SIFMA Files Amicus Brief Supporting a Tri-Party Custodian (with McDonnell Comment)

In a case involving the ability of a secured creditor to impose obligations on a custodian, SIFMA filed an amicus curiae brief with the Fourth Circuit Court of Appeals urging affirmation of a decision issued by the U.S. District Court for the District of Maryland. The District Court dismissed an action brought by Forest Capital LLC against BlackRock, Inc. related to BlackRock's actions as custodian of assets for People's Power & Gas LLC ("PP&G").

Forest Capital sued BlackRock for releasing funds to PP&G after PP&G instructed BlackRock to make all future payments to Forest Capital. BlackRock released the funds to PP&G in accordance with a tri-party custodial agreement among BlackRock, PP&G and ISO New England Inc. (a secured party).

The implications are significant for custodians and for secured creditors. At stake is the ability of a secured creditor to impose obligations on a custodian (technically a "securities intermediary") by instructing the custodian to release collateral only to the secured creditor. The Commercial Finance Association has filed an amicus brief supporting the position taken by Forest Capital, while SIFMA has filed an amicus brief in support of BlackRock's position.

SIFMA's argument centers around whether a custodian maintaining a securities account has obligations under Section 9-406 of the Uniform Commercial Code ("UCC"). Section 9-406 (Discharge of Debtor) allows a secured creditor to notify an "account debtor" of the assignment of any payments owed in connection with an "account, chattel paper, or a payment intangible." Once the account debtor has been notified of the assignment, it must direct future payments to the secured creditor, not to the party originally entitled to the payments. It is BlackRock's failure to direct payments to Forest Capital that forms the basis for the lawsuit.

However, Forest Capital's claim only has merit if BlackRock was an "account debtor" and the relevant payments were made in connection with an "account, chattel paper, or a payment intangible." It is undisputed that a securities account is not an "account, chattel paper, or a payment intangible" under the UCC. Moreover, although Forest Capital has not acknowledged that the account maintained by BlackRock for PP&G was a securities account, it does not seriously dispute this characterization. Instead, Forest Capital argues that a securities account is distinguishable from the custodian's obligation to release funds from a securities account. The former is (by definition) not a payment intangible and cannot give rise to obligations under Section 9-406. The latter, Forest Capital argues, is a payment intangible, and so when a custodian releases funds from a securities account, it is subject to Section 9-406.

SIFMA argues that this distinction is unsupported by the language of the UCC and is contrary to the framework established by the UCC for holding property in a securities account. In effect, the interpretation urged by Forest Capital would graft the requirements applicable to payment intangibles onto many other forms of collateral. SIFMA argues that applying the requirements of Section 9-406 to securities custodians would frustrate the expectations of market participants and would make custodial services much riskier and more labor-intensive to provide, which would in turn make custodial services more expensive to obtain.