15 (7) Nothing in subsection (1) or (2) prevents the following actions from being taken in accordance with the provisions of an eligible financial contract: (a) the termination of the contract; (b) the netting or setting off or compensation of an amount payable under or in connection with the contract; or Although the CDIC Act does not include a provision equivalent to s.65.1(10) of the BIA (which, "for greater certainty", recognizes the calculation of the net termination value), it is our view that it permits the netting of gains and losses to the same extent as under the other federal insolvency legislation such as the WURA and the BIA proposal provisions. As discussed above in Question 1, the safe harbour is subject to a temporary and potentially a longer stay under the CDIC Act in circumstances where a bridge institution is to be incorporated. Receivership Contractual rights of set-off also bind receivers. 52 Where the PCSA applies, the Clearing Member will also be able to rely on the express statutory netting right included in section 13 as described below. Voluntary Wind-up of Trusts If the Covered Customer is in the form of a trust and is voluntarily winding-up, then there is no applicable stay with respect to the netting rights. Proviso 2 - Application of Payment Clearing and Settlement Act Above in Question 1 we addressed the express statutory recognition of a right to terminate Covered Transactions pursuant to a netting agreement under section 13 of the PCSA. Section 13 also protects the right to determine a "net termination value or settlement amount" and provides that the person to whom such amount is owed shall be a creditor of the party owing the amount for that amount. "Net termination value" means the net amount obtained after setting off or otherwise netting the obligations between the parties to a netting agreement in accordance 52 Ching v. Jeffrey (1885), 12 O.A.R. 432 (C.A.); Toronto-Dominion Bank v. Block Bros. Contractors Ltd, (1980), 118 D.L.R. (3d) 311 (Alta. Q.B.); Bank of Montreal v. Tudhope (1911),17 W.L.R. 83 (Man. Q.B.). 30

33 with its provisions. Subject to the analysis in Question 1, the PCSA would apply to the Covered Base Agreement and CDA between the Clearing Member and Covered Customer to the extent the set-off relates to mutual obligations between the Clearing Member and Covered Customer. Qualification 1- Pension Plans Pension Entities that are insolvent may be wound-up under the supervision of the pension regulator. In our view the regulator has no jurisdiction to impose a stay preventing netting in such a context. More detail as to the procedure for winding-up a pension plan entity under Ontario law is provided in Appendix F. Qualification 2 - Corporate Plans of Arrangement The qualification set out above with respect to corporate plans applies also to a right to exercise netting rights or set-off. 3. Assuming the parties have entered into a Covered Base Agreement and CDA, the Covered Customer is insolvent and the Clearing Member has determined a lump-sum termination amount in a currency other than Canadian currency: (1) would courts in Ontario and Quebec enforce a claim for the net termination amount in the currency in which it was determined? (2) can a claim for the net termination amount be proved in insolvency proceedings in commenced in Ontario and Quebec without conversion into the local currency? (3) if in either case the claim must be converted to local currency for purposes of enforcement or proof in insolvency proceedings, what are the rules governing the timing and exchange rate for such conversion? Claim in Court Proceedings for Net Termination Amount The Currency Act (Canada) 53 provides that any reference to money or monetary value in any legal proceeding shall be stated in Canadian currency. This does not mean, however, that a party to an agreement providing for the payment of money in a foreign currency must convert the foreign currency to Canadian currency in its claim. Ontario. The legislation governing the courts in Ontario contains mechanisms for the conversion of foreign currency amounts at the date of payment under the 53 R.S.C. 1985, c.c-52, s

34 judgment. The Courts of Justice Act (Ontario) 54 provides that an Ontario court in granting an order to enforce an obligation in a foreign currency is to convert the amount to the amount of Canadian currency sufficient to purchase the amount of the obligation in the foreign currency at a bank in Ontario listed in Schedule I to the Bank Act (Canada) as at the close of business on the first day on which the bank quotes a Canadian dollar rate for purchase of the foreign currency before the day payment of the obligation is received by the creditor. The court can choose conversion as of a different date if this method of conversion would be inequitable to any party. 55 If the judgment is executed upon, the relevant date for conversion is the date when the bailiff or sheriff receives the money from the sale or garnishment. 56 The parties to a contract can also provide for some different method of conversion and the court must then give effect to that method. 57 Based on these provisions, we conclude that, as a practical matter, the payment of the net termination amount in a non-canadian currency is enforceable in proceedings brought in Ontario. Quebec. In Quebec, a court will not give a judgment denominated in a currency other than Canadian dollars. When a claim in respect of an obligation is in foreign currency, the courts will generally convert the foreign currency into Canadian currency for the purposes of the judgment on the date chosen by the plaintiff between the date of the breach and the date of the judgment as long as there has been no negligence or inaction by the plaintiff which has prejudiced the defendant. 58 Therefore, a court would probably give effect to any express contractual provision which stipulates a date of conversion into Canadian currency at a specific date, if there was such a provision, provided the plaintiff's negligence or inaction does not make the application of such a clause "abusive". Accordingly, we conclude that although the payment of net termination amount is enforceable in proceedings brought in Quebec, payment in the specified currency is not enforceable as such, and a residual exchange risk will remain with respect to the conversion rate, most probably with respect to the period between the date of judgment and the date of payment. It is not clear whether a "topping up" provision would be enforceable, whether outside of insolvency or in an insolvency proceeding. 54 R.S.O. 1990, c.43, s s.121 (3). 56 s.121 (5). 57 s.121(4). Tsakonas c. Valkanas, 2009 QCCS 2008 (CanLII) ) appeal dismissed on motion (C.A., ), 2009 QCCA 1916, SOQUIJ AZ Cohen v. Hill Samuel & Co. [1989] R.J.Q (C.A.); Edelman v. Stendel 1990 CanLII 3046 (QC CA), [1990] R.L. 430 ( C.A.); Gerald Abelson Holdings Inc. v. Platinum Equity Holdings Inc., J.E (S.C.) var'd 2004 CanLII (QC CA), Equipements Stosik inc. c. Hock Seng Lee Heavy Industries, sdn bhd, 2007 QCCA 2197; Gestion BIC inc. v. Centre de recherches Silicium Metal Manitoba SMM inc., , S.C.Q.,

35 Claim in Insolvency Proceedings for Net Termination Amount Some Canadian insolvency statutes expressly deal with the trea ment of foreign currency claims upon commencement of an insolvency proceeding; others do not. Even where the relevant insolvency statutes do not expressly say so, it is accepted that a foreign currency claimant would have to submit its claim to the insolvency representative valued in Canadian dollars. Under the liquidation provisions of the BIA, the general principle is that a creditor is to value its claim as of the date of the bankruptcy, which is the date of the petition into bankruptcy. 59 The Clearing Member would have to convert the net termination amount to Canadian funds using a conversion rate applicable on that date. The BIA does not specify a method of conversion. The trustee in bankruptcy might accept the Clearing Member's choice of the source for the conversion rate, so long as it is a generally accepted rate (for example, the rate quoted by the Bank of Canada or a Canadian Schedule I bank), although the trustee might establish a rate for all creditors with claims in a particular currency based on a particular published source. The WURA does not include any express provisions for conversion, but the practice is similar to that under the BIA. A provision requiring "topping-up" of the amount to account for subsequent foreign currency losses attributable to fluctuations after the bankruptcy or winding-up order may not be enforceable, on the basis that it infringes the pari passu distribution principle. With respect to BIA proposals, claims are to be converted as of (1) the date of filing the notice of intention to file a proposal (or the proposal itself if no notice is filed) or (2) the date of bankruptcy where the proposal is filed by an entity that is already bankrupt, or (3) the date specified in the proposal. The CCAA is similar to the BIA proposal provisions. 60 There is no method of conversion specified in the BIA or CCAA, but the trustee or other insolvency representative could establish an acceptable rate for all creditors with claims in a particular foreign currency for converting the net termination amount to Canadian currency. 59 BIA, s Section 43 -the date of the initial application unless otherwise provided in the proposed compromise or arrangement 33

36 Valuation of claims is generally irrelevant to the CDIC reorganization process and, consequently, there is no conversion issue. CDIC now has power to effect a liquidation of an insolvent entity and in that context we suspect that a similar requirement to value claims on the date the proceeding commenced would be established by CDIC. None of the statutory provisions or established practices apply to converting individual transactions to a base currency as part of the netting process and we do not expect that an insolvency representative would interfere with the contract provisions in this regard. IL Netting for Multi branch Parties A. Assumptions We assume the same facts as set forth in Part 1.II above with the following modifications: When addressing Issue 1 set forth in II. B. 1. below, we assume that a Covered Customer that is a bank organized in Canada (incorporated pursuant to the Bank Act (Canada) has entered into a Covered Base Agreement and CDA that permit it to enter into Covered Transactions acting through branches in multiple jurisdictions (referred to herein as a "multibranch basis"). The Canadian bank then has entered into Covered Transactions under a Covered Base Agreement and CDA through the bank in Canada and also through one or more branches located in other countries (as permitted by the bank's Covered Base Agreement and CDA). After entering into these Covered Transactions and prior to their maturity, the Canadian bank becomes the subject of a voluntary or involuntary proceeding under the Insolvency Laws. B. Issues 1. Would there be any change in your conclusions concerning the enforceability of netting under the Covered Base Agreement and CDA based upon the fact that the Canadian bank has entered into Covered Base Agreement and CDA on a multibranch basis and then conducted business in that fashion prior to its insolvency? For purposes of this question we have not considered questions relating to the jurisdiction of a Canadian liquidator to take title, possession or control of the bank's assets that are situate in foreign jurisdictions. It is possible that a foreign liquidator would have control over non-canadian assets of the bank and that non-canadian laws would govern issues as to the type of claims that could be 34

37 made against those assets. Also, a creditor that recovers any part of its claim in such a foreign proceeding will have to account for that recovery in the Canadian proceedings so that double recovery is avoided. Furthermore, it is theoretically possible that a Canadian court would direct a Canadian liquidator to transfer assets to a foreign liquidator in a concurrent insolvency proceeding. This would only be a realistic scenario in our view if the Canadian bank had as significant a presence or, perhaps, a more significant presence in the foreign jurisdiction as it has in Canada. Consequently, it is not likely that an insolvency representative in a non-netting jurisdiction would be given control over the liquidation or reorganization of a Canadian bank. There is no provision of Canadian banking law, insolvency law or Ontario or Quebec contract law which would prevent a Clearing Member from terminating all Covered Transactions with the Canadian bank and its foreign branches, agencies or offices and netting in accordance with the terms of the Covered Base Agreement or CDA simply because the obligations were contracted through several different branches in different countries. For Canadian banking, insolvency and Ontario and Quebec contract law purposes, the bank and its branches, agencies and offices form a single legal entity. The WURA, for example, provides that all claims against the company can be proved against the company in the winding-up. 61 Consequently, based solely on applicable legal principles, there is no basis for an argument that the Covered Base Agreement and CDA and Covered Transactions made subject to them do not evidence obligations and rights of the Canadian bank recognizable and enforceable in the Canadian insolvency proceeding. This is not to say that there may not be foreign laws that indirectly affect the Canadian insolvency proceedings. For example, under an agreement governed by the laws of the State of New York, the related contract laws of the State of New York that affect termination and netting may be recognized in Canada. If potentially applicable foreign laws that purport to affect termination or netting rights exist, the trealnient of them for Canadian law purposes will be very sensitive to their precise content and nature. Characterization of an issue for conflict of laws purposes is very dependent upon how the foreign law is framed and its precise effect. Therefore, for the purposes of this memorandum, we have assumed that there are no applicable foreign laws that would adversely affect enforceability. 61 WURA, s.71(1). 35

38 III. Collateral Under a Covered Base Agreement and CDA Fact Patterns You have asked us, when responding to each question, to distinguish between the following three fact patterns: I. the Location of the Covered Customer is in the Province of Ontario or the Province of Quebec and the Location of the Futures Credit Support and the Cleared Derivatives Credit Support (Collateral) is outside the Province of Ontario or the Province of Quebec, as applicable; II. III. the Location of the Covered Customer is in the Province of Ontario or the Province of Quebec and the Location of the Collateral is in the Province of Ontario or the Province of Quebec, as applicable; the Location of the Covered Customer is outside the Province of Ontario or the Province of Quebec and the Location of the Collateral is in the Province of Ontario or the Province of Quebec, as applicable. For the foregoing purposes: (a) (b) the "Location" of the Covered Customer is in the Province of Ontario if it is incorporated or otherwise organized in the Province of Ontario or Quebec or if it has a branch or other place of business in the Province of Ontario or the Province of Quebec; and the "Location" of Collateral is the place where an asset of that type is located under the private international law rules of the Province of Ontario or the Province of Quebec. "Located" or references to "Location" when used below in relation to a Covered Customer or any Collateral will be construed accordingly except as expressly provided in this opinion to the contrary. The PPSA contains specific provisions with respect to analyzing the validity, perfection and effect of perfection or nonperfection of a security interest, which are based on the location of the Collateral or the debtor (that is, the Covered Customer), which are different from the above definitions. The Civil Code of Quebec (the Civil Code or the CCQ) also contains specific rules with respect to analyzing the validity, publication and the effects of such publication of a security interest (called a "security" in Quebec), which are based on the location of the Collateral or the debtor (that is, the Covered Customer), which rules are different from the above definitions. Although we do not expressly refer to each fact pattern in our answer to each question, we have taken them into consideration in our analysis. It should be 36

39 generally clear from the context which of the fact patterns is being discussed in each case. A. Assumptions We assume the same facts as set forth in Part I.II above (as applicable) with the following modifications: a) Pursuant to the relevant Covered Base Agreement and CDA, the counterparties agree that Collateral will include cash credited to an account (as opposed to physical notes and coins) and certain types of securities (as further described below) that are located or deemed located either (i) in this jurisdiction, or (ii) outside this jurisdiction (Eligible Collateral). "Eligible Collateral" includes the Covered Customer's right, title and interest in (i) its contractual rights under its Futures Transactions and Cleared Derivatives Transactions, including its Futures Payment Rights and Cleared Derivatives Payment Rights, (ii) its right to any Futures Credit Support and Cleared Derivatives Credit Support and (iii) the proceeds of such rights. b) Any securities provided as Eligible Collateral are denominated in either Canadian currency or any freely convertible currency and consist of (i) corporate debt securities whether or not the issuer is organized or located in this jurisdiction; (ii) debt securities issued by the government of Canada; and (iii) debt securities issued by the government of a member of the "G-10" group of countries, in one of the following forms: (i) (ii) directly held bearer debt securities: by this we mean debt securities issued in certificated form, in bearer form (meaning that ownership is transferable by delivery of possession of the certificate) and, when held by a Clearing Member or a DCO as Collateral under a Covered Base Agreement and CDA, held directly in this form by the Clearing Member or a DCO (that is, not held by the Clearing Member or DCO indirectly with an Intermediary (as defined below)); directly held registered debt securities: by this we mean debt securities issued in registered form and, when held by a Clearing Member or DCO as Collateral under a Covered Base Agreement and CDA, held directly in this form by the Clearing Member or DCO so that the Clearing Member or DCO is shown as the relevant holder in the register for such securities (that is, not held by the Clearing Member or DCO indirectly with an Intermediary); 37

40 (iii) (iv) directly held dematerialized debt securities: by this we mean debt securities issued in dematerialized form and, when held by a Clearing Member or DCO as Collateral under a Covered Base Agreement and CDA, held directly in this form by the Clearing Member or DCO so that the Clearing Member or DCO is shown as the relevant holder in the electronic register for such securities (that is, not held by the Clearing Member or DCO indirectly with an Intermediary); intermediated debt securities: by this we mean a form of interest in debt securities recorded in fungible book entry form in an account maintained by a financial intermediary (which could be a central securities depositary (CSD) or a custodian, nominee or other form of financial intermediary, in each case an Intermediary) in the name of the Clearing Member or DCO where such interest has been credited to the account of the Clearing Member or DCO in connection with a transfer of Collateral by the Covered Customer to the Clearing Member under a Covered Base Agreement and CDA. The precise nature of the rights of the Clearing Member in relation to its interest in intermediated debt securities and as against its Intermediary will be determined, among other things, by the law of the agreement between the Clearing Member and its Intermediary relating to its account with the Intermediary, as well as the law generally applicable to the Intermediary, and possibly by other considerations arising under the general law or the rules of private international law of this jurisdiction. The Clearing Member's Intermediary may itself hold its interest in the relevant debt securities indirectly with another Intermediary or directly in one of the three forms mentioned in (i), (ii) and (iii). In practice, there is likely to be a number of tiers of Intermediaries between the Clearing Member and the issuer of such securities, at least one of which will be an Intermediary that is a national or international CSD. The Clearing Member will normally hold debt securities in the form of intermediated debt securities rather than directly in one of the three forms mentioned in (i), (ii) and (iii). c) Due to regulatory requirements, Collateral posted will be held by intermediaries in a way that identifies the Collateral as belonging to customers of the Clearing Member. For example, if the Collateral is held by the Clearing Member or any intermediary of the Clearing Member, that account will show that it is held for customers generally and the Clearing Member's books will show that the collateral is held for the individual customer. If the Collateral is held by the DCO or an intermediary of the DCO, that account will show that it is held for 38

41 customers generally the DCO's books will show that the Collateral is held for the individual customer. d) Cash Collateral is denominated in a freely convertible currency and is held in an account under the control of the Clearing Member or DCO. e) In the case of cash Collateral that is transferred to a Clearing Member as margin, such cash Collateral can be viewed either as a transfer of title in that cash to the Clearing Member, or as collateral in which the Clearing Member can take a security interest. Under the first alternative, the Clearing Member can be viewed as receiving such cash Collateral as a principal and therefore having a right to net that cash margin against amounts owing from the Covered Customer to the Clearing Member. f) In the case of questions 11 to 14 below, after entering into the Transactions and prior to their maturity, an Event of Default exists and is continuing with respect to the Covered Customer, and/ or the Clearing Member has designated a date to begin exercising its Futures Liquidation Rights or Cleared Derivatives Liquidation Rights (a Liquidation Date) as a result thereof (however, an insolvency proceeding has not been instituted, which is addressed separately in assumption (k) and questions 15 to 19 below). g) In the case of questions 15 to 17 below, a Canadian insolvency proceeding has been instituted by or against the Covered Customer and an Event of Default has accordingly occurred under the Covered Base Agreement and CDA. B. Issues Validity of Security Interests 1. Under the laws of Ontario and Quebec, what law governs the contractual aspects of a security interest in the various forms of Eligible Collateral under the Covered Base Agreement and CDA? Would the courts of Ontario recognize the validity of a security interest created under each Covered Base Agreement and CDA, assuming it is valid under the governing law of such Covered Base Agreement and CDA? a) Introduction to Securities Transfer Acts, PPSA and Civil Code Concepts 39

42 The applicable law with respect to transfer of securities and the taking of security interests in securities is found in the securities transfer legislation in each province (in Ontario, the Securities Transfer Act 2006 (Ontario) 62 (the STA) and in Quebec, An Act respecting the transfer of securities and the establishment of security entitlements (Quebec) 63 (the Quebec STA or the QSTA)) 64 which govern many aspects of the transfer of investment securities, and also in personal property security legislation (in Ontario the Personal Property Security Act (Ontario) 65 (the PPSA) and Quebec the Civil Code), which govern the taking of a security interest in investment securities, futures, contractual rights and cash collateral. The STA and QSTA distinguish between direct holdings of certificated and uncertificated securities and indirect holdings (through an Intermediary, including a CSD). Understanding these distinctions is a precondition to understanding the conflict of laws rules and the substantive law on the validity, perfection and priority of securities interests, so we begin with a brief introduction to those concepts. Under the STA, a person acquires a security or interest in a security 66 if either (a) that person is a purchaser 67 to whom a security is delivered 68 or (ii) that person acquires a security entitlement 69 to the security. A person acquires a security entitlement when a securities intermediary 70 (i) credits a security to such person's securities account by book entry, 71 (ii) receives or acquires a security from or for such person and accepts it for credit to such person's securities account, or (iii) is obligated to credit a security to such person's securities account. 72 A person has a security entitlement upon satisfaction of one of these three methods of 62 S.O. 2006, c.8 63 S.Q., 2008, c All provinces except Prince Edward Island and the Yukon have now passed the legislation. 65 R.S.O. 1990, c. P. 10 as amended in particular by S.O. 2006, c STA, s Note that purchaser is broadly defined and includes a person who acquires a security interest in the security. STA, s.1(1) - definitions of "purchaser" and "purchase", which "means a taking by sale, discount, negotiation, mortgage, hypothec, pledge, security interest, issue or reissue, gift or any other voluntary transaction that creates an interest in property." 68 This method is relevant only in a direct holding system. 69 The term "security entitlement" describes the rights and property interest of an "entitlement holder" with respect to a financial asset held indirectly through one or more tiers of securities intermediaries. STA, s.1(1). A security entitlement is both a package of personal rights against the securities intermediary and an interest in property held by the securities intermediary. It is not, however, a property interest in any specific financial asset held by the securities intermediary. 70 A "securities intermediary" is a clearing agency (which is also defined in the STA) or a person, including a bank or broker, that in the ordinary course of its business maintains "securities accounts" for others and is acting in that capacity (STA, s.1(1)). 71 A "securities account" is an account to which a "financial asset" is credited in accordance with an agreement under which the person maintaining the account undertakes to treat the person for whom the account is maintained as entitled to exercise the rights that constitute the financial asset.- STA, s.1(1). A "financial asset" is, among other things, a certificated or uncertificated security or a "security entitlement" (STA, s.1(1)). 72 STA s.95(1). 40

43 acquisition, regardless of whether the securities intermediary actually holds interests in the financial asset. 73 The QSTA is framed somewhat differently, but essentially to the same effect. Under the QSTA, a security is transferred 74 to a person when that person acquires rights in and takes delivery of such security. 75 A person acquires a security entitlement when a securities intermediary 76 (i) credits a financial asset to such person's securities account by book entry, 77 (ii) receives a financial asset from or acquires a financial asset for such person and accepts it for credit to such person's securities account, or (iii) is obligated to credit a financial asset to such person's securities account. 78 A person has a security entitlement upon satisfaction of one of these three methods of acquisition, regardless of whether the securities intermediary actually holds the financial asset. 79 A security entitlement is a sui generis form of property interest: it is a package of rights and interests that a person has against the person's securities intermediary and the property held by the securities intermediary. The provisions in Part VI of the STA and Chapter IV of the QSTA describe the elements of a security entitlement, including that (i) the entitlement holder 8 does not take credit risk of the securities intermediary's other business activity (i.e. property held by the intermediary as intermediary is not subject to the claims of the securities intermediary's general creditors), 81 (ii) the securities intermediary will maintain a one-to-one match between the financial assets that it itself holds and all the claims of its entitlement holders, 82 (iii) the securities intermediary will pass through to the entitlement holder payments or distributions made with respect to the financial assets, 83 (iv) the securities intermediary will exercise voting rights and other rights and privileges of ownership of the financial assets in the fashion 73 STA, s.95(2). 74 Note that purchaser refers to a person who acquires rights in a security. QSTA, s.6 provides that "Acquisition of rights in a security or financial asset may result from any act constituting or conveying rights in the security or financial asset including by way of issue, sale, exchange, gift or hypothec provided only that the act is consensual." 75 QSTA, s.6. This method is relevant only in a direct holding system. 76 A "securities intermediary" is a clearing agency (which is also defined in the QSTA) or a person, including a bank or dealer that in the ordinary course of its business maintains "securities accounts" for others and is acting in that capacity QSTA, s.8. 7 A "securities account" is an account to which a "financial asset" is or may be credited in accordance with an agreement under which the securities intermediary maintaining the account undertakes to consider the account holder as being entitled to exercise the rights that constitute the financial asset.- QSTA, s.8. A "financial asset" is, among other things, a certificated or uncertificated security.(qsta, s.12). 78 QSTA, s QSTA, s The "entitlement holder" is the person identified in the records of the intermediary as the person having a security entitlement against the intermediary (STA, s.1(1)). 81 STA, s.97(1). QSTA, s.107. See QSTA, s.130 for a limited exception for secured creditors. 82 STA, s.98. QSTA, s STA, s.99. QSTA, s

44 directed by the entitlement holder /84 (v) the securities intermediary will transfer or otherwise dispose of the positions at the direction of the entitlement holder, 85 and (vi) the securities intermediary will act at the direction of the entitlement holder to convert the position into any other available form of securities holding.86 With respect to other Eligible Collateral property (such as Futures Transactions and Futures Payment Rights, and Cleared Derivatives Transactions and Cleared Derivatives Payment Rights, cash collateral (whether a security interest is granted or provided by way of title transfer) and other intangible property, it will be necessary for a Clearing Member (1) with respect to Ontario Customers to perfect by registration of a financing statement and (2) with respect to Quebec Customers to add language to the CDA or Covered Base Agreement or create a separate document to create a moveable hypothec without delivery and to register the security in Quebec. More detail is provided in response to question 5. b) Relevance of Governing Law On purely contractual aspects of the agreements the court would apply New York law as the chosen law. To the extent this question deals with the creation and validity of a security interest, before an Ontario or Quebec court, this issue would not be determined by the governing law of the agreement, except to the extent that their interpretation was relevant to the question. Under Ontario law any interest in property that secures payment or performance of an obligation is a security interest 87 and a court would determine, by applying the contract law interpretation principles of the governing law stated in the agreement, whether or not the interest in the Eligible Collateral granted by the agreement secured payment or performance of an obligation. 88 In other words, an Ontario court would apply the stated governing contract law to determine whether the Covered Base Agreement granted a "security interest" in the Eligible Collateral. Under Quebec law, conflict of laws rules are set out in the Civil Code. Pursuant to Article 3078 of the Civil Code, characterization is a matter to be determined by 84 STA, s.100. QSTA, s STA, s.101. QSTA, s STA, s.102. QSTA, s.122. S7PPSA, s. 1(1). 88 Generally, Canadian common law courts will apply the parties chosen law to matters of essential validity of the agreement and to its interpretation. Subsection 8(1)(b) of the Ontario PPSA provide that substantive issues/matters involving/affecting the enforcement of the rights of a secured party are governed by the proper law of the contract between the secured party and the debtor. 42

45 the law of the forum. Nonetheless, such rule provides that where a legal institution (concept) is unknown to the court, or known to it under a different designation or with a different content, foreign law may be taken into account. In other words, a Quebec court would apply initially Quebec law to determine whether the Covered Base Agreement created a security in the Eligible Collateral. Some commentators advance the proposition that for purposes of determining what constitutes "security" under the Quebec conflict of laws rules, a functional approach similar to the approach under the Ontario PPSA should be taken. To a certain extent, the question of whether a security has been granted is a question of intention. Hence, a Quebec court would likely take into account the governing law stated in the security document in order to determine this intention. c) Validity (A) General The PPSA and Civil Code set out conflict of laws rules that apply specifically to the question of validity (creation and attachment) of the security interest created by security agreements. This memorandum will consider conflict rules first, in the abstract, and then apply the rules to specific types of Eligible Collateral presented in the assumptions above. There are a number of rules relevant to the validity of security interests in the type of collateral that is potential Eligible Collateral. These rules are as follows: The validity of a security interest in a certificated security is governed by the internal law, 89 at the time the security interest attaches, of the jurisdiction where the certificate is located. 90 The validity of a security interest in an uncertificated security is governed by the internal law, at the time the security interest attaches, in Ontario of the "issuer's jurisdiction" and similarly in Quebec (although without using the defined term "issuer's jurisdiction"). 91 The validity of a security interest in a security entitlement (which includes an entitlement to a financial asset credited to a securities account) or a securities account is governed by the internal law, at the time the security interest attaches, in Ontario of the "security intermediary's jurisdiction" 89 PPSA, s Art CCQ. 90 PPSA, s. 7.1(1)(a). Art CCQ. 91 PPSA, s. 7.1(1)(b). Arts to and CCQ. Functionally equivalent to the "issuer's jurisdiction" under the Ontario STA. 43

46 (and similarly in Quebec although without using the defined term "security intermediary's jurisdiction"). 92 In Ontario, the validity of a security interest in a futures contract or a futures account is governed by the internal law, at the time the security interest attaches, of the futures intermediary's jurisdiction. 93 In Ontario, the validity of a security interest in an intangible (excluding securities, titles in bearer form and security entitlements) is governed by the internal law, at the time the security interest attaches, of the jurisdiction where the debtor is located. 94 In Quebec, the validity of a non-possessory security in incorporeal movable property (excluding securities, titles in bearer form and security entitlements) is governed by the internal law, at the time the security is created, of the jurisdiction where the debtor has its domicile. 95 Section 17 of the QSTA provides that commodity futures contracts, security futures contracts, financial instrument futures contracts and other similar futures contracts and options on such contracts are neither securities nor financial assets for purposes of the QSTA. They are considered to be financial assets, for purposes of security law (the law applicable to security interests in Quebec such as under the Civil Code) and related rules for publication (perfection) and conflicts of law, if such are held in a securities account as per the third bullet above). There has been no reported case considering this provision and it is unclear as to its application, particularly if such futures contracts are actually in a futures account, as such term is used in the PPSA. In the absence of clarity on the application of this rule, only the rule on the validity of a non-possessory security in incorporeal property (excluding securities, titles in bearer form and security entitlements) as per the last bullet above would apply to commodity futures contracts, security futures contracts, financial instrument futures contracts and other similar futures contracts and options on such contracts. (B) Cash Collateral The PPSA and Civil Code distinguishes between Cash held in a securities account and Cash which is not held in a securities account. 92 PPSA, s. 7.1(1)(c). Arts and CCQ. Functionally equivalent to the "securities intermediary's jurisdiction" under the Ontario STA. 93 PPSA, s.7.1(1)(d). 94 Ontario PPSA, s. 7.1(1)(a). 95 Art CCQ.

47 Manner of Holding Characterization Governing Law - Validity of Security Interest Cash not held in a "securities account" Cash held in a securities account where intermediary and account holder have not agreed that it is not a financial asset Cash held in a securities account where intermediary and account holder have agreed that it is not a financial asset Ont.- Intangible Que. - Incorporeal movable property Ont. - Investment Property Que. - Financial asset/ security entitlement Ont. - Intangible Que. - Incorporeal Movable Property Ont. - Debtor's location at time of attachment Que. - Debtor's domicile at time of creation Place where the security intermediary is located at the time of attachment/creation Ont. - Debtor's location at time of attachment Que. - Debtor's domicile at time of creation Cash not held in a securities account would likely be characterized for these purposes as an intangible or incorporeal movable property (whether in an account in the name of the Clearing Member or under the Clearing Member's control). Consequently, the validity of the security interest in Cash would be governed by the law of the jurisdiction where the Covered Customer is located (if proceedings are in Ontario) or domiciled (if proceedings are in Quebec) at the time the security interest attaches (in Ontario) or is created (in Quebec). Just to be clear, this means that the place where the deposit is held is not relevant to the conflict of laws analysis. Under the current Ontario PPSA, a debtor (in this case, the Covered Customer) is located at its place of business and if it has more than one place of business at its chief executive office. 96 There are no relevant cases considering the meaning of the phrase "chief executive office". In our view, it refers, not to the registered head office, but to the place where the chief executives of the entity have their offices. It is worth noting, accordingly, that the PPSA does not currently determine location of a debtor on the basis of the jurisdiction of incorporation and organization of the debtor. 97 For Quebec law purposes, legal persons 96 Ontario PPSA, s.7(4). 97 Not all jurisdictions in Canada apply a chief executive office test for location. For example, in Quebec, currently, registered office is the governing connecting factor. 45

48 (corporations) are generally held to have their domicile at the place of their registered office. 98 However, the Ontario government has passed further amendments to the PPSA, which will (if and when they come into force) significantly amend the definition of "location of the debtor." Business corporations and limited partnerships organized provincially will be located in the jurisdiction of incorporation/ organization. Federal corporations will be located where their head office or registered office is located. 99 Ordinary partnerships will be located in the province of the law governing the partnership agreement. It is anticipated that the Ontario government will not proclaim these amendments into force unless and until several other provinces follow suit, which has not yet happened. If and when these changes are brought into force, secured parties relying on financing statements filed in the jurisdiction of the chief executive office will have to consider the transitional rules to determine whether any further action is required. Generally, credit balances in a securities account are characterized as "investment property" (in Ontario) and a "financial asset" 100 which may give rise to a security entitlement (in Quebec) and not as intangibles. Consequently, validity is governed by the law of the "securities intermediary's jurisdiction" 101. "Investment property" includes a "security entitlement". 102 " Security entitlement" is defined in the Ontario STA as the rights and property interest of an entitlement holder with respect to a "financial asset" that are specified in Part VI of the STA. 103 Included in the definition of "financial asset" under the STA and the QSTA is: a credit balance in a securities account, unless the securities intermediary has expressly agreed with the person for whom the account is maintained that the credit balance is not to be treated as a financial asset under this Act. (If the securities intermediary and the person in whose name the account is held did agree that the credit balance was not a financial asset, then the Cash would be an intangible for this purpose.) 98 Art. 307 CCQ. The test for the location of the debtor differs from the test under the Ontario PPSA. Such latter test focuses on the principal place of business and chief executive office. Hence depending upon the jurisdictions having a connecting factor in the analysis, it may be necessary to obtain valid security in various jurisdictions. 99 There are special rules for U.S. corporations and for other foreign corporations. 100 A "financial asset" would also constitute incorporeal movable property in most cases under Quebec law. 101 Discussed immediately below. 102 PPSA, s. 1(4 103 PPSA, s.1(1) and STA, s.1(1). QSTA, s

49 Not every account holding financial assets is a securities account. The person (e.g. a broker, bank or trust company) maintaining the account must be either a clearing agencyl 4 or it must be in the ordinary course of its business to maintain securities accounts for others, and it must be acting in that capacity with respect to the account. So, while a bank could be a securities intermediary, a typical deposit account would likely not be characterized as a securities account. (C) Directly Held Certificated Securities The validity of a security interest in a certificated security 105 held directly by the secured party or its agent is governed by the law of the place where the certificate is located at the time the security interest attaches (in Ontario) or is created (in Quebec). 106 This includes debt securities issued by governments or government agencies. (D) Directly Held Dematerialized or Uncertificated Securities The validity of a security interest in an "uncertificated security"107 is governed by law of the "issuer's jurisdiction". The "issuer's jurisdiction" is defined in the STA. 108 The definition specifies a jurisdiction, but allows the issuer to specify a different jurisdiction if the laws of the otherwise applicable jurisdiction allow. The "issuer's jurisdiction" is not defined in the Quebec STA or the Civil Code, as it is in the Ontario STA. The rules do, however, specify a jurisdiction in substantively the same manner as the Ontario STA, but allow the issuer to specify a different jurisdiction if the laws of the otherwise applicable jurisdiction allow. So, for example, the jurisdiction of an Ontario or Quebec incorporated or organized entity or the Ontario or Quebec Crown is normally Ontario or Quebec respectively, but the STA and QSTA expressly allows the issuer to choose another jurisdiction: 109 The specified jurisdictions are: Type of Entity Canadian federally Jurisdiction The province or territory in which it has its head 104 As defined in the STA, s.1(1) or QSTA, s.4. los A security represented by a certificate. STA, s.1(1). It does not include a security represented by an electronic certificate (see the definition of security - STA, s.1(1)); QSTA, s.9). 106 PPSA, s.7.1(1)(a). Art CCQ. 107 A security which is not represented by a certificate. los As provided for in PPSA, s.7.1(3)(b). Section 44(5) of the STA. 109 STA. s.44(3); Art CCQ. 47

50 incorporated issuers The Canadian federal Crown A Canadian provincial Crown or a territory Other issuers office or registered office (Ontario) or head office (Quebec), or, if Canadian federal law permitsllo, another jurisdiction specified by the issuer The jurisdiction it specifies as its jurisdiction The province (or territory) or, if the provincial (or territorial) law permits, another jurisdiction specified by the issuer The jurisdiction under which the issuer is incorporated or otherwise organized, or, if the law of that jurisdiction permits, another jurisdiction specified by the issuerm (E) Intermediated Securities - Securities Accounts and Security Entitlements The law of the securities intermediary's jurisdiction governs the validity of a security interest in a security entitlement or securities account. 112 The "securities intermediary's jurisdiction" is not defined in the Quebec STA or the Civil Code. However, the rules specify a jurisdiction in substantively the same manner as the Ontario STA. The securities intermediary's jurisdiction is determined in accordance with the rules set out in the STA and QSTA. 113 The STA rules specify a number of alternatives for determining the securities intermediary's jurisdiction applied in the following order: no It does not yet do so. 111 The Ontario STA, for example, permits an Ontario issuer to choose another jurisdiction. Ontario STA, s. 44(3)(1). The Civil Code permits a Quebec issuer to choose another jurisdiction. Art CCQ. 112 PPSA, s.7.1 (1)(c). 113 Ontario PPSA, s.7.1(3)(c) provides that the securities intermediary's jurisdiction is determined under section 45 of the Ontario STA. Article of the Civil Code. 48

51 (i) the jurisdiction specified as the securities intermediary's jurisdiction for the purpose of Ontario, the STA or any provision of the STA in the securities account agreement between the intermediary and its entitlement holder; 114 (ii) the expressly stated governing law of the securities account agreement; (iii) if the securities account agreement expressly provides that the securities account is maintained at an office in a particular jurisdiction, then that jurisdiction; (iv) the jurisdiction in which the office identified in an account statement as the office serving the entitlement holder's account is located; or (v) the jurisdiction where the chief executive office of the securities intermediary is located. In Quebec, the rule specifies the jurisdiction as: (i) (ii) (iii) (iv) the law of the jurisdiction specified as governing the matters set out in the first paragraph of Article of the Civil Code, including the acquisition of a security entitlement from the securities intermediary, in a juridical act (agreement) governing the securities account between the intermediary and its entitlement holder; 115 the expressly stated governing law of a juridical act (agreement) governing the securities account; if a juridical act (agreement) governing the securities account expressly provides that the securities account is maintained at an establishment in a particular jurisdiction, then the law of that jurisdiction; the law of the jurisdiction in which the establishment identified in an account statement as the establishment serving the entitlement holder's account is located; or 114 Note that the CDS Clearing and Depository Services Inc, a clearing agency and therefore a securities intermediary, has specified Ontario as its jurisdiction - CDS Rule Note that CDS Clearing and Depository Services Inc. a clearing agency and therefore a securities intermediary, has specified Ontario as its jurisdiction - CDS Rule

52 (v) the law of the jurisdiction where the decision-making centre of the securities intermediary is located. The STA, but not the QSTA, specifically states that the following factors are not to be taken into account in determining the securities intermediary's jurisdiction: (i) the physical location of certificates representing the financial assets; (ii) the jurisdiction in which the issuer of the financial asset is incorporated or otherwise organization; and (iii) the location of facilities for data processing or other record keeping concerning the securities account. (F) Futures and Options Contracts and Futures Accounts CO Ontario The PPSA provides that the law of the "futures intermediary's jurisdiction" at the time of attachment governs the validity of a security interest in a futures contract or futures account. "Futures contract" is defined to mean: a standardized future or an option on futures, other than a clearing house option, that is, (a) traded on or subject to the rules of a futures exchange 116 recognized or otherwise regulated by the Ontario Securities Commission or by a securities regulatory authority of another province or territory of Canada, or (b) traded on a foreign futures exchange and carried on the books of a futures intermediary for a futures customer 117; "Futures account" is defined to mean: an account maintained by a futures intermediary in which a futures contract is carried for a futures customer; "Futures intermediary" is defined (unfortunately and perhaps in error) to include only dealers or clearing houses registered in a province of Canada. "futures intermediary" means a person that, 116 "futures exchange" means an association or organization operated to provide the facilities necessary for the trading of standardized futures or options on futures. 117 "futures customer" means a person for which a futures intermediary carries a futures contract on its books. 50

53 (a) is registered as a dealer permitted to trade in futures contracts, whether as principal or agent, under the securities laws or commodity futures laws of a province or territory of Canada, or (b) is a clearing house recognized or otherwise regulated by the Ontario Securities Commission or by a securities regulatory authority of another province or territory of Canada; Futures carried by Clearing Members that do not have a Canadian registration or exemption are "intangibles" and the issue of the validity of the security interest would be determined by the location of the Covered Customer. 118 For those futures that are carried by a Canadian registrant or regulated Clearing Member, the futures intermediary's jurisdiction is determined in accordance with the rules set out in section 7.1(4) of the PPSA. Those rules specify a number of alternatives for determining the futures intermediary's jurisdiction applied in the following order: (ii) (i) the jurisdiction specified as the futures intermediary's jurisdiction for the purpose of Ontario law, the STA or any provision of the STA in the futures account agreement between the intermediary and its customer; (ii) the expressly stated governing law of the futures account agreement; (iii) if the futures account agreement expressly provides that the futures account is maintained at an office in a particular jurisdiction, then that jurisdiction; (iv) the jurisdiction in which the office identified in an account statement as the office serving the customer's account is located; or (v) the jurisdiction where the chief executive office of the futures intermediary is located. Quebec Please see the discussion above (A) in respect of Section 17 of the QSTA. (G) Intangibles such as Contractual Rights The validity of the security interest in intangibles, which would include receivables and contractual rights such as the contractual rights under its Futures Transactions (to the extent the Clearing Member is not a "futures intermediary" 118 It is hoped that this issue will be addressed in the next round of PPSA revisions. 51

54 as defined above, at least under Ontario law) and Cleared Derivatives Transactions and its right to payment from DCOs in respect of those Futures Transactions and Cleared Derivatives Transactions and, for Quebec purposes futures contracts in a futures account, would be governed by the law of the jurisdiction where the Covered Customer is located (Ontario) or domiciled (Quebec) at the time the security interest attaches (Ontario) or is created (Quebec). See above under the Validity heading (B) re Cash Collateral for a discussion of location and domicile. 2. Under the laws of Ontario and Quebec, what law governs the proprietary aspects of a security interest (that is, the formalities required to protect a security interest in Eligible Collateral against competing claims) granted by the Covered Customer under each Covered Base Agreement and CDA (for example, the law of the jurisdiction of incorporation or organization of the Covered Customer, the jurisdiction where the Eligible Collateral is located, or the jurisdiction of location of the Clearing Member or DCO's Intermediary in relation to Eligible Collateral in the form of indirectly held securities)? What factors would be relevant to this question? Where the location (or deemed location) of the Eligible Collateral is the determining factor, what are the principles governing such determination under the law of this jurisdiction with respect to the different types of Eligible Collateral? How do the laws of this jurisdiction apply to each form in which securities Eligible Collateral may be held as described in assumption (b) above? (a) Ontario The rules for determining the law governing perfection and the effect of perfection or non-perfection depend to some extent on the method of perfection. Some of the rules are the same as those governing validity of the security interest except with respect to the time at which the determination is made. (Validity is determined as of the time of attachment.) The rules with respect to perfection have no express temporal element, because perfection is a status to be determined throughout the relationship. In other words, it has to be reassessed if circumstances (e.g. the location of a security certificate) change. 119 The rules are as follows: 119 The PPSA includes provisions to continue perfection for a period of time after a change in circumstances. See Ontario PPSA, s.7(2) with respect to Cash collateral not in a securities account and s.7.1(7) with respect to investment property. 52

55 1. The perfection of a security interest in a certificated security is governed by the law of the jurisdiction where the certificate is located The perfection of a security interest in an uncertificated security is governed by the law of the issuer's jurisdiction The perfection of a security interest in a security entitlement or a securities account is governed by the law of the security intermediary's jurisdiction The perfection of a security interest in a futures contract or a futures account is governed by the internal law of the futures intermediary's jurisdiction, where the intermediary is a Canadian registrant or is regulated but exempt from registration in Canada The perfection of a security interest in an intangible is governed by the law of the jurisdiction where the debtor is located The perfection of a security interest in investment property 125 (e.g. futures, futures accounts, securities, securities accounts and securities entitlements) by registration is governed by the law of the jurisdiction where the debtor is located. 126 See Question 1 above for a further explanation of the meaning of securities intermediary's jurisdiction, futures intermediary, futures intermediary's jurisdiction, location of the debtor and issuer's jurisdiction. It should be noted that if there is not a perfection by control or possession regime in the securities intermediary's jurisdiction, but registration is the means of perfection, then it is the conflict of laws rule with respect to registration (6 above) that will apply. (b) Quebec 120 PPSA, s.7.1(2)(a). 121 PPSA, s.7.1(2)(b). 122 Ontario PPSA, s.7.1(2)(c). 123 PPSA, s.7.1(1)(d). 124 Ontario PPSA, s.7(1)(a). 125 A security interest in any type of property can be perfected by registration of a financing statement. As discussed below in the context of priority, this method of perfection does not ensure priority. 126 PPSA, s.7.1(5)(a). There is in addition a special conflict rule for security interests in investment property granted by a broker or securities intermediary where the secured party is relying on attachment of the security interest to perfect the interest. This is also governed by location of the debtor: PPSA, s.7.1(5)(b). 53

56 The rules for determining the law governing publication and its effects (roughly equivalent to perfection, the effect of perfection or non-perfection and priority) 127 depend to some extent on the method of publication. Some of the rules are the same as those governing validity of the security except with respect to the time at which the determination is made. (Validity is determined as of the time of creation.) The rules with respect to publication have no express temporal element, because publication is a status to be determined throughout the relationship. In other words, it has to be reassessed if circumstances (e.g. the location of a security certificate) change. 128 The rules are as follows: 1. Publication of a security in a certificated security and the effects of such publication are governed by the law of the jurisdiction where the certificate is located Publication of a security in an uncertificated security and the effects of such publication are governed by the law of the "issuer's jurisdiction" Publication of a security in a security entitlement and the effects of such publication are governed by the law of the "security intermediary's jurisdiction" Publication of a non-possessory security in incorporeal movable property that is not securities, titles in bearer form or security entitlements, and the effects of such publication are governed by the law of the jurisdiction where the debtor is domiciled Publication by registration (but not its effects) of a security in securities and security entitlements is governed by the law of the jurisdiction where the debtor is domiciled. 133 See Question 1 above for a further explanation of the meaning of "securities intermediary's jurisdiction", domicile of the debtor and "issuer's jurisdiction". Please see above in respect of Section 17 of the QSTA for futures contracts. 127 Art CCQ. 128 The Civil Code includes provisions to continue publication for a period of time after a change in certain circumstances. See Art CCQ with respect to Cash collateral not in a securities account. 129 Art CCQ. 130 Arts to and CCQ. 131 Arts and CCQ. 132 Art CCQ. 133 Art CCQ. There is in addition a special conflict rule for publication (but not its effects) of a security in securities and security entitlements granted by a securities intermediary where the secured party is relying on creation of the security to render opposable such security. This is also governed by the law of the domicile of the grantor: Art CCQ. 54

57 It should be noted that if there is not a publication by control or possession regime in the securities intermediary's jurisdiction, but registration is the means of perfection, then it is the conflict of laws rule with respect to registration (5 above) that will apply. 3. Would the courts of Ontario and Quebec recognize a security interest in each type of Eligible Collateral created under each Covered Base Agreement and CDA bearing in mind the different forms in which securities Collateral may be held, as described in assumption (b) above. An Ontario or Quebec court would recognize the validity of a security interest in each type of Eligible Collateral created under each Covered Base Agreement and CDA if the security interest was valid under the applicable law as determined pursuant to the rules described in Question 1. above, and recognizing that in the case of indirectly held securities the security interest is actually in the sui generis property that is the security entitlement as opposed to the underlying security held by the CSD. See Question 5 below for a description of the conditions for validity where Ontario or Quebec is the applicable law determined pursuant to those rules. With respect to cash Collateral, neither the location of the account nor the currency is relevant. 4. What is the effect, if any, under the laws of Ontario and Quebec of the fact that the amount secured or the amount of Eligible Collateral subject to the security interest will fluctuate under the Covered Base Agreement and CDA (including as a result of entering into additional Covered Transactions from time to time)? In particular: (a) would the security interest be valid in relation to future obligations of the Covered Customer?134 (b) would the security interest be valid in relation to future Collateral (that is, Eligible Collateral not yet delivered to the Clearing Member at the time of entry into the relevant Covered 134 In relation to (a), the security interest in any specific Collateral would only be relevant in relation to future obligations, if ever, at the time such future obligations arise and then only in relation to Collateral held at that time. This question concerns whether it would be necessary for either party to perform any action at such time in order to ensure the effectiveness of the security interest as security for such obligations or whether the security interest would take effect in relation to those future obligations without further action by either party. 55

58 a) Future Obligations Base Agreement and CDA)? 135 (c) is there any difficulty with the concept of creating a security interest over a fluctuating pool of assets, for example, by reason of the impossibility of identifying in the Covered Base Agreement and CDA the specific assets transferred by way of security (assuming each specific delivery to the Clearing Member and return by the Clearing Member of Collateral under the Covered Base Agreement and CDA from time to time would be properly recorded by the Clearing Member, so that, while the pool of Collateral would change from time to time, at any specific time the composition of the pool of Collateral could be clearly identified by the Clearing Member)? (d) is it necessary under the laws of Ontario and Quebec for the amount secured by each Covered Base Agreement and CDA to be a fixed amount or subject to a fixed maximum amount? (e) is it permissible under the laws of Ontario and Quebec for the Clearing Member to hold Collateral in excess of its actual exposure to the Covered Customer under the related Covered Base Agreement and CDA? The security interest would be valid in relation to future obligations of the Secured Covered Customer. The PPSA expressly provides that a security agreement may secure future advances if it expressly so provides. 136 The Civil Code expressly provides that a hypothec including a pledge may secure future advances if it expressly so provides. 137 b) Future Collateral The security interest would be valid in relation to future Collateral. Ontario. The PPSA expressly provides that a security agreement may cover afteracquired property. 138 The security interest would not attach, however, until the 135 In relation to (b), it is understood that the security interest in Collateral to be delivered at some point in the future after the time of entry into the relevant Covered Base Agreement and CDA would not take effect in relation to such Collateral until the Collateral had been delivered to the Clearing Member in accordance with the Covered Base Agreement and CDA. This question concerns whether it would be necessary for either party to perform any action at such time in order to ensure the effectiveness of the security interest in relation to such Collateral or whether the security interest would take effect in relation to such Collateral without further action (other than the delivery) by either party. 136 Ontario PPSA, s Arts 2687, 2688 and 2797 CCQ. The Quebec Court of Appeal has confirmed that a hypothec may secure future obligations. See St-Jacques c. Charbonneau (1999), [1999] R.D.I. 200 (C.A.). 138 Ontario PPSA, s

59 Eligible Collateral met the conditions for attachment described below in Question 5. Quebec. The Civil Code expressly provides that a conventional movable hypothec without delivery (roughly equivalent to a non-possessory security interest) may cover after-acquired property and therefore such security would be valid in relation to future Collatera For a movable hypothec with delivery (also known as a pledge), the security would not charge the Eligible Collateral until the conditions described below in Question 5 are met, including obtaining control. c) Fluctuating Pool of Assets There is no difficulty with the concept of creating a security interest over a fluctuating pool of assets 140, for example, by reason of the impossibility of identifying the specific assets pledged, so long as the pool is identified in such a way that the Collateral in aggregate is identifiable at any given time and the debtor's proportionate interest in the pool can be determined and otherwise meets the conditions described below or under the applicable jurisdiction's law. 141 d) Necessity for Fixed Amount It is not necessary for the amount secured to be a fixed amount or subject to a fixed maximum amount. Under Quebec law, however, please note that for a conventional movable hypothec without delivery, such security must set out a charging amount in Canadian funds. 142 The charging amount is a purely notional amount and need not be related to any quantification of the secured obligations. The general practice is also to include a notional interest rate in addition to a principal charging amount which in total are in an amount large enough that they would not be reached. e) Excess Collateral 139 Arts 2670 and 2954 CCQ. 140 This assumes that the pool of assets is not being held by the debtor. 141 PPSA, s. 17(2)(d) recognizes that fungible Collateral may be commingled and this, in our view, implicitly recognizes that a security interest in a pool of fungible securities is possible and, because fluctuations are inevitable for a pool of assets, that fluctuations will not affect the security interest. Fungible securities are defined in s. 1(2) of the Ontario PPSA as securities of which any unit is, by nature or usage of trade, the equivalent of any other like unit and includes unlike units to the extent that they are treated as equivalents under a security agreement. 142 See the discussion below under Question 5(b)(iii). 57

60 It is permissible for the Clearing Member to hold Collateral in excess of its actual exposure to the Covered Customer if so provided for under the related Covered Base Agreement and CDA. The Clearing Member would, however, be required to return any excess after default and liquidation of the Collateral depending on the particular remedies exercised. 5. Assuming that the courts of Ontario and Quebec would recognize the security interest in each type of Eligible Collateral created under each Covered Base Agreement and CDA, is any action (filing, registration, notification, stamping, notarization or any other action or the obtaining of any governmental, judicial, regulatory or other order, consent or approval) required in Ontario or Quebec to perfect that security interest? If so, what actions must be taken and how would such actions differ depending on the type of Eligible Collateral in question? (a) Ontario (i) General If Ontario is the applicable law with respect to validity or perfection (as determined by applying the rules set out above), then with respect to certain types of Eligible Collateral there are steps that must be taken to ensure attachment and perfection of the security interest. (ii) Attachment of a Security Interest in Eligible Collateral Where Ontario is the law governing validity of the security interest, the Covered Base Agreement and CDA would create a valid security interest upon "attachment" of the security interest. 143 Attachment and validity mean essentially the same thing in the context of the PPSA. We will discuss attachment with respect to each type of Eligible Collateral. However, there are some elements of attachment common to each type of property. Three requirements for all types of property are: (1) value has been given, (2) the debtor has rights in the collateral or the power to transfer rights in the collateral to a third party, and (3) the parties have not agreed to postpone the time for attachment. 144 There is a fourth condition relating to identifying the collateral, but it can be satisfied in a number of different ways depending on the type of collateral. 143 Ontario PPSA, s Ontario PPSA, s. 11(3). If they have so agreed, attachment is delayed until the agreed time. 58

61 With respect to any type of collateral, the fourth element that will complete the conditions for attachment is the signing of a security agreement by the debtor that contains a description of the collateral sufficient for it to be identified. The PPSA also expressly provides that describing the collateral by the terms "security entitlement", "securities account", "futures account" or "investment property" is sufficient where collateral is in that form. Section 17(4) of the STA contains a rule designed to eliminate the problems of coordination of terminology. It provides that unless the context shows otherwise, a person who is required by an agreement to transfer, deliver, present, surrender, exchange or otherwise put in the possession of another person a security or other financial asset satisfies that requirement by causing the other person to acquire an interest in the security or other financial asset as set out in sections 17(1) and (2) of the STA. Also, describing the underlying financial assets in a futures account or securities account or subject to a securities entitlement is sufficient to describe the futures account, securities account or securities entitlement.145 The Ontario government has published a commentary which is based on the U.C.C. Article 8 Official Commentary. This Ontario commentary states (at p. 255) that a description of collateral in a security agreement does not need to refer to the security entitlement or securities account terminology. For certain types of Eligible Collateral the fourth element of attachment can also be met in ways other than having a description in the security agreement. Taking control of investment property pursuant to a security agreement also constitutes attachment. The concept of "control" will be described below in the context of the discussion of perfection. If the Eligible Collateral is a directly held certificated security in registered form an additional element that will complete satisfaction of the attachment criteria is the certificate being "delivered" to the secured party. 146 Delivery of a certificated security occurs when the secured creditor either: 1. acquires possession of the security certificate, 2. another person, other than a securities intermediary, either (i) acquires possession of the security certificate on behalf of the secured creditor or (ii) having previously acquired possession acknowledges that it is holding the certificate for the secured creditor, or 145 Ontario PPSA, s. 11, s STA, s

62 3. a securities intermediary acting for the secured creditor acquires possession of the certificate, the certificate is in registered form and the certificate is either (i) registered in the secured creditor's name, (ii) payable to the order of the secured creditor, or (iii) specially endorsed to the secured creditor by an effective endorsement and has not been endorsed to the securities intermediary or in blank. 147 Attachment of a security interest in a securities account is also attachment of a security interest in the security entitlements carried in the securities account. 148 (iii) Perfection of a Security Interest in Cash Collateral not held in a securities account As noted above 149, perfection of cash collateral that is not credited to a securities account (no matter in what currency or jurisdiction the deposit is made) is likely governed by the law of the place where the Covered Customer is located because of the likely characterization of this Collateral as an intangible. This is also the case for other intangibles such as contractual rights against the DCO. Under Ontario law the means to perfect a security interest in an intangible is the filing of a financing statement. The filing of a financing statement would be made in Ontario if the Covered Customer was located in Ontario. 150 The registration is made with a central government registry. The financing statement can be filed either manually or electronically. The fee varies depending on the length of the registration and perpetual registrations are possible. One financing statement can cover a number of transactions (and fluctuating obligations) and different types and fluctuating amounts of Collateral. For example, the Clearing Member would only have to file one financing statement with respect to Transactions under a particular Covered Base Agreement and CDA. It is possible for a small fee to obtain search reports that disclose all financing statements against a debtor. The agreements are not filed. With respect to cash provided on a title transfer basis, under Ontario law it is nevertheless recommended that the Clearing Member perfect on the basis that it may be characterized as a security agreement regardless of its form as a title transfer agreement. 147 If the certificate is registered to the intermediary or in blank, then the property becomes subject to the rules of the indirect holding system. 148 Ontario PPSA, s Question See Question 1 above for a description of the concept of "location of the debtor." 60

63 It is anticipated that the Ontario government may introduce amendments to the PPSA in 2013 that would permit perfection of a security interest in cash collateral accounts by control (similar to control with respect to a securities account). (iv) Perfection of a Security Interest in Investment Property - Directly Held Certificated Securities, Directly Held Uncertificated Securities, Indirectly Held Securities, Cash Held in a Securities Account Generally, under the PPSA a security interest in investment property (as defined in the PPSA), which includes credit balances in a securities account, may be perfected by "control" of the collatera The PPSA and STA, in pertinent part, provide that a secured party: (1) has control of a certificated security in bearer form if the certificated security is delivered to the secured party or its agent, other than a securities intermediary (i.e. the secured party or its agent acquires possession of the security certificate) and remains perfected by control until (a) the secured party does not have control, and (b) the debtor has or acquires possession of the security certificate; (2) has control of a certificated security in registered form if the certificated security is delivered to the secured party or its agent or securities intermediary and the certificate is endorsed to the secured party or in blank by an effective endorsement, or the certificate is registered in the name of the secured party at the time of the original issue by registration of transfer by the issuer and remains perfected by control until (a) the secured party does not have control, and (b) the debtor has or acquires possession of the security certificate; (3) has control of an uncertificated security if it is delivered to the secured party152 or if the issuer has agreed that it will comply with instructions that are originated by the secured party without the further consent of the registered owner, and remains perfected by control until (a) the secured party does not have control and (b) the issuer has registered or registers the debtor as the registered owner; and 151 Ontario PPSA, s. 22.1(1). The concept of "control" is dealt with in the STA, s. 23, 24, Delivery of an uncertificated security to a secured creditor occurs when (a) the issuer registers the secured creditor as the registered owner on the original issue or the registration of transfer or (b) another person, other than a securities intermediary, either, becomes the registered owner on behalf of the secured creditor or having previously become the registered owner acknowledges that the person holds for the secured creditor. STA, s.68(2). 61

64 (4) has control of a securities entitlement if the secured party becomes the entitlement holder or the securities intermediary agrees that it will comply with entitlement orders originated by the secured party without further consent by the entitlement holder, and remains perfected by control until (a) the secured party does not have control and (b) the debtor is or becomes the entitlement holder. A person becomes the entitlement holder when the security entitlement is transferred to an account in the person's name. Registration of a financing statement also perfects a security interest in any type of collateral, including investment property. 153 Also, a secured party may also perfect a security interest through automatic perfection (i.e. it is perfected when it attaches) if the secured party is a broker or securities intermediary. 154 However, these methods of perfection are not as powerful as control in terms of priority protection. 155 Accordingly, under Ontario, the Clearing Member should have a perfected security interest by control in the Eligible Collateral: (1) in the case of directly held bearer debt securities, when the Covered Customer delivers the security certificates to the Clearing Member or its agent (provided such agent is not a securities intermediary); (2) in the case of directly held registered debt securities, when the Covered Customer delivers the security certificates to the Clearing Member or its agent or the Clearing Member's own securities intermediary, in each case accompanied by any duly executed documents necessary to constitute a legally valid transfer (and in the case of delivery to a securities intermediary the security cannot be endorsed in blank); 156 (3) in the case of directly held dematerialized securities, when the Covered Customer's position is transferred to the Clearing Member so that the 153 Ontario PPSA, s.23. Perfection of a security interest by filing and automatic perfection of a security interest in investment property granted by a broker or securities intermediary, however, are governed by the local law of the jurisdiction in which the debtor is located. 154 PPSA, s.19.2(2). 155 The security interest of a secured party who has control over investment property has priority over a conflicting security interest of a secured party who does not have control (Ontario PPSA, s.30.1(2)). Moreover, a creditor of a securities intermediary, who has a security interest in investment property held by the securities intermediary, has priority over the intermediary's entitlement holders if the creditor has control over the investment property (STA, s.105(2)). 156 STA, s.23, s.68(1). "Delivery" itself also perfects a security interest in a certificated security in registered form. Delivery is a wider concept than control, but as stated above it is better to have control as it confers a more powerful priority position. Note that for certificated securities there is no provision that says there is still control if the registered owner retains the right to make substitutions, originate instructions or otherwise with the certificated security as there is with uncertificated securities. 62

65 Clearing Member or its agent (other than a securities intermediary) is registered on the books of the issuer as the owner of such security or the issuer has agreed that it will comply with instructions that are originated by the purchaser without the further consent of the registered owner; 157 (4) in the case of securities entitlements with respect to financial assets (e.g. indirectly held debt securities and Cash credited to a securities account): 158 (i) (ii) (iii) (iv) assuming that the Covered Customer gives written instructions to the relevant securities intermediary to transfer the security entitlements into an account held in the Clearing Member's name at an Intermediary (which may be acting as Custodian), at the point when that transfer takes place and the security entitlements are credited (or should be credited) to the Clearing Member's account at the relevant Intermediary (i.e. the Clearing Member becomes the entitlement holder); 159 the Intermediary of the Covered Customer has agreed that it will comply with entitlement orders that are originated by the Clearing Member without the further consent of the Covered Customer; 160 an agent has control of the security entitlement on behalf of the Clearing Member; or automatically if the Clearing Member is the Covered Customer's own Intermediary. 161 (v) Futures Contracts and Futures Accounts 162 Generally, under the PPSA a security interest in investment property (as defined in the PPSA), which includes futures contracts and futures accounts, may be perfected by "control" of the collatera The PPSA164 provides that a secured party has control of a futures contract if (i) the secured party is the futures intermediary with which the futures contract is carried, or (ii) the futures 157 STA, s.24, s.68(2). The Clearing Member has control even if the Covered Customer remains the registered owner and retains the right to make substitutions, originate instructions or otherwise deal with the uncertificated security (STA s.24(2)). 158 STA, s This method of perfection provides the highest level of protection. 160 The Clearing Member has control even if the Covered Customer remains the entitlement holder and retains the right to make substitutions for the security entitlement, to originate instructions to the securities intermediary or to otherwise deal with the security entitlement (s.25(2)). 161 STA, s See Question 1 above for an explanation of what futures and futures accounts are covered. 163 Ontario PPSA, s. 22.1(1). The concept of "control" is dealt with in the STA, s. 23, 24, PPSA Section 1(2)(d). 63

66 customer, secured party and futures intermediary have agreed that the futures intermediary will apply any value distributed on account of the futures contract as directed by the secured party without further consent by the futures customer. A secured party having control of all futures contracts carried in a futures account has control over the futures account. 165 If the Clearing Member meets the definition of a futures intermediary (see above question III.), then it would have control of the futures account and futures contracts. As noted above, however, futures carried in non-canadian accounts are not covered by these rules. (vi) Intangibles such as Rights against DCOs The perfection of the security interest in intangibles, which would include receivables and contractual rights such as the Futures Payment Rights under its Futures Transactions (to the extent the Clearing Member is not a "futures intermediary" as defined above) and its Cleared Derivatives Payment Rights under its Cleared Derivatives Transactions and its other rights against CDOs in respect of those Futures Transactions and Cleared Derivatives Transactions would be by registration of a financing statement with respect to Covered Customers located in Ontario. (b) Quebec (i) General If Quebec law is the applicable law with respect to validity or publication and the effects of publication (as determined by applying the rules set out above), then with respect to certain types of Eligible Collateral there are steps that must be taken to ensure creation and publication of such security. (ii) Creation of a Security in Eligible Collateral We will discuss creation with respect to each type of Eligible Collateral. However, there are some elements of validity common to each type of property. Two requirements for all types of property are: (1) the debtor must have the capacity to alienate the collateral, and (2) the debtor must have rights in the collateral or the power to transfer rights in the collateral to a third party. 166 There is a third condition relating to identifying the collateral, but it can be satisfied in a number of different ways depending on the type of collateral. 165 PPSA, s.1(2)(e). 166 Arts 2681 and 2682 CCQ. See also Art CCQ. 64

67 With respect to any type of collateral, other than cash that is not a financial asset in a securities account, an additional element that will complete the conditions for creation of a pledge is the evidence of the intention to grant security which is satisfied by the terms of the security agreement. We have assumed that the debtor has the requisite capacity. Assuming that the Covered Customer has rights in Eligible Collateral, the second element of a valid security interest would also be satisfied. If the Covered Base Agreement evidences the intention to grant security and sufficiently describes the pledged Eligible Collateral it will be valid. Accordingly, we believe that under the applicable document, a security interest in the Eligible Collateral, other than in respect of cash, futures contracts in futures accounts and general contracts and contract rights, in circumstances described below, would be validly created under Quebec law when the Clearing Member obtains control. The concept of "control" will be described below. We believe that describing the collateral by the terms "security entitlement" and "securities account" is sufficient where collateral is in that form. 167 Section 3 of the Quebec STA contains a rule designed to eliminate the problems of coordination of terminology. It provides that unless the context shows otherwise, a person who is required by an agreement to transfer, deliver, present, surrender, exchange or otherwise put in the possession of another person a security or other financial asset satisfies that requirement by causing the other person to acquire an interest in the security or other financial asset. If the Eligible Collateral is a directly held certificated security in registered form, an additional element that will complete satisfaction of the creation criteria is the certificate being "delivered" to the secured party. Delivery of a certificated security occurs when the Secured Creditor either: acquires possession of the security certificate, 2. another person, other than a securities intermediary, either (i) acquires possession of the security certificate on behalf of the Clearing Member or (ii) having previously acquired possession acknowledges that it is holding the certificate for the Clearing Member, or 167 By extension of the general principles of Arts 1373 and 1374 CCQ and QSTA, s.3. Neither the QSTA nor the Civil Code contain a provision similar to the Ontario PPSA, s. 11(4) whereby attachment of a security interest in a securities account is also attachment of a security interest in the security entitlements carried in the securities account. We do not believe that the absence of such a provision adversely affects our conclusions. 168 QSTA, s

68 3. a securities intermediary acting for the Clearing Member acquires possession of the certificate, the certificate is in registered form and the certificate is either (i) registered in the Clearing Member's name, (ii) payable to the order of the Clearing Member, or (iii) specially endorsed to the Clearing Member by an effective endorsement and has not been endorsed to the securities intermediary or in blank. 169 See the discussion below in respect of the validity of a security interest in the contract rights or the futures. (iii) Validity and publication of a Security Interest in Cash Collateral not held in a securities account As noted above, 170 creation and publication of a security interest over cash collateral that is not credited to a securities account (no matter in what currency or jurisdiction the deposit is made) is likely governed by the law of the place where the Covered Customer is domiciled because of the likely characterization of this Collateral as incorporeal movable property which is not a security, title in bearer form or a security entitlement. Under Quebec internal law, the only way of obtaining a valid security on cash would, therefore, be by way of a conventional movable hypothec without delivery. This security must be in writing containing a sufficient description of the collatera In addition, it must be clear that a hypothec is granted and the document must contain a charging amount in Canadian currency (which as described above can be a large notional amount to cover all potential future exposure). Registration is required in order to perfect (render opposable to third parties) a conventional movable hypothec without delivery. The registration is made by way of a Form RH with a central government registry, the Register of personal and movable real rights (the "Register"). Unique Quebec law language must be added to the Covered Base Agreement to create a valid conventional movable hypothec without delivery against a Quebec Customer. The Form RH can be filed either manually or electronically. The fee is CDN$42 and a maximum initial registration period of 10 years is possible. The registration may be extended by way of a renewal prior to the then applicable expiry date. One Form RH may only cover a specific conventional movable hypothec without delivery but the underlying conventional movable hypothec without delivery 169 If the certificate is registered to the intermediary or in blank, then the property becomes subject to the rules of the indirect holding system. 17o Question Art CCQ. 66

69 and the related Form RH may cover different types and fluctuating amounts of obligations and collateral. It is possible for a fee to obtain search reports that disclose all registrations against a particular debtor. In order for a conventional movable hypothec without delivery which charges claims (receivables), other than bearer instruments, to be enforceable against the account debtors of such claims, the account debtors must either acquiesce (consent to) or be appropriately notified of the charge (Arts 2710, 1641 CCQ). (iv) Validity and Publication of a Security Interest in Futures Transactions and Cleared Derivatives Transaction and other contractual rights and intangibles In respect of receivables and contractual rights, such as the contractual rights under Futures Transactions and Cleared Derivatives Transactions, including Futures Payment Rights and Cleared Derivatives Payment Rights and its other rights against CDOs in respect of those Futures Transactions and Cleared Derivatives Transactions, the security interest must be granted by a conventional movable hypothec without delivery (as described in the section immediately above in respect of the validity and publication of security interest in cash collateral not in a securities account) and perfected by registration. Any document constituting the hypothec will need to contain a sufficient description of the property being charged. (v) Validity and Publication of a Security in Directly Held Certificated Securities, Directly Held Uncertificated Securities, Indirectly Held Securities, Cash Held in a Securities Account Generally, under the Civil Code a security interest in securities and security entitlements (as such terms are used in the Quebec STA), which latter concept may include credit balances in a securities account, may be created and rendered opposable to third parties (perfected) by "control" of the collatera The Quebec STA provides that a secured party: 1. has control of a certificated security in bearer form if the certificated security is delivered to the secured party or its agent, 172 Arts 2702 and CCQ. The concept of "control" is dealt with in the QSTA, s. 55, 56 and 113. We believe that the registration seemingly required under Art CCQ is not necessary if the Security Documents charge a universality of claims in light of Art CCQ i.e. obtaining control is all that is required to render the security opposable to all third parties. For similar reasons, no notification to account debtors under Art CCQ should be necessary. This reasoning would not apply to a conventional movable hypothec without delivery and, as discussed, it may be necessary to take such security in order to charge cash not held in a securities account. 67

70 other than a securities intermediary (i.e. the secured party or its agent acquires possession of the security certificate) and remains published until the secured party does not have contro1; has control of a certificated security in registered form if the certificated security is delivered to the secured party or its agent or, provided the endorsement is not in blank, securities intermediary and the certificate is endorsed to the secured party or in blank by an effective endorsement, or the certificate is registered in the name of the secured party at the time of the original issue or by registration of transfer by the issuer and remains published until the secured party does not have control; has control of an uncertificated security if it is delivered to the secured party (i.e. the issuer transfers the uncertificated security from the debtor to the secured party or its agent, other than a securities intermediary) 175 or if the issuer has agreed with the secured party that it will comply with instructions that are originated by the secured party without the further consent of the registered holder and remains published until the secured party does not have control; and 4. has control of a security entitlement if the secured party becomes the entitlement holder or the securities intermediary agrees with the secured party that it will comply with entitlement orders originated by the secured party without further consent of the entitlement holder and remains published until the secured party does not have control. A person becomes the entitlement holder when the security entitlement is transferred to a securities account in the person's name. As indicated in respect of cash, a valid and opposable security may also be obtained by way of a conventional movable hypothec without delivery but there are particular formalities which are required. Also, a secured party may also obtain a conventional movable hypothec without delivery through automatic publication (i.e. it is published when it is created) if the debtor is a securities 173 Art CCQ does not apply in light of the specific requirements of Art CCQ. See QSTA s See Arts to 2704, , 2736 and 2798 CCQ. 175 Delivery of an uncertificated security to a secured creditor occurs when (a) the issuer registers the secured creditor as the registered holder on the original issue or the registration of transfer or (b) another person, other than a securities intermediary, either, becomes the registered holder on behalf of the secured creditor or having previously become the registered holder acknowledges that the person holds for the secured creditor. QSTA, s

71 intermediary. 176 However, these methods of publication are not as powerful as control in terms of priority protection. 177 Accordingly, under Quebec law, the Clearing Member should have a valid and opposable security interest by control in the Eligible Collateral that is securities pledged: 1. in the case of directly held bearer debt securities, when the Covered Customer delivers the security certificates to the Clearing Member or its agent (provided such agent is not a securities intermediary); 2. in the case of directly held registered debt securities, when the Covered Customer delivers the security certificates to the Clearing Member or the Clearing Member's agent or the Clearing Member's securities intermediary, in each case accompanied by any duly executed documents necessary to constitute a legally valid transfer (and in the case of delivery to a securities intermediary the security cannot be endorsed in blank); in the case of directly held dematerialized securities, when the Covered Customer's position is transferred to the Clearing Member so that the Clearing Member or an agent of the Clearing Member (other than a securities intermediary) is registered on the books of the issuer as the owner of such security or the issuer has agreed with the Clearing Member that it will comply with instructions that are originated by the purchaser without the further consent of the registered holder; Publication of a security by registration and automatic publication of a security in securities and security entitlements granted by a securities intermediary, however, are governed by the local law of the jurisdiction in which the debtor is domiciled. Arts and CCQ. 177 The security of a secured party who has control over securities and security entitlements has priority over a conflicting security of a secured party who does not have control (Art CCQ). Moreover, a creditor of a securities intermediary, who has a security in a financial asset held by the securities intermediary, has priority over the intermediary's entitlement holders if the creditor has control over the financial asset (QSTA, s.130). 178 QSTA, s.50 and 55. "Delivery" itself also publishes a security in a certificated security in registered form. See Arts and CCQ. Delivery is a wider concept than control, but as stated above it is better to have control as it confers a more powerful priority position. Note that for certificated securities there is no provision that says there is still control if the registered holder retains the right to make substitutions, endorsements or otherwise dispose of the certificated security as there is with uncertificated securities. 179 QSTA, s.51 and 56. The Clearing Member has control even if the Covered Customer remains the registered holder and retains the right to make substitutions, originate instructions or otherwise dispose of the uncertificated security (QSTA s.56). 69

72 4. in the case of security entitlements with respect to financial assets: 180 (i) (ii) (iii) (iv) assuming that the Covered Customer gives written instructions to the relevant securities intermediary to transfer the security entitlements into a securities account held in the Clearing Member's name at an Intermediary (which may be acting as Custodian), at the point when that transfer takes place and the security entitlements are credited (or should be credited) to the Clearing Member's account at the relevant Intermediary (i.e. the Clearing Member becomes the entitlement holder); 181 the Intermediary of the Covered Customer has agreed with the Clearing Member that it will comply with entitlement orders that are originated by the Clearing Member without the further consent of the Covered Customer; 182 an agent has control of the security entitlement on behalf of the Clearing Member; or automatically if the Clearing Member is the Covered Customer's own Intermediary. 183 (vi) Validity and publication with respect to Futures and Futures Accounts Please refer to the discussion above in respect of the application of Section 17 of the QSTA to futures contracts in a securities account in Part III question 1(c)(A). For futures contracts in a futures account, the discussion in respect of Cash Collateral not held in a securities account is applicable. 6. What other requirements are there under the laws of Ontario and Quebec to ensure the validity or perfection of a security interest in each type of Eligible Collateral created by the Covered Customer under each Covered Base Agreement and CDA? For example, is it necessary as a matter of formal validity that the Covered Base Agreement and CDA be expressly governed by the law of Ontario or Quebec or translated into any other language or for the Covered Base Agreement and CDA to 180 QSTA, s This method of control provides the highest level of protection. Art CCQ and QSTA s The Clearing Member has control even if the Covered Customer remains the entitlement holder and retains the right to make substitutions for the security entitlement, to originate entitlement orders to the securities intermediary or to otherwise dispose of the security entitlement (QSTA, s.113). 183 QSTA, s

73 include any specific wording? Are there any other documentary formalities that must be observed in order for a security interest created under each Covered Base Agreement and CDA to be recognized as valid and perfected in Ontario or Quebec? (a) Ontario We are not aware of any other requirements under Ontario law. It is not necessary for the agreements to be expressly governed by the law of Ontario, to be translated into any particular language or for them to include any specific wording, so long as the intention to create a security interest is clear, and there is a sufficient description of the collateral, as discussed in Question 5 above. A secured creditor does have an obligation to deliver a copy of the security agreement to the debtor within 10 days after its execution. This requirement should be satisfied where the Covered Customer receives or has in its possession an executed copy of the Covered Base Agreement and CDA. Electronic delivery suffices. Failure to deliver does not affect the validity, perfection or priority of the security interest. (b) Quebec Under Article 2692 of the Civil Code, if the conventional movable hypothec without delivery secures bonds or other titles of indebtedness issued by a trustee, limited partnership or a corporation, the hypothec must be in notarial form in favour of a person holding the power of attorney of the creditors (fonde de pouvoir). The Quebec Charter of the French Language requires, for standard form documents in a language other than French, that the parties agree that the document is to be drawn-up in such other language. Provisions of this Charter also restrict the ability of certain governmental entities to conclude contracts in the province of Quebec in a language other than French. In this regard, we note that a bill currently at a preliminary stage before the Quebec National Assembly would provide greater flexibility for governmental entities to conclude such contracts. An example of the language that could be added to the Covered Base Agreement or the CDA is: The parties herein confirm their express wish that this agreement and all documents related thereto be drawn up in English. Les parties aux presentes confirment leur volonte expresse de voir le contrat et tous les documents s'y rattachant etre rediges en anglais. 71

74 We are not aware of any other requirements under Quebec law. Subject to the discussion above, it is not necessary under Quebec law for the security documents to be expressly governed by the law of Quebec, to be translated into any particular language or for them to include any specific wording, so long as the intention to create a security is clear, and there is a sufficient description of the collateral as discussed in Question 5 above. Note also our discussion above in respect of the requirements for a conventional movable hypothec without delivery. 7. Assuming that the Clearing Member has obtained a valid and perfected security interest in the Eligible Collateral under the laws of this jurisdiction, to the extent such laws apply, by complying with the requirements set forth in your responses to questions 1 to 6 above, as applicable, will the Clearing Member or the Covered Customer need to take any action thereafter to ensure that the security interest in the Eligible Collateral continues and/or remains perfected, particularly with respect to additional Collateral transferred by way of security from time to time when required pursuant to the Covered Base Agreement and CDA? (a) Ontario No additional steps will be necessary to ensure that the security interest in the Eligible Collateral continues or remains perfected assuming the financing statement is filed. If the Clearing Member is relying on control to perfect the security interest in the Eligible Collateral, then it need only take control of any additional Eligible Collateral in order to be perfected with respect to that Collateral as long as the Collateral is of a type that can be perfected by control. If the Clearing Member is relying on the registration of a financing statement, then a single filing (together with attachment) will perfect the security interest in after acquired property under the same security agreement. Filings can be perpetual or for a specified period of years. New filings will be required to update expiring registrations. If the Clearing Member is relying on control as the means of perfection and the Eligible Collateral gives rise to Cash proceeds (that do not remain in the securities account), the Clearing Member will be temporarily and continuously perfected for 10 days, but must within that time take steps to perfect with respect to the proceeds. The financing statement filed at the time of entering into the agreements will cover the proceeds. 72

75 Also, perfection is a status that is relevant at any given time. To the extent that any fact or circumstance changes that would result in a different governing law applying to the issue of perfection that will have to be considered. So, for example, if perfection is governed by the law of the debtor's location, if the debtor changes location, perfection will have to be reassessed. The PPSA 184 provides that if a debtor relocates, a security interest in an intangible (e.g. Cash not in a securities account) remains perfected until the earliest of (a) 60 days after the day the debtor relocates, (b) 15 days after the secured party receives notice that the debtor has relocated to another jurisdiction, and (c) the day perfection ceases under the previously applicable law (e.g. the filing expires). Also, if the location of a directly held certificated security changes, the applicable law will also change. If a security interest in investment property is perfected under the law of the issuer's jurisdiction or the securities intermediary's jurisdiction and there is a change of that jurisdiction, it will remain perfected until the earliest of (a) 60 days after the change, (b) 15 days after the secured party knows of the change, and (c) the day perfection ceases under the previously applicable law. (b) Quebec A hypothec on specific property that is transferred in the ordinary course of business of an enterprise will extend to any property that replaces it, if a notice identifying the new property is registered. 185 A movable hypothec on property that is alienated out of the ordinary course of business of an enterprise may be preserved if a notice of preservation of hypothec is filed in the Register. The notice must be registered within fifteen days after the creditor is informed in writing of the transfer of the property and the name of the purchaser or after the creditor consents in writing to the transfer. A notice must also be sent to the purchaser within the same time period. 186 No additional steps will be necessary to ensure that the security interest in the Eligible Collateral continues or remains published. If the Clearing Member is relying on control for the security in the Eligible Collateral, then it need only take control of any additional Eligible Collateral in order to have an enforceable and opposable security with respect to that Collateral as long as the Collateral is of a type whereby a security may be obtained and published by control. So for example, if the Eligible Collateral gives rise to cash not credited to a securities account which is also to be held as Collateral, subject to our discussion below, because that form of Collateral cannot be subject to a valid security by way of 184 Ontario PPSA, s.7(2). 185 Art 2674 CCQ. 186 Art CCQ. These rules are seemingly more applicable to movable hypothecs without delivery. If a secured creditor benefits from a movable hypothec with delivery, possession or control, as the case may be, of the applicable property will constitute sufficient publication. 73

76 control, the Clearing Member will have to ensure that it has valid and opposable security under the applicable law at the time the proceeds or distributions arise. If the Clearing Member is relying on a conventional movable hypothec without delivery, then a single registration will render the security opposable in after acquired property under the Covered Base Agreement. Registration may be for a maximum specified period of 10 years. A renewal registration may be registered prior to the expiry date. If the Clearing Member is relying on control and the Eligible Collateral gives rise to cash proceeds (that do not remain in the securities account), Article 2737 of the Civil Code may apply. This Article provides that the creditor under a movable hypothec with delivery or pledge collects the fruits and revenues of the charged property. Under Quebec internal law, revenues comprise sums of money yielded by property, such as rents, interest and dividends, except those representing the distribution of capital of a legal person (Art. 910 CCQ). The reinvestment of fruits and revenues and the price for any disposal of capital or its reinvestment constitute capital (Art. 909 CCQ). Fruits comprise things spontaneously produced by property without any alteration to the substance of the property. Unless stipulated otherwise, the creditor applies the revenues to expenses, then interest and finally principal. 187 In addition, Article 2674 of the Civil Code would lead to the conclusion that the Clearing Member continues to have a valid and published security in Cash proceeds that are identifiable. If distributions arise that are in the form of intangibles and the parties' intention is that the security would extend to those distributions (and they will not be credited to a securities account), then consideration should be given to obtaining and publishing valid security in the jurisdiction where the Covered Customer is domiciled. Also, publication is a status that is relevant at any given time. To the extent that any fact or circumstance changes that would result in a different governing law applying to the issue of publication and its effects, that will have to be considered. So, for example, if publication is governed by the law of the debtor's domicile, if the debtor changes domicile, publication will have to be reassessed. The Civil Code188 provides that if a debtor relocates its domicile to Quebec, a security in incorporeal movable property other than securities, titles in bearer form and security entitlements (e.g. Cash not in a securities account) remains published until the earliest of (a) 30 days after the day the debtor relocates, (b) This provision seems to apply with difficulty to the types of obligations secured by the Security Documents. Principal may refer more to the principal obligations secured. An alternative to a nonpossessory security interest would be to render any monetary distributions subject to this same set-off provision if the distributions are not to remain in the securities account to which the securities collateral is credited. 188 Art CCQ. 74

77 days after the secured party receives notice that the debtor has relocated to Quebec, and (c) the day publication ceases under the previously applicable law (e.g. the registration expires). Also, if the location of a directly held certificated security changes, the applicable law will also change. There is no rule in Quebec analogous to the rules in Ontario in case of a change of the "issuer's jurisdiction" or the "securities intermediary's jurisdiction" Assuming that (a) pursuant to the laws of Ontario and Quebec, the laws of another jurisdiction govern the creation and/or perfection of a security interest in the Eligible Collateral transferred by way of security pursuant to each Covered Base Agreement and CDA (for example, because such Collateral is located or deemed to be located outside Ontario or Quebec) and (b) the Clearing Member has obtained a valid and perfected security interest in the Eligible Collateral under the laws of such other jurisdiction, will the Clearing Member have a valid security interest in the Collateral so far as the laws of Ontario or Quebec are concerned? Is any action (filing, registration, notification, stamping or notarization or any other action or the obtaining of any governmental, judicial, regulatory or other order, consent or approval) required under the laws of Ontario and Quebec to establish, perfect, continue or enforce this security interest? Are there any other requirements of the type referred to in question 6 above? If, pursuant to the laws of this jurisdiction, the laws of another jurisdiction govern the creation, validity and perfection of a security interest in the Eligible Collateral and the Clearing Member has obtained a valid and perfected security interest pursuant to the laws of that other jurisdiction, then a court applying Ontario or Quebec law will recognize that the Clearing Member has a valid and perfected security interest in the Eligible Collateral. No action is required in this jurisdiction or under its law to establish, perfect, continue or enforce 190 this security interest. There are no other requirements of the type referred to in Question 6 above. 9. Are there any particular duties, obligations or limitations imposed on the Clearing Member under the laws of Ontario or Quebec in relation to the care of the Eligible Collateral held by it pursuant to each Covered Base Agreement and CDA? 189 Ontario PPSA s. 7.1(7). 190 We assume that "enforce" in this context does not refer to the procedural requirements that apply to realizing on the Collateral, which are dealt with below in Questions 12 to

78 There are particular duties, obligations and limitations under the Ontario PPSA and Quebec Civil Code imposed on a secured party in relation to the care of the collateral in its possession or contro A preliminary question, however, is whether either the PPSA or Civil Code would govern this issue. There is no specific conflict of laws rule in these statutes that applies to a secured party's obligations with respect to the collateral. If the issue arose in the context of whether or not a secured party had breached a security agreement, then the governing law of the security agreement might be the applicable law. There is a specific conflict of laws rule in the PPSA (but not the Civil Code) that applies to "substantive matters affecting the enforcement of the rights of a secured party against collateral". Such matters are determined by the governing law of the agreement. 192 If a wide interpretation is given to the words "enforcement" and "rights", then the issue of duties of care with respect to collateral may be a matter for the governing law in Ontario. However, because the duty of care is essentially a matter of protecting the position of the debtor, it is possible that a court would find that this issue was governed by the law of the place where the debtor was located (Ontario) or domiciled (Quebec). If so and if the Covered Customer was located in Ontario or domiciled in Quebec, then the question of what duties it has in relation to the Collateral would be a matter of Ontario or Quebec law. If Ontario law is the applicable law then the following duties apply (subject to the rehypothecation rights with respect to investment property described below): A secured party must use reasonable care in the custody and preservation of collateral in its possession. 193 A secured party cannot contract out of this obligation 194 (except to the extent it has rehypothecation rights with respect to investment property as described below), although a security agreement may set out the standards by which the rights of the debtor and duties of the secured party are to be measured, so long as those standards are not manifestly unreasonable having regard to the nature of the rights and duties. 195 There is also a duty imposed on a secured party in possession of collateral to keep collateral identifiable (although fungible collateral 191 PPSA, s.17 and Ontario PPSA, s.8(1)(b). 193 PPSA, s.17(1). Note that this has not been amended to add collateral in the control of a secured party. 194 Ontario PPSA, s.59(5). 195 Ontario PPSA, s. 59(4). 76

79 can be commingled). This duty applies unless otherwise agreed between the parties. 196 Under the Ontario PPSA, fungible securities are securities of which any unit is, by nature or usage of trade, the equivalent of any other like unit and includes unlike units to the extent that they are treated as equivalents under a security agreement. 197 These duties are modified in Ontario with respect to "investment property" where the secured party has "control" of the investment property. PPSA section 17.1(1) specifically states that a secured party having control may hold as additional security any proceeds received from the collateral, must either apply money or funds received from the collateral to reduce the secured obligation or remit the money or funds to the debtor, and may create a security interest in the collateral. Further, section 17.1(2) provides that despite the duties otherwise imposed, a secured party having control of investment property may sell, transfer, use or otherwise deal with the collateral in the manner and to the extent provided in the security agreement. In Quebec, in accordance with Article of the Civil Code, a secured party with control of securities or security entitlements may alienate or grant a hypothec on the collateral unless provided otherwise. If Quebec law is the applicable law then the following duties apply: The Civil Code contains the requirement that a secured party must act in good faith in the performance of an obligation and in the exercise of rights. 198 Additionally, a creditor holding a pledge may not "abuse" the property and must do whatever is necessary to preserve it although the creditor may use the property with the permission of the debtor. 199 A secured party is not liable for loss of pledged property by force majeure or as a result of its ageing, perishability or normal and authorized use. Article 2737 of the Civil Code specifically states that a secured party holding property collects fruits and revenues received from the collateral and, unless otherwise stipulated, must apply revenues 196 PPSA, s.17(2). 197 Ontario PPSA, s.1(2). 198 Arts 6, 7 and 1375 CCQ. 199 Arts 2736, 2739 and 2741 CCQ. 77

80 received from the collateral to reduce the secured obligation. The secured party remits the fruits to the debtor. 10. A Covered Base Agreement and CDA may grant the Clearing Member broad rights with respect to the use of Collateral. Additionally, the Covered Base Agreement and CDA are subject to the rules of DCOs, which may also grant DCOs similar rights with respect to the use of Collateral that has been on-posted from a Clearing Member to a DCO. Such use might include pledging or rehypothecating the securities, disposing of the securities under a securities repurchase (repo) agreement or simply selling the securities. Do the laws of Ontario and Quebec recognize the right of the Clearing Member or DCO so to use such Collateral pursuant to an agreement with the Covered Customer? In particular, how does such use of the Collateral affect, if at all, the validity, continuity, perfection or priority of a security interest otherwise validly created and perfected prior to such use? Are there any other obligations, duties or limitations imposed on the Clearing Member or DCO with respect to its use of the Collateral under the laws of Ontario and Quebec? As noted in the answer to Question 9, the laws of Ontario and Quebec do expressly recognize the rights of a secured party to use collateral that is "investment property" (Ontario) or security entitlements (Quebec) if the secured party has "control" of it. PPSA Section 17.1(2) provides that despite the duties otherwise imposed, a secured party having control of investment property may sell, transfer, use or otherwise deal with the collateral in the manner and to the extent provided in the security agreement. Article of the Civil Code provides that a secured party having a movable hypothec with delivery on securities or security entitlements may alienate or grant a hypothec on the collateral unless agreed otherwise with the debtor. 200 This provides another reason why perfection by control is a superior form of perfection from a secured party's perspective. Given this express permission, such use by the Clearing Member will not affect the validity or perfection of its security interest in securities Collateral. This conclusion is affirmed in Ontario by the provisions described in the answer to Question 8 regarding the continuity of perfection of a security interest in investment property as long as the debtor does not reacquire full control. 200 In light of this specific provision, the prohibition in Art CCQ will not apply. 78

81 The Quebec STA and the Civil Code do not contain a provision similar to Section 22.1(2) of the Ontario PPSA (stating that control continues until the secured party no longer has control and the debtor has reacquired possession of the certificated security, been registered by the issuer as the registered holder of the uncertificated security or become the entitlement holder of a security entitlement, as the case may be). Hence, a secured party must continue to have control in order to continue to have a valid and published security. From a practical standpoint, if a creditor has obtained control of a security entitlement by becoming the entitlement holder, then it may deal with the security entitlement as it pleases without any intervention from the debtor. The same is also true in respect of control by way of a control agreement for all security entitlements in a securities account over which the Clearing Member has control. The creditor would have control of all present and future financial assets in such securities account irrespective of the moment that a financial asset is credited to the securities account. Perhaps the only practical concern will be in respect of a certificated security. We note however that in all cases, if the secured party again regains control, it will have a valid and published security. Additionally, see below the discussion concerning priority and in respect of adverse claims. This express right, however, does not apply to cash collateral that is not investment property (i.e. cash not in a securities account). In Ontario it is clear that damages are the only remedy for breach of the non-waivable duty to use care in the custody and preservation of collateral and to keep collateral identifiable and it is unlikely that the Covered Customer would suffer any damage where cash is concerned. It is also specifically stated in the Ontario PPSA that breach does not affect the validity of the security interest. 201 Since perfection is by means of filing a financing statement, use would also not affect the perfection of the security interest. Similarly in Quebec, since validity and publication of a security in cash is by means of a registered conventional movable hypothec without delivery, use would also not affect the publication of the security. There are no other obligations, duties or limitations imposed on the Clearing Member with respect to its use of the Collateral. In this regard we have not considered the rules of any self-regulatory organization applicable to the Clearing Member or securities, commodities or other regulatory laws. The same analysis would apply to the DCO so long as the DCO had control of the Collateral as long as there is an agreement between the DCO and the Customer that authorizes such use of the Collateral. 201 Ontario PPSA, s.17(3). 79

82 Enforcement of Futures Credit Support Rights and Cleared Derivatives Credit Support Rights under the Covered Base Agreement and CDA by the Clearing Member in the Absence of an Insolvency Proceeding. Note the additional assumption (d) which applies to questions 11 to Assuming that the Clearing Member has obtained a valid and perfected security interest in the Eligible Collateral as recognized under the laws of Ontario and Quebec by complying with the requirements set forth in our responses to questions 1 to 6 above, as applicable, what are the formalities (including the necessity to obtain a court order or conduct an auction), notification requirements (to the Covered Customer or any other person) or other procedures, if any, that the Clearing Member must observe or undertake in enforcing its security interest in the Eligible Collateral and exercising its Futures Credit Support Rights and Cleared Derivatives Credit Support Rights (Credit Support Rights) as a Clearing Member under each Covered Base Agreement and CDA, such as the right to liquidate Eligible Collateral? For example, is it free to sell the Eligible Collateral (including to itself) and apply the proceeds to satisfy the Covered Customer's outstanding obligations under the Covered Base Agreement and CDA? Do such formalities or procedures differ depending on the type of Eligible Collateral involved? The Clearing Member must follow the procedures contemplated in the Covered Base Agreement and CDA and, where Ontario law applies to the enforcement issues, in the PPSA and where Quebec law applies to the enforcement issues, in the Civil Code and, to the extent applicable, the Code of Civil Procedure (Quebec). (a) What Law Governs Enforcement Issues? (i) Ontario The formalities and notification requirements that apply to the enforcement of rights against collateral are not necessarily governed by the same law that governs validity and perfection/publication. The Ontario PPSA contains its own set of conflict of laws rules dealing with enforcement issues. The governing law for enforcement issues depends on whether the particular enforcement issue is procedural or substantive and on the nature of the collateral. Therefore, these conflict of laws rules must be considered whether or not Ontario governs validity and perfection of the security interest (as described in Part I, Questions 1 and 2 above). 80

83 In proceedings in Ontario, procedural issues in the enforcement of the right of a secured party against collateral are governed by the law of the "jurisdiction in which the enforcement rights are exercised." 202 Substantive issues involved in the enforcement of the rights of a secured creditor against collateral are governed by the proper law of the agreement between the parties (e.g. the governing law of the agreements). 203 If any of these rules lead to the application of Ontario law, then the procedures described in Question 12 apply. If Eligible Collateral is being held in Ontario, it is possible that Ontario procedural rules would apply to the extent any court involvement is required. (ii) Quebec The Civil Code does not contain conflict of laws rules dealing with substantive enforcement issues. The Civil Code states that procedure is governed by the law of the forum. 204 Unlike the Ontario PPSA, the Civil Code does not contain a specific conflict of laws rule dealing with substantive issues involved in enforcement of a right of a secured creditor. The law applicable to the enforcement of a security, including recourses and remedies, is the subject of some debate. One view is that the law applicable at the time of the creation of the security should also govern the effect of the security, including content, recourses of the creditor and enforcement issues. Others have argued that, as with the effects of publication, it would be the law of the actual situs that applies. Furthermore, certain commentators have argued that the exercise of rights should be governed by the law of the forum. Article 3132 of the Civil Code provides that it is the law of the forum which governs procedure. Additionally, a Quebec court may be influenced by the mandatory regime for realization in the Civil Code and impose such regime on the enforcement of a valid foreign security when enforcement is sought in the Province of Quebec. If any of these rules lead to the application of Quebec law, then the procedures described below apply. (b) Enforcement Rights and Restrictions (i) Collection rights 202 Ontario PPSA, s.8(1)(a). 203 Ontario PPSA, s.8(1)(b). 204 Art CCQ. 81

84 We would characterize collection rights as substantive rights with respect to enforcement, which would be governed by the proper law of the security agreement as far as Ontario law is concerned. Since New York law is the governing law, Ontario law is not relevant to this particular remedy. Collection rights are also provided for under Quebec law (Art and 2745 CCQ). Unless the security provides that the debtor is authorized to collect any claims (which we assume would not be the case with respect to any of the Eligible Collateral in the form of receivables from the DCO for example or proceeds and distributions forming part of the Collateral), from the moment of execution of a hypothec on a claim, the creditor has the right to collect the same (Art CCQ). This right is in addition to any hypothecary rights respecting enforcement. If the Clearing Member is authorized in the security agreement to collect the claims, this authorization may be withdrawn at any time by the creditor, subject to the terms of the security agreement (Art CCQ). However a notice of withdrawal must be registered and the debtor and the account debtors appropriately notified. We would not characterize these as matters of a procedural nature with respect to enforcement. (ii) Disposal of Eligible Collateral - Ontario Under Ontario law, upon the debtor's default, a secured party has a statutory right to dispose of any collateral and to satisfy the obligation as well as recover realization expenses from the proceeds. The disposition must be conducted in a commercially reasonable manner and can be by way of public or private sale, lease or otherwise. 205 Under the PPSA, disposition can be delayed by a secured party for such period of time as is commercially reasonable. 206 A right of disposal is in our view a substantive right with respect to enforcement which would be governed by the governing law of the security agreement. Notice of Sale. Subject to certain exceptions, a secured party must give 15 days notice (under the Ontario PPSA) of the disposition, in writing: 207 to the debtor, every person the secured party knows to be an owner of the collateral or to owe payment of the secured obligation, every person with a perfected security interest in the collateral, and 205 If Cash Collateral is characterized as an intangible (see above Question 1), then in principle the account in which the cash is held should also be "disposed of" in such a way. This is impractical and, we believe, is ignored as a matter of practice. Please see, however, our comments below concerning foreclosure. 206 Ontario PPSA, s.63(3). 207 Ontario PPSA, s. 63(4). 82

85 every person with an interest in the collateral who has delivered a written notice to the secured party of its interest in the collateral before the secured party's notice is sent. The written notice must contain a brief description of: the collateral, the amount required to satisfy the obligation secured by the security interest, the amount of actual realization expenses or, where they have not yet been incurred, a reasonable estimate of them, a statement that upon receipt of payment the payor will be credited with any rebates or allowances to which the debtor is entitled by law or under the security agreement, a statement that upon payment of the amounts due (obligation plus realization expenses), the person can redeem the collateral, a statement that the collateral will be disposed of and the debtor may be liable for a deficiency unless the amounts due are paid, and the date, time and place of any public sale or the date after which any private disposition of the collateral is to be made. Exemption from Notice Requirements. This notice is not required where: the collateral is perishable, the secured party believes on reasonable grounds that the collateral will decline speedily/ substantially in value, the collateral is of a type customarily sold on a recognized market, the cost of care and storage of the collateral is disproportionately large relative to its value, the court orders that notice is not required, after default every person entitled to notice agrees to immediate disposition of the collateral, or a receiver and manager disposes of the collateral in the course of the debtor's business. It is not clear whether this notice requirement is a procedural or substantive matter affecting the enforcement of the right of a secured party in respect of collateral. We think it likely that it is a procedural matter. Consequently, this notice provision will apply only if the enforcement action against the Collateral takes place in Ontario. 83

86 Where Ontario law applies and where the Collateral is investment property, the exemption for Collateral sold on a recognized market could apply. For Cash Collateral, there is no particular exemption, but because secured parties would not as a practical matter sell the Cash Collateral, this is not an issue. (See our comments with respect to Cash Collateral below in the discussion of foreclosure.) If it was a foreign currency, then the exemption for collateral, which a secured party believes on reasonable grounds, will decline speedily in value might apply in the circumstances. (iii) Hypothecary Rights - Quebec - sale, foreclosure etc. The exercise of hypothecary rights under any hypothec, whether a pledge or a movable hypothec without delivery, is subject to the enforcement provisions of the Civil Code and the Code of Civil Procedure, most of which are of public order. This includes (i) sending a prior notice of the intention to exercise a specific hypothecary right (which notice must be registered at the Register), and (ii) in general, waiting the required period, normally 20 days, before exercising the specific right. There are four hypothecary rights available if the security charges assets used in an enterprise: taking of possession for the purposes of administration, taking in payment, sale by the creditor and sale by judicial authority. Only one of these rights may be exercised at a time. The rights of taking in payment (roughly equivalent to foreclosure) and sale by judicial authority are available even if the security does not charge assets used in an enterprise. It should be noted that by virtue of Article 2759 of the Civil Code, a creditor who has a hypothec on securities or security entitlements that has obtained control, may, where permitted by its agreement with the grantor, sell the securities or security entitlements or otherwise dispose of them without giving prior notice, obtaining surrender or observing any time limits prescribed under the Civil Code. A creditor who disposes of securities or security entitlements acts on behalf of the grantor and is not bound to declare the creditor's position as creditor to the purchaser. The secured party must impute the proceeds to payment of the costs incurred to dispose of the securities or the security entitlements, to payment of the obligations secured by prior ranking security and finally to payment of the secured obligations. The secured party must remit any surplus to the grantor. (iv) Setting Off against Collateral Value A secured party may buy the collateral itself only at a public sale unless the court orders otherwise. Any term of a security agreement allowing a secured party to appropriate the collateral and credit its value to the debtor (which would be akin 84

87 to the secured party buying the collateral) will not be enforceable if Ontario law applies and may not be enforceable if Quebec law applies. The CDA and Covered Base Agreements allow the Clearing Member to set off or apply the value of Collateral without selling it in a private sale. Under Ontario law, set-off is a concept that applies only to monetary claims which parties have against each other208; there is no concept of setting off a property claim against a monetary claim. The right of the Clearing Member to keep the Collateral and setoff its value against the Covered Customer's obligations could be seen as a private sale of the Collateral to the Clearing Member itself. It is unclear whether this restriction on private sale would be characterized as a procedural or a substantive matter affecting the enforcement of a secured party's rights. In our view, it is probably a procedural matter because of the fact that it sets out a process and because it refers to an application to the court, which would generally only be appropriate if the court was otherwise the appropriate one to deal with the issues. 209 Therefore, it would apply if the enforcement action was being taken in Ontario and likely apply if enforcement was being taken in the Province of Quebec. (v) Foreclosure - Ontario There is a notice requirement if a secured party proposes to accept its collateral in satisfaction of the secured obligations. Exercising a right of set-off against collateral might be characterized as accepting the collateral in satisfaction of an obligation if set-off was the only remedy being asserted. The notice must be sent to the same persons that the notice of disposition must be sent to (see above). There are no exceptions. If any person entitled to be notified who would be adversely affected by the proposal objects in writing to the proposal within 30 days (under the Ontario PPSA), then the collateral must be disposed of (subject to the requirements described above). A secured party can apply to the court for an order that the objection is ineffective and the court can grant the order if the person's objection was not for the purpose of protecting its interest in the collateral or its proceeds or the fair market value of the collateral is less than the total amount owing to the secured party plus realization expenses. If no objection is made, the secured party is deemed to have accepted the collateral in full satisfaction of the obligation secured (i.e. it has no claim for any deficiency) and the debtor has no claim for any excess value of the collateral above the amount of the debt. 208 K. Palmer, The Law of Set-Off in Canada, (Aurora: Canada Law Book, 1993) at 24; Dresser v. Vos (1985), 60 A.R. 226 (Q.B.); Telford v. Holt, [1987] 2 S.C.R McLaren, Secured Transactions in Personal Property in Canada, 2nd ed., 1989, (suppl.) 6.05, p. 6-49, describes procedural matters as the steps necessary to enforce rights against Collateral. 85

88 As with the notice of disposition and for the same reasons, this process for foreclosure could be characterized as a procedural matter. Therefore, it would apply to foreclosure actions taken in Ontario. As stated above, cash collateral not held in a securities account is an intangible. The PPSA does not specifically provide for the exercise of set-off rights. There is some risk that the exercise of the set-off right would be characterized as a private sale of the Cash Collateral to the Clearing Member or perhaps as a foreclosure. If so, then the notice requirements set out above would apply and a court order would be required. Obviously, these requirements are not practical. It appears that in practice secured parties exercise rights of set-off against cash collateral without complying with such procedures. For Quebec, this issue is addressed above under the Hypothecary Rights section. 12. Assuming that (a) pursuant to the laws of Ontario and Quebec, the laws of another jurisdiction govern the creation and/or perfection of a security interest in the Eligible Collateral transferred by way of security pursuant to each Covered Base Agreement and CDA (for example, because such Eligible Collateral is located or deemed located outside Ontario and Quebec) and (b) the Clearing Member has obtained a valid and perfected security interest in the Eligible Collateral under the laws of such other jurisdiction, are there any formalities, notification requirements or other procedures, if any, that the Clearing Member must observe or undertake in Ontario and Quebec in exercising its Credit Support Rights as a Clearing Member under each Covered Base Agreement and CDA? Even if the laws of another jurisdiction govern validity and priority, Ontario or Quebec law may impose notification requirements and a requirement of court approval of a private sale on the Clearing Member. These requirements and the circumstances in which they could potentially apply are discussed above in Question Are there any laws or regulations in Ontario and Quebec that would limit or distinguish a creditor's enforcement rights with respect to Eligible Collateral depending on (a) the type of transaction underlying the creditor's exposure, (b) the type of Eligible Collateral, or (c) the nature of the creditor or the debtor? For example, are there any types of "statutory liens" that would be deemed to take precedence over a creditor's security interest in the Eligible Collateral? 86

89 There are no limitations that depend on the type of underlying transaction, the nature of the creditor or the debtor or the type of Collateral, but there are statutory liens that could potentially take precedence over a creditor's security interest in Collateral. Debtor in Possession Financing Under the CCAA and BIA Proposals. The CCAA210 confers on the court the statutory jurisdiction to authorize a security interest or a charge in favour of the debtor-in-possession financier and to order that this security interest or charge has priority over the security interest of any other secured party. A similar jurisdiction to grant a priority charge is available with respect to (i) credit granted by critical suppliers to the debtor, (ii) indemnities in favour of directors and officers who continue to service the debtor company after the filing, and (iii) fees and expenses of the monitor and experts (such as lawyers and financial experts) engaged by the monitor, the debtor or any other interested person 211 for the purpose of the proceedings under the Act. Affected secured creditors are entitled to prior notice of any application requesting such a charge on the assets of the debtor. Similar provisions apply in BIA proposal proceedings. 212 However, there are applicable exemptions to these priorities. Both the BIA and CCAA provide that no order can be made under the Act that has the effect of subordinating "financial collateral" for an "eligible financial contract." 213 Not all Eligible Collateral may be financial collateral. See Question 16. There are certain other statutory liens that would or might take precedence over the Clearing Member's security interest in the Collateral. Crown and other Statutory Claims. Certain statutes create Crown priorities for certain amounts that apply with respect to certain types of collateral. These include such debts as employee income tax remittances, Canada Pension Plan contributions, contributions to the Employment Insurance Plan, statutory vacation pay claims, employer contributions to employee pension plans, and sales tax remittances. They may take priority over certain types of collateral only. Crown priorities may apply only in certain circumstances and priority also may depend on whether or not there is a bankruptcy proceeding. 214 This is a very complex area of law that cannot be adequately addressed in the context of a 210 S.C. 2005, c. 47 as amended by S.C. 2007, c Where engaged by a person other than the debtor or the monitor the court must be satisfied that the security or charge is necessary for their effective participation in the proceedings. 212 Although the BIA does not expressly provide for a charge for critical suppliers. 213 S.C. 2007, c. 29; see CCAA, s.34(11); BIA, s Certain Crown claims have priority outside of bankruptcy, but not if the debtor becomes bankrupt under the BIA or WURA. 87

90 memorandum such as this. Generally, however, it can be said that these types of Crown priorities should not attach to Eligible Collateral in the possession or control of the Clearing Member. 215 However, a prior ranking security interest might, in certain circumstances, attach to Eligible Collateral in the possession or control of the Clearing Member, where the Covered Customer owes Canadian Revenue Agency (the Canadian federal taxing authority) with respect to amounts it did or should have withheld at source under the Income Tax Act (Income Tax Act (Canada), Section 227(4.1)). Because these are federal liens, the provincial STA provisions regarding a purchaser taking a financial asset free of adverse claims may not be effective with respect to them. A recent decision of the Supreme Court of Canada held that the Crown's claim for income tax and employment insurance remittance arrears arising prior to the date of the exercise of the set-off right took priority over a credit institution's right to set off loan obligations against its own term deposit liability to the borrower. 216 This case is discussed in more detail below in the answer to Question III.B.16. The BIA also includes a secured priority charge for employee wage claims of up to $2000 per employee that can take priority over any other secured creditors. Provincially created special liens and charges are generally subordinated in a federal bankruptcy proceedings under the BIA. In restructuring proceedings generally the order of priorities that would prevail in bankruptcy is adhered to (to avoid legal arbitrage among the different types of proceedings). However, there are some provincial liens and charges that could prevail over certain secured creditors. For example, the provincial lien and deemed trust over the assets of an employer for the amount of the unfunded liabilities in certain types of pension plans may prevail over cash collateral arrangements. A recent decision of the Supreme Court of Canada held that this provincial lien extended to all unfunded liabilities in provincially regulated defined benefit pension plans (not just for funding payments actually due at the time but which would have been payable over time) How would your response to questions 11 to 13 change, if at all, assuming that an insolvency proceeding described in assumption (e) above has occurred with respect to the Clearing Member (notwithstanding that the Covered Base Agreement and CDA 215 On the other hand, assignments of receivables as collateral are clearly subordinate to Crown claims for employee income tax remittances, Canada Pension Plan and Unemployment Insurance contributions and in certain cases Goods & Services Tax on the sale of the goods or services that gave rise to the receivable. 216Caisse Desjardins de l'est du Drummond v. Canada, 2009 SCC 29 (S.C.C.) 217 Sun Indalex, Finance LLC v United 2011 ONCA 265. Steelworkers, 2013 SCC 6 (February 1, 2013) 88

91 STIKE MAN ELLIOTT may not provide for any events of default in respect of the Clearing Member) rather than or in addition to the Covered Customer (for example, would this affect this ability of the Clearing Member to exercise its enforcement rights with respect to the Eligible Collateral)? This would not affect the responses. Enforcement of Credit Support Rights Under the Covered Base Agreement and CDA by the Clearing Member after the Commencement of an Insolvency Proceeding Note the additional assumption in (3) above, which applies to questions 15 to 17 below. 15. How are competing priorities between creditors determined in Ontario and Quebec? What conditions must be satisfied if the Clearing Member's security interest is to have priority over all other claims (secured or unsecured) of an interest in the Eligible Collateral, other than claims of a DCO? (a) Law Governing Priority The PPSA choice of law rules described in Question 2 apply to priority as well as perfection, where the priority dispute is between competing secured creditors. Similar conflict of laws rules in the STA and QSTA govern the priority of a Clearing Member's interest over other adverse claimants. The additional STA and QSTA conflict of laws rules affecting priority are the following: Certificated Securities The internal law of the issuer's jurisdiction 218 governs whether an adverse claim can be asserted against a person to whom the transfer of a certificated security is registered. 219 Ontario and Quebec incorporated issuers or the provincial Crown may specify a different jurisdiction to govern this issue. 220 The internal law of the place where the security certificate is located at the time of delivery governs whether an adverse claim may be asserted against a person to whom the security certificate is delivered For a definition of "issuer's jurisdiction" see Question STA, s.44(2)(d); Art CCQ. 220 STA, s.44(3); Art CCQ. 221 STA, s.46; Art CCQ. 89

92 Uncertificated Securities The law of the issuer's jurisdiction 222 governs whether an adverse claim can be asserted against a person to whom the transfer of an uncertificated security is registered or who obtains control of an uncertificated security. 223 Ontario and Quebec incorporated issuers or the provincial Crown may specify a different jurisdiction to govern this issue. 224 Security Entitlements (including Cash in a securities account) The internal law of the securities intermediary's jurisdiction 225 governs whether an adverse claim may be asserted against a person who (i) acquires a security entitlement from the securities intermediary, or (ii) purchases (which includes taking a security interest) a security entitlement, or interest in it, from an entitlement holder. 226 Generally, a party with a prior perfected/ published security interest has priority over unsecured parties and lien creditors, including a bankruptcy trustee. As for priority between secured creditors and other adverse claimants, see the following discussion. (b) Cash Collateral Not in a Securities Account and other Intangibles such as Contractual Rights If the PPSA or Civil Code applies, priority between competing secured creditors with an interest in Cash (not credited to a securities account) or other intangibles would be determined by the order of registration of the financing statements in Ontario or by order of registration of the conventional movable hypothec without delivery in Quebec 227 (subject to our comments below with respect to set-off arrangements). For example, if a secured creditor has a security interest in all "accounts" of an entity that is a Covered Customer and had filed a financing statement prior to the Clearing Member's own filin g228, the secured creditor would have priority over the Clearing Member. Consequently, to be certain of priority over other consensual secured creditors, it is necessary with respect to Cash Collateral and other intangibles not in a securities account to conduct 222 For a definition of "issuer's jurisdiction" see Question STA, s.44(2)(d); Art CCQ. 224 STA, s.44(3); Art CCQ. 225 For a definition and discussion of "securities intermediary's jurisdiction" see Question STA, s.45(1); Art CCQ. 227 Ontario PPSA, s.30(1)1; Art CCQ. However, in Quebec a movable hypothec that charges claims may have priority from the date that the creditor advances money if registered within 10 days Art CCQ. 228 Recall that in Ontario the secured party can file at any time, including upon entering into the Security Documents. In Quebec, the secured party can file only after the grantor enters into the hypothec. 90

93 searches of the register and obtain subordinations or waivers (called cessions of rank in Quebec). If, however, the Clearing Member has a right of set-off against the cash collateral, then any competing creditor should take subject to this right of set-off. 229 The setoff must be true set-off (or contractual compensation in Quebec), namely a right to set off personal (i.e. mutual claims in the same capacity) claims between the parties. If the cash or the trust for the Covered Customer is maintained in an account with a third party institution in the name of the Covered Customer, then any set-off of amounts in the account against obligations is not a personal claim set-off; the obligation with respect to Cash is not an obligation of the Clearing Member, but of the third party institution. The same would be true of setting off any amounts owing by the DCO to the Covered Customer. In Caisse Desjardins de l'est du Drummond v. Canada230 the majority of the court characterized an agreement that permitted a lender to set-off the value of its borrower's term deposit with the lender as creating a "security interest" 231 in the term deposit. The court applied what it described as a "functional" approach to characterization. It adopted a security interest characterization largely because the borrower was required to maintain the term deposit with the lender, because the lender had a right to withhold payment of the deposit until the loan was paid and because the right of set-off was intended to ensure that the loan was repaid. Effectively the court viewed the right of set-off as a remedy to realize on its security interest in the term deposit as opposed to an independent right that defined the nature of the borrower's interest in the term deposit. The court arguably found that because the arrangement was intended to provide assurance that the loan would be repaid, it was a security interest. This is using the term "security" in a generic and arguably vernacular sense. The agreements between the parties also did grant express charges to the Caisse over its own term deposit and did use language consistent with a security interest characterization. However, that was not the main reason for the court's conclusion. The result in the case was that the federal Crown took priority over the term deposit with 229 PPSA, s.40(1); The CCQ provides rules for legal and judicial compensation at Articles Contractual compensation has been recognized in a number of Quebec cases. (See Quebec Inc. c. Caisse populaire de Ste-Anne-des-Monts [2004] R.RA (S.C.)). See also M. Deschamps, "La compensation comme mecanisme de garantie et les sfiretes sur les depots bancaires ", Le Droit Bancaire en 2011 : Nouveautes et Tendances, Montreal, Les Editions Themis, 2011 p.1 and Gennium Pharmaceutical Products Inc. c. Genpharm Inc., [2008] Q.J. No (C.S.). Article 2682 CCQ may also be of assistance as it provides as follows : "a person whose right in a property is conditional...may only grant a hypothec subject to the same condition..." 230 [2009] 2 S.C.R. 94 (S.C.C.). 231 As defined in the Income Tax Act (Canada). 91

94 respect to income tax and employment insurance employee source deductions that arose prior to the Caisse purporting to exercise its set-off right. 232 It is not clear that the case would apply outside of the Crown lien context to determining whether a security interest within the meaning of the PPSA was created by the agreements. Even if it did, where Ontario law applies parties should be able to rely on section 40 of the Ontario PPSA to ensure that any other consensual secured creditor, having taken an assignment by way of security of any rights of a party with respect to Cash it has delivered as collateral (including those with prior registrations), takes subject to the rights of set-off with respect to the cash. Section 40(1.1) of the Ontario PPSA provides that an account debtor, unless it has contractually waived defences, (e.g., the party having the obligation to return the cash, the Clearing Member) may set up by way of defence against the assignee (e.g. a competing secured party) all defences available to the account debtor against the assignor (e.g. the Collateral Provider) arising out of the terms of the contract or a related contract. The "account" in this case is the amount owing by the Clearing Member with respect to the cash and the "defence" is the right to set off the net termination amount. Perfection should not be relevant to priority as against competing assignees, including secured creditors. Because section 40 of the Ontario PPSA has not been considered in the context of a priority dispute between competing secured creditors, there is some uncertainty as to how they relate to the priority rules of the PPSA. It is also somewhat unclear, how these provisions would relate to the rights of a trustee in bankruptcy or others who have priority over unperfected security interests and who are not competing assignees (e.g. statutory lien holders, garnishees, other creditor representatives). Consequently, it would be advisable to file a financing statement in the jurisdiction where the Counterparty is located to preclude any argument that there is an unperfected security interest in the cash that has no priority over the interests of unsecured creditors, other secured creditors with subsequent registrations and lien holders. Even if the security interest is perfected by registration, there is a possibility, given the lack of certainty as to the effect of section 40(1.1) of the Ontario PPSA, that a secured creditor with a security interest in the type of property that would include the Counterparty's rights against a Clearing Member with respect to cash and that registered a financing statement to perfect that security interest before the Clearing Member's registration would have priority. Consequently, the Clearing Member may also 232 The Income Tax Act and Employment Insurance Act give the federal government a prior claim over property of the debtor even if it is subject to a "security interest" (as defined in the Income Tax Act). 92

95 choose to conduct searches of the PPSA register and obtain subordinations or waivers from potentially competing secured creditors. The Quebec legislator recently amended the Derivatives Act (Quebec) (the "QDA") to add two sections in respect of cash collateral. The sections provide MARGIN OR SETTLEMENT DEPOSIT An instrument under which a person is required to pay an amount of money to a party to a derivative, including as a margin or settlement deposit, and which allows that party, in all circumstances described in the instrument, to extinguish or reduce, by means of a set-off, its obligation to repay that amount to the person is enforceable against third persons without further formality. Such an instrument is governed by the law expressly designated in it or the designation of which may be inferred with certainty from the terms of the instrument For the purpose of section 11.1, the following are considered to be derivatives: (1) an exchange, securities lending or securities redemption contract, including any contract governing such a contract; and (2) a contract between a clearing house and one of its members, and the rules governing their relationship. A derivative is defined in the QDA as an option, a swap, a futures contract, a contract for difference or any other contract or instrument whose market price, value, or delivery or payment obligations are derived from, referenced to or based on an underlying interest, or any other contract or instrument designated by regulation or considered equivalent to a derivative on the basis of criteria determined by regulation. 93

96 Given the more formalistic requirements under Quebec law for the creation and publication of a movable hypothec without delivery and in light of the recent modifications to the QDA, 233 we believe that a Quebec court, in a properly presented and argued case, would not require the creation and publication of a movable hypothec without delivery in addition to the constitution of rights of set-off or compensation in order to have valid, enforceable rights of compensation opposable as against third parties. Consequently, we believe that, if the Covered Base Agreement and CDA are modified in order to clarify the establishment of a debtor-creditor relationship with respect to cash collateral, in respect of margin in connection with derivatives, as defined in the QDA, which is not in a securities account, it would not be necessary to modify such documents to create a movable hypothec without delivery or register the same to the extent that internal Quebec law applies to the issues of validity or opposability with respect to cash collateral. However, since it is necessary in any event to create a movable hypothec without delivery for some other Eligible Collateral, such as the Futures Payment Rights and Cleared Derivatives Payment Rights, the analysis here with respect to cash and the possibility of set-off will not avoid the requirement to have the Customer grant such security. (c) Investment Property - Directly Held Securities, Securities Entitlements and Cash in a Securities Account The security interest of a secured party with control of "investment property" (which includes directly held certificated securities, directly held uncertificated securities, indirectly held securities (i.e. securities entitlements, including cash credited to a securities account, and securities accounts), and, in Ontario, certain futures and futures accounts) has priority over the secured interest of a secured party who does not have control (i.e. a secured party that perfects automatically 234 or by filing a financing statement in Ontario or a conventional movable hypothec without delivery in Quebec). 233 This is true even if the security interest perfected by control was perfected after the security interest perfected automatically or by filing. If a secured party maintains sole control of the directly held securities or the securities account, it will have priority over any other secured creditor of the debtor. If more than one secured party has control of the investment property, then priority is determined by the order of satisfaction of the requirements for control. 233 See Arts 2663, 2664 and 2938 CCQ and the Commentaires du ministre de la Justice (Quebec : Les Publications du Quebec, 1993) p and Art CCQ. 235 Ontario PPSA, s.30.1(2); Art CCQ. 94

97 A "protected purchaser" of directly held certificated or uncertificated securities acquires the transferee's interest in them free from other adverse claims. 236 A protected purchaser is a purchaser who gives value, does not have notice of any adverse claim to the property and obtains control of the security. 237 A purchaser includes someone taking a security interest in the property. If the Clearing Member follows the steps set out in Question 5 above with respect to obtaining control, and it does not have notice of an adverse claim, then it should qualify as a protected purchaser with respect to directly held debt securities. With respect to security entitlements to financial assets (including cash credited to a securities account), section 96 of the STA and section 110 of the QSTA provides that a legal proceeding or action based on an adverse claim to a financial asset, however framed, may not be brought against a person who acquires a security entitlement for value and without notice of the adverse claim. 238 If the Clearing Member follows the steps outlined in Question 5 above, the Clearing Member should become the entitlement holder with respect to Collateral consisting of security entitlements and assuming that the Clearing Member does not have notice of any adverse claim, the Clearing Member should take any Eligible Collateral consisting of such financial assets free from adverse claims. 239 If the Clearing Member is a securities intermediary its interest as purchaser has priority over a conflicting purchaser who also has control unless the intermediary has subordinated its interest. 240 If the Covered Customer is itself a securities intermediary (such as an Investment Firm), then, in addition to the above rules, section 105 of the STA and 130 of the QSTA address the priority between the Covered Customer's entitlement holders 236 STA, s. 70; QSTA, s STA, s.1; Quebec, ibid. 238 Section 104 of the STA provides priority rules for a case not covered by the priority rules in the PPSA. We believe that these rules are intended to apply where the purchaser (or secured party's) rights are derivative of the entitlement holders and not when the secured party becomes the entitlement holder. Section 104(1) provides that a legal proceeding based on an adverse claim to a financial asset, however framed, may not be brought against a person who purchases a security entitlement, or interest in it, from an entitlement holder if that purchaser gives value, does not have notice of the adverse claim and obtains control. Section 111 of the QSTA provides priority rules for a case not covered by the priority rules in the Civil Code regarding hypothecs and the general priority rules of the QSTA. Such section provides that an action based on an adverse claim to a security entitlement or the financial asset to which an entitlement holder has a security entitlement, however framed, may not be brought against a purchaser of the security entitlement who purchased the security entitlement from the entitlement holder if that purchaser purchases the security entitlement for value, does not, at the time of the purchase, have notice of any adverse claim and obtains control of the security entitlement or if such an action could not have been brought against the entitlement holder under section 110 of the QSTA. 239 Subject to the discussion of super-priority statutory liens and charges in Question 13 above. 240 STA, s.104(4); QSTA, s.129 and Art CCQ. 95

98 and the Clearing Member as secured party. That section provides that a secured party who has obtained control over a security entitlement pledged to it by a securities intermediary has priority over entitlement holders of the securities intermediary. If the actions to take control specified above in Question 5 are taken the Clearing Member's security interest should have priority over claims of the Covered Customer's entitlement holders and other secured creditors. (d) Futures Contracts and Futures Accounts (i) Ontario The security interest of a secured party with control of a futures contract or futures account has priority over the secured interest of a secured party who does not have control (eg. a secured party that perfects by filing a financing statement). 241 If a secured party maintains sole control of the directly held securities or the securities account, it will have priority over any other secured creditor of the debtor. If more than one secured party has control of the investment property, then priority is determined by the order of satisfaction of the requirements for control. A security interest held by a futures intermediary in a futures contract or futures account maintained with the futures intermediary has priority over a conflicting security interest held by another secured party. 242 Conflicting security interests granted by a futures intermediary that are perfected without control rank equally with each other. 243 There are no statutory provision that otherwise provide protection against adverse claims (as with securities entitlements). (ii) Quebec See the discussion above in respect of Section 17 of the QSTA and futures contracts in a securities account as well as the discussion in respect of futures contracts in a futures account. 16. Would the Clearing Member's right to enforce its security interest in the Eligible Collateral and exercise its Credit Support Rights under each Covered Base Agreement and CDA, such as the right to liquidate the Eligible Collateral, be subject to any 241 PPSA, s.30.1(2). 242 PPSA, s.30.1(6). 243 PPSA, s.30.1(7). 96

99 stay or freeze or otherwise be affected by commencement of the insolvency (that is, how does the institution of an insolvency proceeding change your responses to questions 11 and 12 above, if at all)? In insolvency proceedings there are generally stays that can prevent or delay a secured creditor from liquidating the Collateral or otherwise dealing with it. However, in CCAA, WURA, BIA bankruptcy and proposal proceedings, and, subject to the bridge institution provisions, CDIC Act proceedings there is express statutory protection for "dealings with financial collateral". The PCSA also provides the same express protection with an expanded definition of "financial collateral". The specific context for each proceeding is set out in the discussion with respect to each proceeding below. In this section we highlight the relevant definitions and common elements of the protections. Dealing with Collateral. The express protection applies to any "dealing" or right to "deal with" "financial collateral" in the manner provided for in the agreement between the parties. "Dealing with" includes the following actions: (a) selling or foreclosing or, in the Province of Quebec, surrendering financial collateral; and (b) setting off or compensating financial collateral or applying the proceeds or value of financial coil atera Financial Collateral. In the BIA, CCAA and WURA, "financial collateral" is defined as: "financial collateral" means any of the following that is subject to an interest, or in the Province of Quebec a right, that secures payment or performance of an obligation in respect of an eligible financial contract or that is subject to a title transfer credit support agreement: (a) cash or cash equivalents, including negotiable instruments and demand deposits, (b) securities, a securities account, a securities entitlement or a right to acquire securities, or 244 BIA bankruptcy, s.69.3(2.1); BIA proposal, s.65.1(9); CCAA, s.34(8) and (9)); CDIC Act, s.35.15(7); PCSA, s.13(1.1); WURA, s.22.1(1). The BIA bankruptcy provision (s.69.3(2.1)) protects dealings with financial collateral but does not go on to include this wider description of what constitutes dealing with. 97

100 (c) a futures agreement or a futures account; 245 A title transfer credit support agreement is: "title transfer credit support agreement" means an agreement under which a debtor company has provided title to property for the purpose of securing the payment or performance of an obligation of the debtor company in respect of an eligible financial con tract;246 The Collateral which is cash, securities, securities entitlements, securities accounts, futures contracts and options and futures accounts would constitute "financial collateral". "Securities", "securities account", "securities entitlement", are not defined, but in our view would at least include any publicly traded debt or equity securities. "Futures" and "futures account" are also not defined, and consequently are not restricted to accounts held with Canadian registered intermediaries. The PCSA was recently amended 247 to expand the definition of "financial collateral" to also include: (d) an assignment of a right to payment or delivery against a clearing house 248' or (e) any other collateral that is prescribed. 249 This expanded definition is incorporated by reference into the CDIC Act as well, but not the BIA or CCAA. The drafting of (d) is odd in terms of a reference to "an 245 BIA, s.2; CCAA, s.2; CDIC Act, s.35.15(9); PCSA, s.13(2); WURA, s.22.1(2). 246 BIA, s.2; CCAA, s.2; CDIC Act, s.35.15(9); PCSA, s.13.2; WURA, s.22.1(2). 247 By the Jobs and Growth Act, 2012, S.C. 2012, c An "entity that provides clearing or settlement services for a clearing and settlement system". A "clearing and settlement system" means a system or arrangement for the clearing or settlement of payment obligations or payment messages in which (a) there are at least three participants, at least one of which is a Canadian participant and at least one of which has its head office in a jurisdiction other than the jurisdiction where the head office of the clearing house is located; (b) clearing or settlement is all or partly in Canadian dollars; and (c) except in the case of a system or arrangement for the clearing or settlement of derivatives contracts, the payment obligations that arise from clearing within the system or arrangement are ultimately settled through adjustments to the account or accounts of one or more of the participants at the Bank. For greater certainty, it includes a system or arrangement for the clearing or settlement of securities transactions, derivatives contracts, foreign exchange transactions or other transactions if the system or arrangement also clears or settles payment obligations arising from those transactions. 249 None have been prescribed as yet. 98

101 assignment" since that defines a method of transfer not a type of collateral. The intention, however, would appear to be to include collateral that a clearing member is holding in the form of rights that the customer has against the clearing house. A clearing house for purposes of this section of the PCSA is not restricted to those designated under the PCSA. Consequently, the rights to payment and/ or delivery in respect of Futures Transactions and Cleared Derivatives Transactions with a DCO should constitute financial collateral. Consequently, to the extent the PCSA applies and the Collateral is financial collateral, the commencement of an insolvency proceeding will not alter the conclusions in Question 16. Bankruptcy and Winding-Up As a general matter, secured creditors fall outside the bankruptcy provisions of the BIA and the WURA and are not prevented from realizing on collateral. The BIA prevents creditors from taking any remedy against the bankrupt's property once a proceeding has commenced, but specifically states that this stay provision does not prevent a secured creditor from realizing or otherwise dealing with its security in the same manner as it would have been entitled to do in the absence of the stay. 250 The court may, however, make a specific order staying a secured creditor, but the maximum stay period is six months where the debt is owing to the creditor at the date of commencement of the bankruptcy. 251 Such stay orders are rarely asked for or granted. They may be appropriate in situations where the trustee in bankruptcy requires a period of time to value the collateral and determine if it should exercise a right to redeem. There are no similar provisions in the WURA, but the case law has established a similar position for liquidations under the WURA. If the WURA proceeding is a restructuring, as opposed to a winding-up, the court might grant a wider general stay. If the secured creditor has already exercised its realization rights prior to the trustee in bankruptcy obtaining the stay order, then it will be unaffected by the stay, so there is some benefit to prompt realization. Stay orders generally do not bind a person until it becomes aware of the order. A trustee in bankruptcy or liquidator might also delay 252 a secured creditor in realizing on its collateral by giving the secured creditor notice of its intention to 250 BIA, s.69.3(2). 251 BIA, s.69.3(2). 252 No specific period is provided for, but it would generally be a short time. 99

102 inspect the property of the bankrupt that is subject to the security, generally for the purpose of valuing the collatera A trustee in bankruptcy or liquidator is also entitled to require a secured creditor to value its collateral and the trustee or liquidator may redeem the collateral on payment to the secured creditor of the debt or the value of the collateral as assessed. 254 Exercise of this right is unlikely to significantly prejudice the Clearing Member. It is also unlikely to be exercised by a trustee in bankruptcy or liquidator as it provides little or no benefit to the estate given the nature of the Collateral (e.g. securities) and their usually easily determined value. Neither the BIA bankruptcy provisions nor the WURA (including both the reorganization and liquidation provisions) impose any stay on the exercise of rights of set-off against cash collateral. Both the BIA and WURA exempt dealings with financial collateral. The WURA expressly provides that nothing in the WURA and no order of a court prevents or prohibits any dealing with financial collatera Also, the BIA exempts any dealing with "financial collateral" from the court's power to grant the stay of up to six months. 256 The definition of "financial collateral" is set out in part (ii) above but does not include the expanded definition in the PCSA and so would not protect rights to deal with contractual payment rights against the DCO. If the protections of the PCSA apply, then any of the limited stays described above would not apply to the Collateral. Receivership Orders If a Receivership order was made that covered the Collateral, given the protections that exist under the federal insolvency statutes with respect to "financial collateral" for "eligible financial contracts", we believe that a court could be persuaded to not maintain a stay even though there is no express statutory exemption. Nor should any stay prevent the set-off. Also, if the PCSA applies, the protections described above should override any inherent power of the court to grant a stay in a receivership proceeding. 253 BIA, s BIA, s.128(3); WURA, s.78, WURA, s. 22(1). This section only applies to a Canadian branch of a foreign bank, however, with respect to eligible financial contracts with respect to its business in Canada. 256 Section 69.3(2.1). The trustee still has the power to redeem the collateral under s

103 Proposals under the BIA Once the amount of a claim is determined, subject to certain exceptions, the BIA proposal provisions prevent any proceeding against the property of a debtor to collect payment of the claim, including the realization of collateral, during the reorganization period. 257 This stay is automatic and is not dependent on notice being sent or received. The BIA also permits a party affected by any of the stays to the court for an order permitting it to exercise its rights and the court will grant the order if satisfied that the operation of the stay would likely cause it financial hardship. 258 Any stay against enforcing payment lasts until a bankruptcy order is made or until completion of the restructuring. The proposal provisions of the BIA do not specifically provide for a stay on the exercise of rights of set-off. Therefore, set-off rights against cash collateral, will be enforceable in a BIA proposal proceeding, although they may be temporarily delayed until the claims are processed. The plan proposed by the debtor and voted upon by its creditors could propose a compromise of the rights of secured creditors and this compromise could involve a continuance of the stay in whole or in part pending a new default. The stay on realization does not apply to a secured creditor who took possession of the secured assets "for the purpose of realization" before the notice of intention under section 50.4 was filed. A secured creditor must be in the process of exercising its realization rights prior to the section 50.4 notice being filed in order to be exempt from the stays on this basis. In addition, any dealings with financial collateral for obligations under eligible financial contracts entered into before the filing are exempt from the stay. The definition of "financial collateral" is as set out above, but does not include the expanded definition in the PCSA and so would not protect rights to deal with contractual payment rights against the DCO. If the protections of the PCSA apply, then any of the limited stays described above would not apply to the Collateral. Restructuring or Receivership Under the CDIC Act Once the amount of the claim is determined, subject to certain exceptions, the CDIC Act prevents any proceeding against the property of a debtor to collect 257 BIA, s.69(1)(1). 258 BIA, s.65.1(6). 101

104 payment of the claim, including the realization of collateral, during the reorganization period. 259 This stay is automatic and is not dependent on notice being sent or received. The CDIC Act also voids any stipulation in an agreement that provides that the insolvent institution ceases to have the rights to use or deal with assets that it would otherwise have, upon the institution's insolvency, default under the agreement or the Superintendent having made a vesting order under the Act. 260 In our view, this provision does not have any effect on the Clearing Member if it is already in possession and control of the Collateral prior to insolvency, an Event of Default or the CDIC Act order. The CDIC Act also permits a party affected by any of the stays to apply to the court for an order permitting it to exercise its rights and the court will grant the order if satisfied that (a) the person is likely to be materially prejudiced if the permission is not granted or (b) it is equitable on other grounds to grant the permission. 261 Subject to the bridge institutions provisions discussed below, the CDIC Act also includes the exemption from these stays for dealings with "financial collateral" for an eligible financial contract and for this purpose the expanded definition of financial collateral in the PCSA applies (i.e. contractual rights against a DCO are financial collateral). 262 Consequently, subject to the bridge institution provisions, it should override any of the other provisions imposing stays. The restructuring provisions of the CDIC Act do stay the exercise of set-off rights,263 but expressly state that the insolvent financial institution cannot require payment of any amount owing by the other party that could otherwise be set off. The provisions for lifting the stay against the realization of collateral apply also to this stay against exercise of set-off rights. If the set-off relates to the value of collateral, the exemption for dealings with financial collateral would also apply. The CDIC Act permits CDIC to assign all of the eligible financial contracts between a member institution that is subject to a receivership order under the CDIC Act and its counterparty to a bridge institution. If the transactions are assigned to the bridge institution, the collateral rights related to the transaction 259 CDIC Act, s.39.15(1)(c). With respect to financial institutions subject to the CDIC Act, the Superintendent of Financial Institutions in giving permission to create security interests, has the power to exempt the security agreement from the application of these stay provisions (s (3)(b)), but has not exercised this power as far as we are aware. 260 CDIC Act, s.39.15(2). 261 CDIC Act, s.39.16(1). 262 CDIC Act, s (7). 263 But this does not apply to close-out netting rights under certain eligible financial contracts. 102

105 must also be assigned. Where an order directing the incorporation of a bridge institution is made, (1) the automatic temporary stay discussed above in I.B.1, question 1 prevents reliance on the eligible financial contract safe-harbour that would otherwise permit dealings with financial collateral and (2) the potential permanent stay 264 applies if the Covered Customer's obligations under the Covered Base Agreement and CDA are either assumed by a bridge institution or CDIC guarantees the payment obligations under them. These stays take precedence over the stay protections in the PCSA. 265 In summary, the right of the Clearing Member to deal with financial collateral for an eligible financial contract is not adversely affected by the making of an order to facilitate a restructuring of a federal deposit taking financial institution under the CDIC Act. If the federal institution is placed into receivership under the CDIC Act and if the government makes an order to incorporate a bridge institution, then a temporary one business day stay on relying on the eligible financial contracts exemption applies. If CDIC then makes either the guarantee undertaking or the undertaking to have the bridge institution assume the obligations, then there is a further stay preventing reliance on the eligible financial contracts exemption. The stay is a permanent stay once the contracts have been assigned to the bridge institution or the guarantee given (subject to a fresh default). CCAA A court order in a CCAA proceeding typically stays the ability of a secured party to realize on collatera1 266 pending development of a plan of compromise and arrangement. The plan itself may provide for a permanent stay of these rights, subject to any new event of default. A secured party would have a right to vote on this plan, but would not necessarily have sufficient power within the voting class (e.g. all secured creditors) to veto the plan. Dissenting creditors are bound by a plan approved by the requisite majorities and the court. Set-off rights are respected in a CCAA proceeding. 267 This express protection should apply to the right to set off against Cash Collateral. In addition, any dealings with financial collateral for obligations under eligible financial contracts entered into before the filing are exempt from the stay. definition of "financial collateral" is set out in Qualification 3 of I. 1 above but 268 The 264 This does not apply to rights to terminate based on new defaults. 265 PCSA, s. 13(1.2). 266 But this stay does not apply to close-out netting rights under certain eligible financial contracts. 267 CCAA, s CCAA, s. 34(8) and (9)). 103

106 does not include the expanded definition in the PCSA and so would not protect rights to deal with contractual payment rights against the DCO. If the protections of the PCSA apply, then any of the limited stays described above would not apply to the Collateral. To the extent that the exemption does not apply and Collateral has a volatile value, the Clearing Member should have grounds to ask the court to lift the stay, but there is no specific statutory procedure for applying for a lift of the stay order. Corporate Plans of Arrangement The analysis in I.I would apply equally to the issue of enforcement of rights against Collateral. In summary, while there is some precedent granting a stay, 269 we do not believe that a stay should be granted in a properly argued case. Voluntary Wind-up If the trustee of a trust is conducting a voluntary wind-up outside of a court process, then there is no stay possible with respect to the collateral realization rights. Involuntary Wind-up under Supervision of Pension Regulator For the reasons outlined in more detail in Appendix F - pension entity windingup there is no material stay risk with respect to collateral realization where a pension plan is being wound up under the supervision of the applicable pension regulator. Special Circumstances of CPPIB and PSPIB Given the statutory immunity from insolvency proceedings, there are no insolvency laws currently in place that could interfere with the exercise of collateral enforcement rights. The Canada Pension Plan Investment Board (CPPIB) and the Public Sector Pension Investment Board (PSPIB) cannot be subject to an insolvency type proceeding unless Parliament takes the very significant step of passing legislation. Summary of Collateral Realization In summary, collateral enforcement rights may be delayed as follows: 269 Example, the proceedings involving Abitibi-Consolidated which are discussed in this memorandum. 104

107 Likelihood of Stay on Realization of Collateral Length of Stay on Realization of Collateral (without statutory exemption) Likelihood of Stay on Set-off Statutory Exemption for Financial Collateral for Eligible Financial Contracts BIA Bankruptcy Unlikely for securities, futures or cash collateral Up to 6 months No stay likely Yes (financial collateral does not include contractual rights against DCO unless PCSA applies) BIA Proposal Automatic stay Up to 6 months plus possibility that plan may stay permanently (subject to new default ) or otherwise compromise rights No stay likely Yes (financial collateral does not include contractual rights against DCO unless PCSA applies) WURA Unlikely for securities or cash collateral Up to 6 months (may be longer in restructuring proceedings) No stay Yes, subject to bridge institution provisions if preceded by CDIC Act receivership proceeding (financial collateral does not include contractual rights against DCO unless PCSA applies) CCAA Automatic stay No limit; plus possibility that plan or court order may stay permanently (subject to new default) or otherwise compromise rights CDIC Automatic stay No limit; if proceeding is a liquidation, Superintendent may realize on secured party's behalf No stay Automatic stay Yes (financial collateral does not include contractual rights against DCO unless PCSA applies) Yes, but subject to bridge institution provisions Receivership Unlikely No limit Unlikely No, unless PCSA applies Corporate Plan Voluntary Wind-up Windup by pension regulator Unlikely No limit Unlikely No No stay N/A No stay No No stay N/A No stay No unless PCSA applies CPPIB, PSPIB No stay N/A No stay No Note that bankruptcy, reorganization or other insolvency proceedings under Canadian law could extend to all assets of the Covered Customer, wherever 105

108 located. The court has the power to sanction an agreement with a foreign insolvency representative for a co-ordinated insolvency. This could involve an agreement whereby the Canadian trustee or liquidator or court has jurisdiction over Canadian assets and a foreign representative over the foreign assets. Alternatively, a Canadian court could empower the Canadian insolvency representative to take whatever proceedings are permitted by the foreign country. This usually involves commencing an ancillary insolvency proceeding in the foreign jurisdiction, particularly if there are significant assets in the foreign jurisdiction. In addition, a Clearing Member would be required to bring into account assets recovered abroad when proving its claim or exercising its rights of enforcement or set-off in Canada. 17. Will the Covered Customer (or its administrator, provisional liquidator, conservator, receiver, trustee, custodian or other similar official) be able to recover any transfers of Collateral made to the Clearing Member during a certain "suspect period" preceding the date of the insolvency as a result of such a transfer constituting a "preference" (however called and whether or not fraudulent) in favor of the Clearing Member or on any other basis? If so, how long before the insolvency does this suspect period begin? If such a period exists, would the substitution of Collateral by the Covered Customer during this period invalidate an otherwise valid security interest if the substitute Collateral is of no greater value than the assets it is replacing? Would the posting of additional "variation margin" in an amount that reflects a change in the mark-to-market value of one or more Covered Transactions) during the suspect period be subject to avoidance, either because the Collateral was considered to relate to an antecedent or pre-existing obligation or for some other reason? (a) General The Covered Customer (or its administrator, provisional liquidator, conservator, receiver, trustee, custodian or other similar official) may be able to recover any transfers of Collateral made to the Clearing Member during a certain "suspect period" preceding the date of the insolvency. Whether it will be able to or not depends very much on the facts of the case. There are a number of different preference laws with potential application, some of which apply only to certain types of entities. There are a number of potentially applicable fraudulent conveyance or creditor preference laws. Two of these are federal laws. These are the preference provisions in the BIA and those in the WURA. They would apply to proceedings 106

109 in both Ontario and Quebec. Two are Ontario provincial laws. These are the preference and fraudulent conveyance provisions of the Assignments and Preferences Act (APA) and the fraudulent conveyance provisions of the Fraudulent Conveyances Act. Under Quebec law the relevant action is the Paulian action under the Civil Code The discussion below refers to the preference laws only, as it seems unlikely to us that a fraudulent conveyance issue could be raised in a typical transaction. 270 The BIA currently applies only where the Covered Customer is the type of entity subject to the BIA (see Appendix C) and the WURA would apply only where the Covered Customer is an entity subject to the WURA (see Appendix C). The BIA provisions are incorporated by reference into the CCAA. The preference periods relate to the period prior to commencement of the proceeding, and under the CCAA the monitor (as opposed to the bankruptcy trustee) would have the right to bring the proceeding. The Ontario acts, the APA and FPA, can apply to any entity and can be enforced by creditors, a trustee in bankruptcy, a receiver or a liquidator. In summary, under any of the preference laws there is a risk (although in the typical situation probably not a significant one) that a transfer of Collateral made by an insolvent Covered Customer or Covered Customer on the verge of insolvency, particularly to the extent it relates to a pre-existing transaction (i.e. providing Collateral as Exposure increases as opposed to delivering an Independent Amount at the inception of the Transaction), will be set aside as a creditor preference even if it is made pursuant to a binding security agreement entered into prior to the insolvency. In most cases, if the transfer or payment is made with the genuine intent to try to avoid bankruptcy and to remain in business, then any presumption that the transfer or payment prefers the secured creditor will be rebutted. The risk of transfers of Collateral being set aside as creditor preferences is unlikely to be material. However, the risk is not one that can be accurately assessed at the time of entering into the agreement because the relevant intention is the intention of the transferee at the time of making the transfer. The federal statutes do recognize a limited protection for transfers of financial collateral under terms of an eligible financial contract in that there is no presumption that transfers are preferential if they have a preferential effect, as there is for other types of collateral. These provisions are discussed below. 270 An atypical transaction might be one where there were unusual circumstances, such as, for example, substantial over-collateralization with a view to removing assets from other creditors. 107

110 In our view, the substitution of Collateral by the Covered Customer during this period would not invalidate an otherwise valid pledge if the substitute Collateral was of no greater value than the asset it was replacing. A more detailed discussion of preference laws follows. (b) BIA271 Section 95 of the BIA would allow a trustee to move to set aside a transfer of Collateral to a Clearing Member if it showed that: the transfer was a transfer of property, a charge on property, or a payment made, the Clearing Member was a "creditor" at the time of the conveyance or transfer, the Covered Customer was insolvent at the time of the transfer, the transfer was made with the intent of preferring the Clearing Member over the Covered Customer's other creditors, and the transfer, charge or payment took place within three months of the commencement of the Covered Customer's bankruptcy. In the past, the trustee would not have had to prove that the debtor intended to prefer a secured party, but only that the transfer, charge or payment had the effect of preferring a secured party. The onus would then shift to the secured party272 to prove that the debtor did not intend to prefer it. This "presumption" was repealed with respect to a transfer made in connection with "financial collateral" and in accordance with the provisions of eligible financial contracts. 273 Consequently, the trustee must now prove intent with respect to this type of collateral. If the Clearing Member and Covered Customer are not at arm's length, then section 95 operates slightly differently. Usually it is not necessary to prove intent in such a case, only that the transfer, charge or payment has the effect of preferring the creditor. The suspect period is 12 months before the date of the initial bankruptcy event. However, the parties are deemed to be dealing with each other at arm's length in respect of a transfer, charge or payment made in connection with financial collateral and in accordance with the provisions of an 271 These apply also in and with respect to a CCAA proceeding. 272 Technically speaking it shifts to the debtor, but practically it is the transferee that must rebut the presumption. 273 BIA, s. 95(2.1); see Question 17 (ii) above. 108

111 eligible financial contract. In other words, the law with respect to non-arm's length transfers of financial collateral for an eligible financial contract is the same as for arm's length transfers except that the suspect period is 12 months. If the trustee did satisfy the onus to prove each of these elements, any such transfer would be void. The trustee may have difficulty proving intent, however. Canadian cases generally have taken the position that an agreement to provide security in future upon request is not in and of itself preferential. The fact that the Collateral is provided pursuant to an agreement that pre-dates the Covered Customer's insolvency and particularly the three-month suspect period, will be considered evidence, possibly determinative evidence, that the Covered Customer did not have the requisite intent to prefer the Clearing Member. There is case law, however, where a pre-existing contractual obligation to post margin to a futures account has not, in and of itself, rebutted the presumption. Also, if the Covered Customer is insolvent at the time it enters into the Transactions, then the Clearing Member might not be able to rely on the fact of this preexisting contract to disprove intent to prefer. In any event, other evidence may be relevant to intent. For example, the Covered Customer may have valid reasons to transfer the Collateral to the Clearing Member in preference to its other creditors. Delay in the transfer of Collateral to the Clearing Member would constitute an Event of Default and, consequently, an acceleration of its obligations. Nonpayment of other creditors may not be as disadvantageous. The Covered Customer might honestly and reasonably believe that by transferring the Collateral it buys time necessary to allow it to carry on in business. In such a case, the trustee would not likely be able to prove the requisite intent as long as the Covered Customer's hope that the business would recover was both bona fide and reasonable. (c) WURA The WURA contains fraudulent conveyance and preference provisions that differ from those under the BIA and the provincial statutes. Because the WURA applies to limited types of entities and, consequently, liquidations are far less common than bankruptcies, the jurisprudence is not very well developed. Although the form of the provisions are different from those in the BIA, in substance most of them operate in much the same way and are intended to effect the same result. Therefore, the following analysis relies on the case law considering the analogous provisions in these other statutes. The WURA contains two sets of provisions with potential application. These are: the unjust preference provisions, and the payments within 30 days of winding-up provision. 109

112 Unjust Preferences Section 100 of the WURA voids any deposit, transfer or payment to a creditor "in contemplation of insolvency" that has the effect of giving the creditor an "unjust preference". Normally, any deposit, transfer or payment made within 30 days of the appointment of the liquidator is deemed to have been made in contemplation of insolvency. This presumption does not apply to a sale, deposit, pledge or transfer of "financial collateral" made in accordance with the provisions of an "eligible financial contract." 274 This means that the liquidator would have to prove the transfer of collateral was made with the intention to provide the secured party an unjust preference as it would for transfers more than 30 days prior to the proceeding. Although the wording is quite different, the intent of this provision is similar to the unjust preference provisions in Section 95 of the BIA and in the APA and FPA. However, unlike the BIA, it is not just transfers and transactions that take place within the suspect period (i.e. three months) that are subject to being set aside; any transaction made with the requisite intent and effect can be set aside. Transfers of Collateral would be transfers of property and so are subject to the preference analysis. The meaning of the term "unjust" in this context is unclear. However, there is some early case law suggesting that it means only that the transfer or payment interferes with the rateable distribution of the insolvent company's assets. Therefore, there is a risk that a court would view the transfers of Collateral as having the effect of unjustly preferring the Clearing Member. The meaning of the phrase "in contemplation of insolvency" is also unclear. However, by analogy to the BIA preference provision, it likely means that the transfer or payment is made at a time when the Covered Customer is either insolvent or very nearly insolvent with the intention of giving the creditor a preferred position over other creditors. The liquidator has the onus to prove intent for transfers or payments with respect to financial collateral for an eligible financial contract; transfers of other types of collateral or other types of payments made within 30 days of the commencement of liquidation would be deemed to be made with this intent. A Clearing Member would have to bring forth evidence to generally meet the liquidator's case with respect to the Covered Customer's intent. It will always be essential to demonstrate that in making any transfer at a time when it is insolvent, the Covered Customer had a reasonable and bona fide belief that by doing so it would be able to carry on in business and the fact that a failure to deliver Collateral is an Event of Default entitling the Clearing Member to 274 WURA, s.100(3); See Question 17 (ii) and (iv) above. 110

113 terminate all Transactions will be of assistance in this regard. As with the BIA, the preferential intent might be disproved by evidence that the transfer was made pursuant to an agreement that pre-dated insolvency and the suspect period. Payments within 30 Days of Winding-up With respect to entities subject to the WURA, there is an additional provision, not found in the BIA or provincial legislation, which must be considered in relation to any transfers of money. Transfers of money made within 30 days of the commencement of liquidation can be set aside. Subsection 101(1) voids every "payment" made within 30 days of commencement of the liquidation by an insolvent company to a person who knows of the insolvency or who has reason to know of it. Intent in making the payment is not relevant under this provision. If, during this 30-day period, the Clearing Member had actual knowledge of the Covered Customer's insolvent state or reason to question its solvency, then the payments made during this period might be set aside. This provision does not apply, however, to a payment made in connection with financial collateral in accordance with the provisions of an eligible financial contract. 275 (d) APA and FPA In Ontario, the relevant provision in the APA is Section 4, which is similar to Section 95 of the BIA. 276 Unlike the BIA, however, an intent to prefer is presumed if the effect of the transfer is to prefer a creditor over others; but this presumption only operates if there is an assignment for the benefit of creditors or a proceeding is brought to attack the transfer within 60 days of the transfer. 277 In other words, a creditor could attack any of the transfers as preferential, but it would only have the benefit of the presumption for deliveries of Collateral in the prior 60 days. 275 WURA s.101(3) (1) "Subject to section 5, every... conveyance... or transfer... or payment... of any.. property, real or personal, made by a person when insolvent or unable to pay the person's debts in full or when the person knows that he, she or it is on the eve of insolvency, with intent to defeat, hinder, delay or prejudice creditors, or any one or more of them, is void as against the creditor or creditors injured, delayed or prejudiced. (2) Subject to section 5, every such... conveyance... or transfer... or payment made by a person being at the time in insolvent circumstances, or unable to pay... its debts in full, or knowing... itself to be on the eve of insolvency, to or for a creditor with the intent to give such creditor an unjust preference over other creditors or over any one or more of them is void as against the creditor or creditors injured, delayed, prejudiced or postponed". [Emphasis Added] 277 Subsections 4(3) and 4(4). 111

114 The case law and analysis discussed above in relation to the preference provision in Section 95 of the BIA is also relevant in this context. The only significant differences between the two provisions are (1) there is no presumption of a preference under the BIA if the effect of the transfer is to prefer and there is such a presumption under the APA, and (2) the fact that the APA and FPA can void transactions that take place any time outside the 60 day and 1 year period, respectively, so long as the applicant (i.e. creditors and a trustee in bankruptcy) proves the requisite intent. The crucial issue is intent and the analysis would be the same as that described with respect to the BIA. (e) When Suspect Periods Commence A summary of the suspect periods is as follows. Under the BIA the period begins 90 days278 prior to the commencement of bankruptcy proceedings. A bankruptcy commences upon the filing of the petition in bankruptcy or the assignment into bankruptcy by the insolvent party. Under the WURA (both Sections 100 and 101(2)), the period begins 30 days prior to commencement of the liquidation proceedings. These commence when a court order is obtained appointing a liquidator. Under the WURA unjust preference provision (Section 100), the APA and the FPA there is no true preference period. A rebuttable presumption of a preference applies with respect to transactions that have the effect of preferring a creditor during certain periods. Under the APA the presumption applies if the proceedings to set the transfer aside are commenced within 60 days of the transfer. Under the FPA the presumption applies if the proceedings to set the transfer aside are commenced within 1 year of the transfer. Also under WURA, section 101(1), the period during which payments can be challenged is 30 days prior to commencement of the liquidation proceedings. (f) Transfers at an Undervalue The BIA and CCAA 279 include a transfer at an undervalue provision. Under this provision a "transfer at an undervalue" is void as against or may not be set up against the trustee. In addition, any person that is a party to the transaction or is a privy of a party to the transaction may be ordered to make compensatory payments to the estate if the transaction is found to be a transaction at an undervalue. A "transfer at an undervalue" is: 278 One year if not arm's length. 279 S.C. 2005, c. 47 as amended by S.C. 2007, c

115 a disposition of property or provision of services for which no consideration is received by the debtor or for which the consideration received by the debtor is conspicuously less than the fair market value of the consideration given by the debtor; Where the debtor and the party to the transaction are dealing at arm's length, the trustee must prove that (i) the transfer occurred during the period that begins on the day that is one year before the date of the initial bankruptcy event (e.g. the date of the assignment, the filing of a notice to make a proposal etc.) and that ends on the date of the bankruptcy, (ii) the debtor was insolvent at the time of the transfer or was rendered insolvent by it, and (iii) the debtor intended to defraud, defeat or delay a creditor. Where proved the transfer is void and the transferee may be ordered to pay the difference between the value of the consideration given or received by the debtor and the fair market value of the property or services given or received by the debtor. This provision does not appear to be directed at transfers of collateral or additional collateral to existing creditors. Those types of transactions would be considered pursuant to the creditor preference provisions discussed above. (g) Paulian Action Articles 1631 to 1636 of the Civil Code set out when a creditor can challenge a "juridical act" (which term would include, inter alia, both (i) a contract and (ii) a payment made for the performance of a contract) made by a party who is insolvent or on the brink of insolvency. The trustee or creditor challenging the transaction must prove that the act was done "in fraud of his rights" and that the effect of the transaction was (i) to grant a preference to another creditor when the debtor was insolvent or (ii) to render the debtor insolvent. While the sanction in a Paulian action is not the nullity of the juridical act but that the act is declared "inopposable", that is, of no effect, visa-vis the attacking creditor, the effect is the same. The act is also inopposable to any creditor who could have taken a Paulian action and the property involved or payment may be seized and sold, or paid to the creditors. Article 1635 provides that a Paulian action must be brought within one year of the appointment of the trustee in bankruptcy where the action is brought by a trustee. The same article provides that, if a creditor challenges the transaction, it must be brought within one year of his learning of the prejudice resulting from the act which is being attacked or the fraudulent nature of the act. There is jurisprudence, including cases from the Quebec Court of Appeal, holding that the one-year period is of strict application and therefore the creditor or the trustee will not be able to take an action after this period has expired. However, 113

116 there is also jurisprudence holding that the Paulian action may also be subject to the general prescription period of three years for all personal actions which is set out at Article 2925 of the Civil Code. According to this jurisprudence, despite the one-year period set out in Article 1635, Article 2925 also applies to a Paulian action and therefore a creditor has three years from its knowledge of the fraudulent or prejudicial nature of the transaction to institute a Paulian action. In our view, it is likely that the one-year period applies although this conclusion is not free from doubt. In order to attack a transaction under the Paulian action provisions, a trustee or creditor must prove fraudulent intent and the ease with which he can do so will be determined by whether the transaction or payment is in the context of a gratuitous contract - a contract made without consideration - or an onerous contract - a contract made for consideration. In our view, a transfer of Eligible Collateral would not be considered to be a payment made in the context of a gratuitous contract because it is originally negotiated in the context of an onerous contract. Therefore, it is the presumption in Article 1632 of the Civil Code with respect to onerous contracts that might be held to apply. Pursuant to Article 1632, in the case of an onerous contract or a payment made for the performance of an onerous contract, the contract or payment is deemed to have been made with fraudulent intent if the advantaged creditor knew of the debtor's insolvent state or knew that the debtor was rendering himself or was seeking to render himself insolvent. Generally, a "deemed" presumption in the Civil Code is held to be an irrebuttable one. 280 There has been some controversy, however, in the legal writing and case law as to whether this is the case with Article In our view, which is supported by some legal writing and several recent cases, the presumption in Article 1632 should be rebuttable even though the word "deemed" is used. 281 In light of the most recent decisions and especially that of the Court of Appeal in Soracchi, there is now a strong argument to be made that a creditor may, on proof of its good faith and/ or that the transaction was in the ordinary course of business, be able to rebut the presumption of fraudulent intent even if the creditor had knowledge of the insolvency of the debtor at the time of the transaction or payment. In conclusion, we are of the view that the deemed presumption for gratuitous contracts in the Civil Code would not apply to a transfer of Eligible Collateral 280 Article 2847, CCQ. 281 See Banque Nationale du Canada v. Soracchi. REJB (C.A.) (Soracchi). Also Compagnie Montreal Trust du Canada v. Bergeron, J.E (C.S.). See also Baudouin & Jobin, Les Obligations, 5th ed., Cowansville, Qc.: Yvon Blais, 1998 at pg. 717 cited with approval in Soracchi. 114

117 because this transfer would not be considered to be a payment made in the context of a gratuitous contract. For the deemed presumption in Article 1632 to apply, there must be knowledge by the advantaged creditor of the debtor's insolvency or impending insolvency and, even in such a case, it may be possible to rebut the presumption of fraudulent intent. Therefore, if the Clearing Member were not aware of the insolvent state of the debtor at the time that the security agreements were entered into and when a transfer of Eligible Collateral took place, the deemed presumption of fraudulent intent in Article 1632 should not apply at all and a Paulian action would not likely be successful. Even if the Clearing Member did have such knowledge when a transfer of Eligible Collateral was made, as mentioned above, it will likely be possible for it to rebut the presumption of fraudulent intent upon proof of good faith and that the transfer was made in the interests of the debtor in that it permitted it to carry on business and for the Transactions not to be terminated prematurely. While we view the risk of a transfer of Eligible Collateral being set aside in a Paulian action as being quite small, the risk cannot be predicted with certainty since knowledge by the Clearing Member of the debtor's insolvency may trigger the presumption of fraudulent intent set out in the Civil Code and rebutting the presumption will depend upon the factual context of the transfer. In any case where the debtor is insolvent, this issue will be of some concern. Miscellaneous 18. Would the parties' agreement on governing law of each Covered Base Agreement and CDA and submission to jurisdiction be upheld in Ontario and Quebec, and what would be the consequences if they were not? (a) Choice of Law Subject to the following qualifications, an Ontario or Quebec court would respect the parties' choice of governing law. It would apply the chosen law to determine the validity of the agreement (insofar as contractual matters are concerned) and its interpretation. An Ontario and Quebec court will apply its own procedural laws notwithstanding the choice of a different governing law. For example, certain matters with respect to the realization of the Collateral may be characterized as procedural matters and subject to the PPSA or Quebec Civil Code. An Ontario court will not apply a foreign law that is against public policy in the province and similarly a Quebec court will not apply a foreign law that is against public order as understood in international relations. 115

118 A court will apply laws of mandatory application or, as it is expressed in Quebec, laws that apply by reason of their particular object. An Ontario court will not apply a foreign law if its application would cause a party to breach a law in the place of performance of the obligation. (b) Submission to Jurisdiction The parties' submissions to the jurisdiction of courts outside of Ontario or Quebec would be recognized by court in Ontario and Quebec. Note, however, that if proceedings were to be taken with respect to Collateral situated in Ontario or Quebec, it may as a practical matter be preferable to take proceedings in an Ontario or Quebec court in the first instance, thereby avoiding the need to first take proceedings in a foreign court and then further proceedings to have a foreign judgment recognized and enforced in the province. There is some question as to whether a Canadian court will recognize and enforce a nonmonetary order of a foreign court with respect to Canadian property and, therefore, it may require the issue to be relitigated. 19. Are there any other local law considerations that you would recommend the Clearing Member to consider in connection with taking and realizing upon the Eligible Collateral from the Covered Customer? Other than those described above, there are no other local law considerations. In this regard, we have not considered any tax, securities or other regulatory law issues. No. RELIANCE 20. Are there any other circumstances you can foresee that might affect the Clearing Member's ability to enforce its security interest in Ontario and Quebec? This memorandum of law is intended solely for the benefit of ISDA and the FIA and their members. No other party may rely on it without our prior written consent. Without limiting the foregoing, ISDA, the FIA and their members may provide a copy of this opinion to (i) any competent regulatory authority or supervisory body including the UK Financial Services Authority and the German Bundesanstalt fur Finanzdienstleistungsaufsicht and (ii) their advisors; however this opinion is not addressed to such regulatory authorities or advisors and may not be relied upon by them. 116

119 We assume no obligation to any person or entity to make any investigations as to or inform them of any change in law arising subsequent to the date of this opinion that might affect the opinions expressed in it. STIKEMAN ELLIOTT LLP Contacts: Margaret Grottenthaler (Toronto) Sterling Dietze (Montreal) 117

120 APPENDIX A - CERTAIN DERIVATIVES TRANSACTIONS APPENDIX A SEPTEMBER 2012 Basis Swap. A transaction in which one party pays periodic amounts of a given currency based on a floating rate and the other party pays periodic amounts of the same currency based on another floating rate, with both rates reset periodically; all calculations are based on a notional amount of the given currency. Bond Forward. A transaction in which one party agrees to pay an agreed price for a specified amount of a bond of an issuer or a basket of bonds of several issuers at a future date and the other party agrees to pay a price for the same amount of the same bond to be set on a specified date in the future. The payment calculation is based on the amount of the bond and can be physically-settled (where delivery occurs in exchange for payment) or cash-settled (where settlement occurs based on the difference between the agreed forward price and the prevailing market price at the time of settlement). Bond Option. A transaction in which one party grants to the other party (in consideration for a premium payment) the right, but not the obligation, to purchase (in the case of a call) or sell (in the case of a put) a specified amount of a bond of an issuer, such as Kingdom of Sweden or Unilever N.V., at a specified strike price. The bond option can be settled by physical delivery of the bonds in exchange for the strike price or may be cash settled based on the difference between the market price of the bonds on the exercise date and the strike price. Bullion Option. A transaction in which one party grants to the other party (in consideration for a premium payment) the right, but not the obligation, to purchase (in the case of a call) or sell (in the case of a put) a specified number of Ounces of Bullion at a specified strike price. The option may be settled by physical delivery of Bullion in exchange for the strike price or may be cash settled based on the difference between the market price of Bullion on the exercise date and the strike price. Bullion Swap. A transaction in which one party pays periodic amounts of a given currency based on a fixed price or a fixed rate and the other party pays periodic amounts of the same currency or a different currency calculated by reference to a Bullion reference price (for example, Gold-COMEX on the COMEX Division of the New York Mercantile Exchange) or another method specified by the parties. Bullion swaps include cap, collar or floor transactions in respect of Bullion.

121 Bullion Trade. A transaction in which one party agrees to buy from or sell to the other party a specified number of Ounces of Bullion at a specified price for settlement either on a "spot" or two-day basis or on a specified future date. A Bullion Trade may be settled by physical delivery of Bullion in exchange for a specified price or may be cash settled based on the difference between the market price of Bullion on the settlement date and the specified price. For purposes of Bullion Trades, Bullion Options and Bullion Swaps, "Bullion" means gold, silver, platinum or palladium and "Ounce" means, in the case of gold, a fine troy ounce, and in the case of silver, platinum and palladium, a troy ounce (or in the case of reference prices not expressed in Ounces, the relevant Units of gold, silver, platinum or palladium). Buy/Sell-Back Transaction. A transaction in which one party purchases a security (in consideration for a cash payment) and agrees to sell back that security (or in some cases an equivalent security) to the other party (in consideration for the original cash payment plus a premium). Cap Transaction. A transaction in which one party pays a single or periodic fixed amount and the other party pays periodic amounts of the same currency based on the excess, if any, of a specified floating rate (in the case of an interest rate cap), rate or index (in the case of an economic statistic cap) or commodity price (in the case of a commodity cap) in each case that is reset periodically over a specified per annum rate (in the case of an interest rate cap), rate or index (in the case of an economic statistic cap) or commodity price (in the case of a commodity cap). Collar Transaction. A collar is a combination of a cap and a floor where one party is the floating rate, floating index or floating commodity price payer on the cap and the other party is the floating rate, floating index or floating commodity price payer on the floor. Commodity Forward. A transaction in which one party agrees to purchase a specified quantity of a commodity at a future date at an agreed fixed or floating price, and the other party agrees to deliver such quantity in exchange for payment at such price on a specified date in the future. Commodity Index Transaction. A transaction, structured in the form of a swap, cap, collar, floor, option or some combination thereof, between two parties in which the underlying value of the transaction is based on a rate or index based on the price of one or more commodities. Commodity Option. A transaction in which one party grants to the other party (in consideration for a premium payment) the right, but not the obligation, to 2

122 purchase (in the case of a call) or sell (in the case of a put) a specified quantity of a commodity at a specified strike price. The option can be settled either by physically delivering the quantity of the commodity in exchange for the strike price or by cash settling the option, in which case the seller of the option would pay to the buyer the difference between the market price of that quantity of the commodity on the exercise date and the strike price. Commodity Swap. A transaction in which one party pays periodic amounts of a given currency based on a fixed price and the other party pays periodic amounts of the same currency based on the price of a commodity, such as natural gas or gold, or a futures contract on a commodity (e.g., West Texas Intermediate Light Sweet Crude Oil on the New York Mercantile Exchange); all calculations are based on a notional quantity of the commodity. Contingent Credit Default Swap. A Credit Default Swap Transaction under which the calculation amounts applicable to one or both parties may vary over time by reference to the mark-to-market value of a hypothetical swap transaction. Credit Default Swap Option. A transaction in which one party grants to the other party (in consideration for a premium payment) the right, but not the obligation, to enter into a Credit Default Swap. Credit Default Swap. A transaction in which one party pays either a single fixed amount or periodic fixed amounts or floating amounts determined by reference to a specified notional amount, and the other party (the credit protection seller) pays either a fixed amount or an amount determined by reference to the value of one or more loans, debt securities or other financial instruments (each a "Reference Obligation") issued, guaranteed or otherwise entered into by a third party (the "Reference Entity") upon the occurrence of one or more specified credit events with respect to the Reference Entity (for example, bankruptcy or payment default). The amount payable by the credit protection seller is typically determined based upon the market value of one or more debt securities or other debt instruments issued, guaranteed or otherwise entered into by the Reference Entity. A Credit Default Swap may also be physically settled by payment of a specified fixed amount by one party against delivery of specified obligations ("Deliverable Obligations") by the other party. A Credit Default Swap may also refer to a "basket" (typically ten or less) or a "portfolio" (eleven or more) of Reference Entities or may be an index transaction consisting of a series of component Credit Default Swaps. Credit Derivative Transaction on Asset-Backed Securities. A Credit Default Swap for which the Reference Obligation is a cash or synthetic asset-backed security. Such a transaction may, but need not necessarily, include "pay as you go" 3

123 settlements, meaning that the credit protection seller makes payments relating to interest shortfalls, principal shortfalls and write-downs arising on the Reference Obligation and the credit protection buyer makes additional fixed payments of reimbursements of such shortfalls or write-downs. Credit Spread Transaction. A transaction involving either a forward or an option where the value of the transaction is calculated based on the credit spread implicit in the price of the underlying instrument. Cross Currency Rate Swap. A transaction in which one party pays periodic amounts in one currency based on a specified fixed rate (or a floating rate that is reset periodically) and the other party pays periodic amounts in another currency based on a floating rate that is reset periodically. All calculations are determined on predetermined notional amounts of the two currencies; often such swaps will involve initial and or final exchanges of amounts corresponding to the notional amounts. Currency Option. A transaction in which one party grants to the other party (in consideration for a premium payment) the right, but not the obligation, to purchase (in the case of a call) or sell (in the case of a put) a specified amount of a given currency at a specified strike price. Currency Swap. A transaction in which one party pays fixed periodic amounts of one currency and the other party pays fixed periodic amounts of another currency. Payments are calculated on a notional amount. Such swaps may involve initial and or final payments that correspond to the notional amount. Economic Statistic Transaction. A transaction in which one party pays an amount or periodic amounts of a given currency by reference to interest rates or other factors and the other party pays or may pay an amount or periodic amounts of a currency based on a specified rate or index pertaining to statistical data on economic conditions, which may include economic growth, retail sales, inflation, consumer prices, consumer sentiment, unemployment and housing. Emissions Allowance Transaction. A transaction in which one party agrees to buy from or sell to the other party a specified quantity of emissions allowances or reductions at a specified price for settlement either on a "spot" basis or on a specified future date. An Emissions Allowance Transaction may also constitute a swap of emissions allowances or reductions or an option whereby one party grants to the other party (in consideration for a premium payment) the right, but not the obligation, to receive a payment equal to the amount by which the specified quantity of emissions allowances or reductions exceeds or is less than a specified strike. An Emissions Allowance Transaction may be physically settled by delivery of emissions allowances or reductions in exchange for a specified 4

124 price, differing vintage years or differing emissions products or may be cash settled based on the difference between the market price of emissions allowances or reductions on the settlement date and the specified price. Equity Forward. A transaction in which one party agrees to pay an agreed price for a specified quantity of shares of an issuer, a basket of shares of several issuers or an equity index at a future date and the other party agrees to pay a price for the same quantity and shares to be set on a specified date in the future. The payment calculation is based on the number of shares and can be physicallysettled (where delivery occurs in exchange for payment) or cash-settled (where settlement occurs based on the difference between the agreed forward price and the prevailing market price at the time of settlement). Equity Index Option. A transaction in which one party grants to the other party (in consideration for a premium payment) the right, but not the obligation, to receive a payment equal to the amount by which an equity index either exceeds (in the case of a call) or is less than (in the case of a put) a specified strike price. Equity Option. A transaction in which one party grants to the other party (in consideration for a premium payment) the right, but not the obligation, to purchase (in the case of a call) or sell (in the case of a put) a specified number of shares of an issuer or a basket of shares of several issuers at a specified strike price. The share option may be settled by physical delivery of the shares in exchange for the strike price or may be cash settled based on the difference between the market price of the shares on the exercise date and the strike price. Equity Swap. A transaction in which one party pays periodic amounts of a given currency based on a fixed price or a fixed or floating rate and the other party pays periodic amounts of the same currency or a different currency based on the performance of a share of an issuer, a basket of shares of several issuers or an equity index, such as the Standard and Poor's 500 Index. Floor Transaction. A transaction in which one party pays a single or periodic amount and the other party pays periodic amounts of the same currency based on the excess, if any, of a specified per annum rate (in the case of an interest rate floor), rate or index level (in the case of an economic statistic floor) or commodity price (in the case of a commodity floor) over a specified floating rate (in the case of an interest rate floor), rate or index level (in the case of an economic statistic floor) or commodity price (in the case of a commodity floor). Foreign Exchange Transaction. A deliverable or non-deliverable transaction providing for the purchase of one currency with another currency providing for settlement either on a "spot" or two-day basis or a specified future date. 5

125 Forward Rate Transaction. A transaction in which one party agrees to pay a fixed rate for a defined period and the other party agrees to pay a rate to be set on a specified date in the future. The payment calculation is based on a notional amount and is settled based, among other things, on the difference between the agreed forward rate and the prevailing market rate at the time of settlement. Freight Transaction. A transaction in which one party pays an amount or periodic amounts of a given currency based on a fixed price and the other party pays an amount or periodic amounts of the same currency based on the price of chartering a ship to transport wet or dry freight from one port to another; all calculations are based either on a notional quantity of freight or, in the case of time charter transactions, on a notional number of days. Fund Option Transaction: A transaction in which one party grants to the other party (for an agreed payment or other consideration) the right, but not the obligation, to receive a payment based on the redemption value of a specified amount of an interest issued to or held by an investor in a fund, pooled investment vehicle or any other interest identified as such in the relevant Confirmation (a "Fund Interest"), whether i) a single class of Fund Interest of a Single Reference Fund or ii) a basket of Fund Interests in relation to a specified strike price. The Fund Option Transactions will generally be cash settled (where settlement occurs based on the excess of such redemption value over such specified strike price (in the case of a call) or the excess of such specified strike price over such redemption value (in the case of a put) as measured on the valuation date or dates relating to the exercise date). Fund Forward Transaction: A transaction in which one party agrees to pay an agreed price for the redemption value of a specified amount of i) a single class of Fund Interest of a Single Reference Fund or ii) a basket of Fund Interests at a future date and the other party agrees to pay a price for the redemption value of the same amount of the same Fund Interests to be set on a specified date in the future. The payment calculation is based on the amount of the redemption value relating to such Fund Interest and generally cash-settled (where settlement occurs based on the difference between the agreed forward price and the redemption value measured as of the applicable valuation date or dates). Fund Swap Transaction: A transaction a transaction in which one party pays periodic amounts of a given currency based on a fixed price or a fixed rate and the other party pays periodic amounts of the same currency based on the redemption value of i) a single class of Fund Interest of a Single Reference Fund or ii) a basket of Fund Interests. Interest Rate Option. A transaction in which one party grants to the other party (in consideration for a premium payment) the right, but not the obligation, to receive a payment equal to the amount by which an interest rate either exceeds 6

126 (in the case of a call option) or is less than (in the case of a put option) a specified strike rate. Interest Rate Swap. A transaction in which one party pays periodic amounts of a given currency based on a specified fixed rate and the other party pays periodic amounts of the same currency based on a specified floating rate that is reset periodically, such as the London inter-bank offered rate; all calculations are based on a notional amount of the given currency. Longevity/Mortality Transaction. (a) A transaction employing a derivative instrument, such as a forward, a swap or an option, that is valued according to expected variation in a reference index of observed demographic trends, as exhibited by a specified population, relating to aging, morbidity, and mortality/longevity, or (b) A transaction that references the payment profile underlying a specific portfolio of longevity- or mortality- contingent obligations, e.g. a pool of pension liabilities or life insurance policies (either the actual claims payments or a synthetic basket referencing the profile of claims payments). Physical Commodity Transaction. A transaction which provides for the purchase of an amount of a commodity, such as oil including oil products, coal, electricity or gas, at a fixed or floating price for actual delivery on one or more dates. Property Index Derivative Transaction. A transaction, often structured in the form of a forward, option or total return swap, between two parties in which the underlying value of the transaction is based on a rate or index based on residential or commercial property prices for a specified local, regional or national area. Repurchase Transaction. A transaction in which one party agrees to sell securities to the other party and such party has the right to repurchase those securities (or in some cases equivalent securities) from such other party at a future date. Securities Lending Transaction. A transaction in which one party transfers securities to a party acting as the borrower in exchange for a payment or a series of payments from the borrower and the borrower's obligation to replace the securities at a defined date with identical securities. Swap Deliverable Contingent Credit Default Swap. A Contingent Credit Default Swap under which one of the Deliverable Obligations is a claim against the Reference Entity under an ISDA Master Agreement with respect to which an Early Termination Date (as defined therein) has occurred. Swap Option. A transaction in which one party grants to the other party the right (in consideration for a premium payment), but not the obligation, to enter into a 7

127 swap with certain specified terms. In some cases the swap option may be settled with a cash payment equal to the market value of the underlying swap at the time of the exercise. Total Return Swap. A transaction in which one party pays either a single amount or periodic amounts based on the total return on one or more loans, debt securities or other financial instruments (each a "Reference Obligation") issued, guaranteed or otherwise entered into by a third party (the "Reference Entity"), calculated by reference to interest, dividend and fee payments and any appreciation in the market value of each Reference Obligation, and the other party pays either a single amount or periodic amounts determined by reference to a specified notional amount and any depreciation in the market value of each Reference Obligation. A total return swap may (but need not) provide for acceleration of its termination date upon the occurrence of one or more specified events with respect to a Reference Entity or a Reference Obligation with a termination payment made by one party to the other calculated by reference to the value of the Reference Obligation. Weather Index Transaction. A transaction, structured in the form of a swap, cap, collar, floor, option or some combination thereof, between two parties in which the underlying value of the transaction is based on a rate or index pertaining to weather conditions, which may include measurements of heating, cooling, precipitation and wind.

128 APPENDIX B - CERTAIN COUNTERPARTY TYPES 282 Description Covered by opinion Legal form(s) 283 Bank/Credit Institution. A legal entity, which may Yes Canadian domestic banks be organized as a corporation, partnership or in are bodies corporate. They some other form, that conducts commercial use the word "Bank" or banking activities, that is, whose core business However, to "Banque" in their name. typically involves (a) taking deposits from private the extent They are governed by the individuals and/or corporate entities and incorporated Bank Act (Canada). (b) making loans to private individual and/or provincially corporate borrowers. This type of entity is in a sometimes referred to as a "commercial bank" or, if its business also includes investment banking province other than Other covered credit institutions are: and trading activities, a "universal bank". (If the Ontario or entity only conducts investment banking and Quebec the trading activities, then it falls within the governing - trust and/or loan "Investment Firm/Broker Dealer" category below.) legislation companies incorporated This type of entity is referred to as a "credit of the entity under Canadian federal law institution" in European Community (EC) should be (the Trust and Loan legislation. This category may include specialised reviewed to Companies Act) or the laws types of bank, such as a mortgage savings bank determine if of any of the provinces of (provided that the relevant entity accepts deposits insolvency Canada. and makes loans), or such an entity may be winding-up considered in the local jurisdiction to constitute a or separate category of legal entity (as in the case of a restructuring -a credit union central or building society in the United Kingdom (UK)). is possible credit union (which is a counder that operative credit institution provincial or financial services colegislation operative) incorporated under Canadian federal law (the Cooperative Credit Association Act) or the laws of any of the provinces of Canada 282 In these definitions, the term "legal entity" means an entity with legal personality other than a private individual. 283 If appropriate, please indicate, as discussed in the instruction letter, any naming convention or rule that would help a reader of the opinion to identify and classify the entity.

129 Description Covered by opinion Legal form(s) 283 Central Bank. A legal entity that performs the No The Bank of Canada. It is a function of a central bank for a Sovereign or for an area of monetary union (as in the case of the European Central Bank in respect of the euro zone). body corporate governed by the Bank of Canada Act (Canada). Corporation. A legal entity that is organized as a corporation or company rather than a partnership, is engaged in industrial and/or commercial activities and does not fall within one of the other categories in this Appendix B. Yes A domestic business corporation is one incorporated under the Canada Business Corporations Act, the Canada Corporations Act or the business corporations legislation of a province of Canada. Identifying terminology in the name is "Corporation", "Corp.", "Limited", "Ltd.", "Limitee", "Ltee.", "Incorporated", "Incorporee", "Inc." Railway corporations are excluded for the scope of the opinion. Hedge Fund/Proprietary Trader. A legal entity, Yes Such funds are partnerships, which may be organized as a corporation, partnership or in some other legal form, the principal business of which is to deal in and/or manage securities and/or other financial instruments and/or otherwise to carry on an investment business predominantly or exclusively as principal for its own account. corporations or trusts Insurance Company. A legal entity, which may be Yes Canadian domestic organised as a corporation, partnership or in some other legal form (for example, a friendly society or industrial & provident society in the UK), that is licensed to carry on insurance business, and is typically subject to a special regulatory regime and a special insolvency regime in order to protect the insurance companies are bodies corporate. They may be incorporated under federal legislation (the Insurance Companies Act (Canada) or provincial

130 Description interests of policyholders. Covered by opinion Legal form(s) 283 legislation. The corporate name would typically use the word "Insurance", "Assurance", "Assurances", "Reassurance", "Reinsurance" or "Lifeco", but might also be "Society", "Life", "Re", "Casualty", "Indemnity" "Guarantee", "Guaranty", "Surety", "Underwriters". International Organization. An organization of Sovereigns established by treaty entered into between the Sovereigns, including the International Bank for Reconstruction and Development (the World Bank), regional development banks and similar organizations established by treaty. No Investment Firm/Broker Dealer. A legal entity, Yes An investment firm (a which may be organized as a corporation, partnership or in some other form, that does not conduct commercial banking activities but deals in and/or manages securities and/or other financial instruments as an agent for third parties. It may also conduct such activities as principal (but if it does so exclusively as principal, then it most likely falls within the "Hedge Fund/Proprietary Trader" category above.) Its business normally includes holding securities and/or other financial instruments for third parties and operating related cash accounts. This type of entity is referred to as a "broker-dealer" in US legislation and as an "investment firm" in EC legislation. broker or broker dealer) would typically be incorporated under the Canada Business Corporations Act or the business corporations legislation of province (not the Canada Corporations Act). See Corporation, above. They would not normally be partnerships or in any other legal form. Investment Fund. A legal entity or an arrangement Yes An investment fund without legal personality (for example, a common law trust) established to provide investors with a share in profits or income arising from property acquired, held, managed or disposed of by the manager(s) of the legal entity or arrangement or a right to payment determined by reference to such profits or income. This type of entity or organized as a corporation (see Corporation above), limited partnership (LP) or trust.

131 Description Covered by opinion Legal form(s) 283 arrangement is referred to as a "collective investment scheme" in EC legislation. It may be regulated or unregulated. It is typically administered by one or more persons (who may be private individuals and/or corporate entities) who have various rights and obligations governed by general law and/or, typically in the case of regulated Investment Funds, financial services legislation. Where the arrangement does not have separate legal personality, one or more representatives of the Investment Fund (for example, a trustee of a unit trust) contract on behalf of the Investment Fund, are owed the rights and owe the obligations provided for in the contract and are entitled to be indemnified out of the assets comprised in the arrangement. Local Authority. A legal entity established to administer the functions of local government in a particular region within a Sovereign or State of a Federal Sovereign, for example, a city, county, borough or similar area. No Partnership. A legal entity or form of arrangement Yes Ordinary (general) or without legal personality that is (a) organised as a general, limited or some other form of partnership and (b) does not fall within one of the other categories in this Appendix B. If it does not have legal personality, it may nonetheless be treated as though it were a legal person for certain purposes (for example, for insolvency purposes) and not for other purposes (for example, tax or personal liability). limited partnerships formed under provincial law. A limited partnership may use the term "limited partnership" or LP in its name.

132 Description Covered by opinion Legal form(s) 283 Pension Fund. A legal entity or an arrangement without legal personality (for example, a common law trust) established to provide pension benefits to a specific class of beneficiaries, normally sponsored by an employer or group of employers. It is typically administered by one or more persons (who may be private individuals and/or corporate entities) who have various rights and obligations governed by pensions legislation. Where the arrangement does not have separate legal personality, one or more representatives of the Pension Fund (for example, a trustee of a pension scheme in the form of a common law trust) contract on behalf of the Pension Fund and are owed the rights and owe the obligations provided for in the contract and are entitled to be indemnified out of the assets comprised in the arrangement. Yes if governed by the Ontario or federal law, namely governed by the Ontario Pension Benefits Act or the Pension Benefits Standards Act (Canada) Corporate entities or trusts. Includes Ontario Teachers Pension Plan Board, OMERS Corporation, Healthcare of Ontario Pension Plan Board (formerly Hospitals of Ontario Pension Plan Board), Canadian Pension Plan Investment Board (CPPIB) and Public Sector Pension Investment Board (PSPIB). Does not include other public sector plans governed by special Act or Quebec pension plans Private Business Trusts. A form of arrangement Yes As defined where trust is without legal personality that is organized by declaration or deed of trust, to carry on business, other than an Investment Fund. One or more trustees in their capacity as trustees of the Trust, are owed the rights and owe the obligations provided for in the contract and are entitled to be indemnified out of the trust assets. stated in its constituting document to be governed by the laws of the province of Ontario or Quebec. Sovereign. A sovereign nation state recognized internationally as such, typically acting through a direct agency or instrumentality of the central government without separate legal personality, for example, the ministry of finance, treasury or national debt office. This category does not include a State of a Federal Sovereign or other political sub-division of a sovereign nation state if the sub-division has separate legal personality (for example, a Local Authority) and it does not include any legal entity owned by a sovereign nation state (see "Sovereign-owned Entity"). No

133 Description Covered by opinion Legal form(s) 283 Sovereign Wealth Fund. A legal entity, often created by a special statute and normally wholly owned by a Sovereign, established to manage assets of or on behalf of the Sovereign, which may or may not hold those assets in its own name. Such an entity is often referred to as an "investment authority". For certain Sovereigns, this function is performed by the Central Bank, however for purposes of this Appendix B the term "Sovereign Wealth Fund" excludes a Central Bank. No Sovereign-Owned Entity. A legal entity wholly or majority-owned by a Sovereign, other than a Central Bank, or by a State of a Federal Sovereign, which may or may not benefit from any immunity enjoyed by the Sovereign or State of a Federal Sovereign from legal proceedings or execution against its assets. This category may include entities active entirely in the private sector without any specific public duties or public sector mission as well as statutory bodies with public duties (for example, a statutory body charged with regulatory responsibility over a sector of the domestic economy). This category does not include local governmental authorities (see "Local Authority"). No State of a Federal Sovereign. The principal political sub-division of a federal Sovereign, such as Australia (for example, Queensland), Canada (for example, Ontario), Germany (for example, Nordrhein-Westfalen) or the United States of America (for example, Pennsylvania). This category does not include a Local Authority. No

134 APPENDIX C - APPLICATION OF INSOLVENCY REGIMES BIA WURA CCAA CDIC Act Provincial Receiver BIA Receiver Corp.plan Corporations other than Banks, Insurance Companies, Credit Institutions, Pension Funds Partnerships (including Investment Fund, Hedge Fund/Proprietary Trader) Ai Al Not if CBCA; Others theoretically possible but not likely X Al X Al Al Al Only corporate general partners Banks X Al X Ai Insurance Companies Canadian or Provincial Credit Institutions that are trust/ loan/ savings corporations Credit Institutions that are Credit Unions (federal or provincial) X Al X X X Ai Al Ai (possibly if non- CPA members) If federal X; if prov. unclear but not likely Unclear but not likely if CPA members; possibly if not CPA members X Ai Ai If federal I; Not presently if prov. X Only corporate general partners Unclear but very unlikely X X Unclear but very unlikely X X Unclear but very unlikely Unclear but not likely if CPA members; possibly if not CPA members Bank of Canada X X X X X X X Ai X Depends on governing legislation Pension Plan if CPPIB, PSPIB X X X X X X X Pension Plan (not CPPIB, PSPIB)284 Unclear but not likely X X X Al Ai X Income Trusts * Al X Al X Ai Ai X Trusts (other than Investment Trusts and Pension Plans), including Investment Funds organized as trusts Unclear X Unclear X Al Al X 284 As noted in the memorandum, pension plan trusts are likely to be wound up by the trustee either voluntarily or under the supervision of the regulator. publicly traded.

135 APPENDIX D - DESCRIPTION OF CANADIAN INSOLVENCY REGIMES Canadian insolvency regimes can be divided into two general categories. The first category is liquidation regimes. These include: (2) the bankruptcy provisions of the BIA, (3) the liquidation provisions of the WURA, (4) the receivership provisions of the CDIC Act, (5) court administered receivership, (6) in the case of Pension Plans, winding-up under the supervision of the regulator, and (7) in the case of Pension Plan and other trusts such as Investment Funds, voluntary winding-up by the trustee or plan administrator. 285 The primary purpose of liquidation regimes is for the insolvency representative, whether the trustee in bankruptcy, the liquidator, the court appointed receiver, administrator or trustee, to realize all of the assets of the insolvent entity for the benefit of its creditors. The second category is reorganization regimes. These include: (1) the proposal provisions of the BIA, (2) the reorganization provisions of the CDIC Act, (3) the arrangement provisions of the CCAA, and (4) a corporate plan of arrangement under the relevant corporate legislation. BIA Bankruptcy. This is a voluntary or involuntary proceeding where a trustee in bankruptcy is appointed to liquidate the assets of the debtor for the benefit of creditors. The debtor's assets vest by operation of law in the trustee. By its terms the BIA applies to almost any type of legal entity, including individuals, partnerships, associations and corporations. The BIA defines "corporations" to include any company incorporated or authorized to do business by or under a federal or provincial Act or any incorporated company 285 This is not strictly speaking an insolvency regime, but it is likely the manner in which an insolvent trust would be dealt with.

136 that has an office in or carries on business in Canada. However, excluded from the definition of "corporations" are banks, savings banks, insurance companies, trust companies, loan companies and railway companies. 286 Holding companies of such entities are subject to the BIA. The BIA expressly applies to non-canadian corporations with assets in Canada. 287 The BIA applies to "income trusts" (including publicly listed investment funds). An "income trust" is a trust that has assets in Canada and the units of which are traded on a prescribed stock exchange or a trust all of the units of which are held by an entity that trades on a prescribed stock exchange. A prescribed stock exchange is one that is regulated by an Act of Parliament or the legislature of a province. It is not clear whether the BIA applies to trusts that are not income trusts. Its application to trusts is an open question. It may be that the trustee in its capacity as trustee could become subject to the BIA, but there are impediments to this analysis because the BIA generally excludes property held in trust from the scheme of distribution. In any event, if the trustee is a financial institution it likely could not be subject to the BIA even if it sought to apply solely in its capacity as trustee and with respect to the assets held in trust. For the purpose of analyzing netting rights, parties should assume that the BIA might apply to a trust, such as an Investment Fund, Trust or Pension Plan that does not have a Canadian trust company as trustee. WURA Liquidation. A liquidator appointed by order of the court takes control of the debtor's assets to deal with in accordance with the court order for the purpose of liquidating the assets for the benefit of creditors. Banks, other Credit Institutions, Insurance Companies, incorporated under Canadian law or carrying on operations in Canada are potentially subject to the WURA. Although the WURA also applies to other types of "trading companies" 288 (except corporations incorporated under the Canada Business 286 BIA, s BIA. s.2. "insolvent person". 288 The WURA defines a "trading company" as: any company, except a railway or telegraph company, carrying on business similar to that carried on by apothecaries, auctioneers, bankers, brokers, brickmakers, builders, carpenters, carriers, cattle or sheep salesmen, coach proprietors, dyers, fullers, keepers of inns, taverns, hotels, saloons or coffee houses, lime burners, livery stable keepers, market gardeners, millers, miners, packers, printers, quarrymen, sharebrokers, ship-owners, ship-wrights, stockbrokers, stock-jobbers, victuallers, warehousemen, wharfingers, persons using the trade of merchandise by way of bargaining, exchange, bartering, commission, consignment or otherwise, in gross or by retail, or by persons who, either for themselves, or as agents or factors for others, seek their living by buying and selling or buying and letting for hire goods or commodities, or by the manufacture, workmanship or the conversion of goods or commodities or trees.

137 Corporations Act)289, Corporations that are not financial institutions are normally liquidated under the BIA. Trusts and Partnerships are not subject to the WURA, although the trustee or partner may be. The liquidator of a company being wound-up under the WURA can also take advantage of the BIA proposal provisions if the entity is a Corporation of a type that could be subject to the BIA. 290 BIA Proposal. The purpose of the proposal provisions of the BIA is to allow the insolvent entity time to develop a plan for the continued operation of the business which involves the compromise of the existing claims of its creditors. The proposal provisions potentially apply to the same types of entities that the BIA bankruptcy provisions potentially apply to. CCAA. The purpose of the proposal provisions of the BIA and the arrangement provisions of the CCAA is to allow the insolvent entity time to develop a plan for the continued operation of the business which involves the compromise of the existing claims of its creditors. For larger corporations it is the preferred procedure over BIA proposal. It is also occasionally used to effect an orderly liquidation of an entity. The CCAA applies to corporations with aggregate claims against it of over 5 million CAD. Banks, insurance companies, railways and federal loan and trust corporations are expressly excluded from the application of the CCAA. Provincial loan and trust corporations are not expressly excluded, and there is some uncertainty as to whether the CCAA could apply to such entities. The CCAA applies to "income trusts" (including publicly traded mutual funds). An "income trust" is a trust that has assets in Canada and the units of which are traded on a prescribed stock exchange or a trust all of the units of which are held by an entity that trades on a prescribed stock exchange. A prescribed stock exchange is one that is regulated by an Act of Parliament or the legislature of a province. It is not clear whether the CCAA applies to trusts that are not income trusts. Its application to trusts is an open question. A corporate trustee in its capacity as trustee could become subject to the CCAA 291, but the CCAA is intended to apply to corporations. In any event, if the trustee is a financial institution it likely could 289 The Canada Business Corporations Act, R.S.C. 1985, c.c-44, s.3(3), specifically provides that corporations governed by it are not to be wound-up under the WURA. 290 BIA, s As occurred with respect to the restructuring of many of the issuer trusts of Canadian asset backed commercial paper market.

138 not be subject to the CCAA even if it sought to apply solely in its capacity as trustee and with respect to the assets held in trust. For the purpose of analyzing netting rights, parties should assume that the CCAA might apply to a trust, such as an Investment Fund, Trust or Pension Plan that does not have a Canadian trust company or individuals as trustees. CDIC Act Receivership or Restructuring. Prior to the involvement of Canada Deposit Insurance Corporation (CDIC), the Superintendent of Financial Institutions may take control of a deposit taking institution's assets. 292 After taking control, the Superintendent might also, as a further step, take over the management of the business and affairs of the institution. 293 The Superintendent is not given any extraordinary powers that could, in our view, allow him to alter the contractual arrangements of the financial institution. In certain circumstances, CDIC can obtain an order vesting the shares and subordinated debt of such institutions in it in order to attempt a sale of the institution, an amalgamation or any other transaction to restructure a substantial part of the institution's business. 294 The purpose of the CDIC Act reorganization provisions is to place CDIC in control of a federal deposit taking institution (namely banks and deposit taking federal loan and trust corporations) for the purpose of restructuring its affairs at a shareholder level. Under this regime, the rights of creditors are delayed in order to facilitate the restructuring, but are not compromised. A receivership with CDIC as receiver is also possible. An entity might also be restructured under the WURA. We have discussed the WURA under the liquidation heading and the CDIC Act under the restructuring heading. Court Administered Receivership. Generally, court administered receivership is an alternative regime to the BIA. Unlike the BIA and the WURA, no particular statute governs a court-administered receivership. In Ontario, a judge is given jurisdiction by provincial statute to appoint a receiver whenever it appears convenient to do so on whatever terms the judge determines to be appropriate. The receiver's function is to realize upon all of the assets of the debtor for the benefit of all creditors. Through the court order, the judge (most often upon the application of a major secured creditor) designs the procedure and rules for the particular receivership. The terms of such orders tend to be fairly standard, but are also constantly and gradually evolving. Recent amendments to the BIA 292 The statutory authority for the Superintendent's intervention depends upon the type of entity involved. The Bank Act (Canada), S.C. 1991, c.46, s.538 confers the authority with respect to banks. The Trust and Loan Companies Act (Canada), S.C. 1991, c.45, s.510 confers the authority with respect to federal trust or loan companies. 293 Bank Act, s.538; Trust and Loan Companies Act, s CDIC Act, s

139 provide for the appointment of a national receiver. Although there is no provincial law in Quebec with respect to the appointment of a receiver in the context of an insolvency, the BIA appointed receiver would have jurisdiction with respect to assets and entities located in Quebec. A national receiver is also appointed by court order and the terms of the order would be similar to the receiver appointed under provincial law. There is no restriction on the type of entity that could be subject to a receivership order. The Courts of Justice Act (Ontario) do not specify and, therefore, do not limit, the types of entities over which a judge has jurisdiction to appoint a receiver. As far as we are aware, there is no precedent supporting the jurisdiction of a judge to appoint a receiver of a financial institution. Liquidation under the WURA and now under the CDIC Act is a very similar proceeding to court administered receivership and, therefore, there is no need to resort to this procedure for such institutions. With respect to banks and other federal deposittaking institutions, the federal deposit insurer, CDIC, has the power to control the liquidation and it is highly unlikely that it would cede this power to a courtappointed receiver. Also, receiverships are typically orchestrated by a major secured creditor, which financial institutions do not have given that they do not grant blanket security to secured creditors. 295 Corporate Plan. Corporate Plans of Arrangement are governed by corporate statutes, such as the Canada Business Corporations Act and the Ontario Business Corporations Act (Corporate Plan). 296 A corporate plan procedure is relevant only to corporations that are governed by a corporations statute that provides for the plan of arrangement procedure. This would include most Canadian business corporations, but does not include banks, insurance companies and other federally incorporated financial institutions. The Corporate Plan proceeding is not an insolvency proceeding and is most often used outside of an insolvency context to restructure the equity and/ or debt securities of a corporation. This proceeding also involves voting on the plan by classes of security holders and court sanction following a fairness hearing. Notwithstanding that most business corporation statutes require the applicant corporation to be solvent, it has been employed where corporations are on the verge of insolvency or insolvent to restructure debt security holders. Rarely has this procedure affected other 295 The BIA now provides for the appointment of a national receiver under the BIA. In the past appointments were made under provincial law only. 296 These statutes apply regardless of the province in which the matter is being litigated. Each province has its own business corporation legislation, all of which provide for plans of arrangement and some of which expressly provide for the arrangement of creditors.

140 creditor classes, although a recent decision allowed it to be extended to term lenders. 297 PCSA. The PCSA is not an insolvency statute, but is overriding legislation that, in part, ensures the enforceability of termination and netting rights in agreements between financial institutions. 297 See the Abitibi case discussed in more detail in Question I.B.1 (Qualification 1).

141 APPENDIX E - DEFINITION OF ELIGIBLE FINANCIAL CONTRACT ELIGIBLE FINANCIAL CONTRACT REGULATIONS [BANKRUPTCY AND INSOLVENCY ACT/ CANADA DEPOSIT INSURANCE CORPORATION ACT/ PAYMENT CLEARING AND SETTLEMENT ACT/ WINDING UP AND RESTRUCTURING ACT/ COMPANIES' CREDITORS ARRANGEMENT ACT] 1. The following definitions apply in these Regulations. "derivatives agreement" means a financial agreement whose obligations are derived from, referenced to, or based on, one or more underlying reference items such as interest rates, indices, currencies, commodities, securities or other ownership interests, credit or guarantee obligations, debt securities, climatic variables, bandwidth, freight rates, emission rights, real property indices and inflation or other macroeconomic data and includes (a) a contract for differences or a swap, including a total return swap, price return swap, default swap or basis swap; (b) a futures agreement; (c) a cap, collar, floor or spread; (d) an option; and (e) a spot or forward (contrat derive). "financial intermediary" means (a) a clearing agency; or (b) a person, including a broker, bank or trust company, that in the ordinary course of business maintains securities accounts or futures accounts for others. (intermediaire financier). 2. The following kinds of financial agreements are prescribed for the purpose of the definition "eligible financial contract" in [refers to relevant section in relevant Act]: (a) a derivatives agreement, whether settled by payment or delivery, that (i) trades on a futures or options exchange or board, or other regulated market, or (ii) is the subject of recurrent dealings in the derivatives markets or in the over-the-counter securities or commodities markets; (b) an agreement to

142 (i) borrow or lend securities or commodities, including an agreement to transfer securities or commodities under which the borrower may repay the loan with other securities or commodities, cash or cash equivalents, (ii) clear or settle securities, futures, options or derivatives transactions, or (iii) act as a depository for securities; (c) a repurchase, reverse repurchase or buy-sellback agreement with respect to securities or commodities; (d) a margin loan in so far as it is in respect of a securities account or futures account maintained by a financial intermediary; (e) any combination of agreements referred to in any of paragraphs (a) to (d); (f) a master agreement in so far as it is in respect of an agreement referred to in any of paragraphs (a) to (e); (g) a master agreement in so far as it is in respect of a master agreement referred to in paragraph (f); (h) a guarantee of, or an indemnity or reimbursement obligation with respect to, the liabilities under an agreement referred to in any of paragraphs (a) to (g); and (i) an agreement relating to financial collateral, including any form of security or security interest in collateral and a title transfer credit support agreement, with respect to an agreement referred to in any of paragraphs (a) to (h).

143 APPENDIX F - PENSION ENTITY WINDING-UP Ontario Pension Benefits Act (Ontario PBA) There is nothing in the Ontario PBA that expressly imposes any stay on termination of contracts pursuant to their terms, or netting of transaction values or on liquidating credit support when a wind-up is commenced. Nor is there anything that expressly gives the regulator the power to impose any such requirement. If the regulator purported to exercise such a power, section 13 of the PCSA might provide a basis upon which to challenge his action. See the analysis of section 13 above. The trustees of the pension entity (or the entity itself if in corporate form) would be a "financial institution" or a "customer". However, there is uncertainty as to whether section 13 applies because of the fact that the pension statute is not strictly speaking an "insolvency" law. 298 In any event, we do not believe that the Ontario regulator would have any power to prevent a party from exercising its termination rights to the extent they are triggered and we believe any attempt to do so could be successfully challenged in our view simply on the basis that he does not have the statutory jurisdiction to take such action. Federal Pension Benefits Standards Act (Federal PBSA) There is nothing in the Federal PBSA that expressly imposes any stay on termination of contracts pursuant to their terms, or netting of transaction values or on liquidating collateral when a wind-up is commenced. Nor is there anything that expressly gives the regulator the power to impose any such requirement. The federal Superintendent of Financial Institutions (the pension regulator) does have wide remedial powers of a general nature. Section 11 of the Federal PBSA provides that the Superintendent can give directions to plan administrators "or any person" in respect of a pension plan who is about to commit an act or pursue a course of conduct that is contrary to safe and sound financial or business practices. The Superintendent can direct the person to refrain from committing the act or to perform a remedial act. We do not believe that this general power would give the Superintendent jurisdiction to order a party to a Transaction with the trustee/administrator of the plan to refrain from terminating its agreement There may also be constitutional limitations to applying the PCSA to a provincial winding-up process. 299 Given that the Superintendent of Financial Institutions is also the regulator that requires financial institutions to have robust termination and netting rights under such contracts, it would be surprising if it tried to undermine those same rights by attempting to use the section 11 power to prevent a third party institutions from exercising them.

144 Superintendent's directions to administrators 11. (1) If, in the opinion of the Superintendent, an administrator, an employer or any person is, in respect of a pension plan, committing or about to commit an act, or pursuing or about to pursue any course of conduct, that is contrary to safe and sound financial or business practices, the Superintendent may direct the administrator, employer or other person to (a) cease or refrain from committing the act or pursuing the course of conduct; and (b) perform such acts as in the opinion of the Superintendent are necessary to remedy the situation. Directions in the case of non-compliance (2) If, in the opinion of the Superintendent, a pension plan does not comply with this Act or the regulations or is not being administered in accordance with this Act, the regulations or the plan, the Superintendent may direct the administrator, the employer or any person to (a) cease or refrain from committing the act or pursuing the course of conduct that constitutes the noncompliance; and (b) perform such acts as in the opinion of the Superintendent are necessary to remedy the situation. Opportunity for representations (3) Subject to subsection (4), no direction shall be issued under subsection (1) or (2) unless the Superintendent gives the administrator, employer or other person a reasonable opportunity to make written representations. Temporary direction (4) If, in the opinion of the Superintendent, the length of time required for representations to be made under subsection (3) might be prejudicial to the interests of the members, former members or any other persons entitled to pension benefits or refunds under the pension plan, the Superintendent may make a temporary direction with respect to the matters referred to in subsection (1) or (2) that has effect for a period of not more than fifteen days. Continued effect (5) A temporary direction under subsection (4) continues to have effect after the expiry of the fifteen day period referred to in that subsection if no representations are made to the Superintendent within that period or, if representations have been made, the Superintendent notifies the administrator, employer or other person that the Superintendent is not satisfied that there are sufficient grounds for revoking the direction.

145 If the Superintendent purported to exercise a stay power with respect to the termination rights, section 13 of the PCSA might provide a basis upon which to challenge his action. As with Ontario PBA plans, there is uncertainty as to whether section 13 applies because of the fact that the Federal PBSA is not strictly an "insolvency" law. 300 In any event, do not believe that the Superintendent has any power to prevent a party from exercising its termination rights and we believe any attempt to do so could be successfully challenged in our view simply on the basis that he does not have the statutory jurisdiction to take such action. CPPIB and PSPIB The analysis with respect to the federal public sector plans (CPPIB and PSBIB) is somewhat different because of the fact that they cannot be wound up without an Act of Parliament. In light of the statutory immunity provisions it is somewhat odd that both pension entities are specifically defined as a "financial institution" for purposes of section 13 of the PCSA. If a court appointed a receiver to manage and reorganize an entity (as opposed to winding it up), this restructuring procedure may not be caught by the statutory immunities. However, receivership seems an unlikely possibility for these entities. We suspect that when they were included in the list of financial institutions in section 13, the legislators did not have the statutory immunities in mind. In any event, with respect to these entities there is a specific netting law, even though it may not ever come into play in practice. If the government were to pass legislation for the winding up it would have to specifically repeal the PCSA in so far as it applies to these entities or specifically override it. Given the statutory immunity from insolvency proceedings, there are no insolvency laws currently in place that could interfere with the enforceability of a termination right. CPPIB and PSPIB cannot be subject to an insolvency type proceeding unless Parliament takes the very significant step of passing legislation. 300 Although unlike the Ontario case, there is no constitutional impediment to the PCSA taking priority over the provincial regime.

146 Likelihood of Stay on Realization of Collateral APPENDIX G - INSOLVENCY PROCEEDING STAYS Length of Stay on Realization of Collateral (without statutory exemption) Likelihood of Stay on Set-off Statutory Exemption for Financial Collateral for Eligible Financial Contracts BIA Bankruptcy Unlikely for securities or cash collateral Up to 6 months No stay likely Yes BIA Proposal Automatic stay Up to 6 months plus possibility that plan may stay permanently (subject to new default ) or otherwise compromise rights No stay likely Yes WURA Unlikely for securities or cash collateral Up to 6 months (may be longer in restructuring proceedings) No stay Yes, subject to bridge institution provisions if preceded by CDIC Act receivership proceeding CCAA Automatic stay No limit; plus possibility that plan or court order may stay permanently (subject to new default) or otherwise compromise rights CDIC Automatic stay No limit; if proceeding is a liquidation, Superintendent may realize on secured party's behalf No stay (temporary only) Automatic stay Yes Yes, but subject to the bridge bank provisions Receivership Unlikely No limit Unlikely No, unless PCSA applies Corporate Plan Voluntary Wind-up Windup by pension regulator CPPIB, PSPIB and Bank of Canada Unlikely No limit Unlikely No No stay N/A No stay No No stay N/A No stay No unless PCSA applies No stay N/A No stay No

147 APPENDIX H - SUMMARY OF CONFLICT OF LAWS RULES Validity, Perfection and Priority of Security Interests Manner of Holding Characterization for PPSA/CCQ Purposes Governing Law - Validity of Security Interest Governing Law- Perfection/ Publication and Priority 301 Cash not held in a "securities account" Ont. Intangible; Que. Incorpreal Movable Property Place where debtor is located (Ont) or domiciled (Que) at time of attachment/creation Place where debtor is located (Ont) or domiciled (Que) at time of attachment/creation Cash held in a securities account where intermediary and account holder have not agreed that it is not a financial asset Investment Property Securities intermediary's jurisdiction at the time of attachment/ creation Securities intermediary's jurisdiction if perfecting by control Cash held in a securities account where intermediary and account holder have agreed that it is not a financial asset Intangible Place where debtor is located at time of attachment/ creation Place where debtor is located Directly held bearer or registered securities Investment Property (Ont.) Financial Assets (Que.) Place where certificate is located at time of attachment/ creation Place where certificate is located if perfecting by delivery or control Directly held uncertificated/ demateriali zed securities Investment Property (Ont.) Financial Assets (Que. Issuer's jurisdiction at time of attachment/creation Issuer's jurisdiction if perfecting by delivery or control Indirectly held securities Investment Property (Ont.) Financial Assets (Que.) Securities intermediary's jurisdiction at the time of attachment/ creation Securities intermediary's jurisdiction if perfecting by control Futures Contracts and Ont. Intangibles if Clearing Member is Ont. Intangible - see Intangible - see 301 This is always location/ domicile of debtor if means of perfection is registration.