учебный год 2023 / Haentjens, Between Property Law and Contract Law. The Case of Securities. The Future of European Property Law

Please note:

This paper was first published by Matthias Haentjens in The Future of European Property Law and should be cited as “Haentjens M. (2012), Between Property Law and Contract Law: the Case of Securities. In: Erp, S. van (Eds.) The Future of European Property Law: Sellier”. This version uploaded to SSRN is a working paper and should not be cited in publications. The article published in The Future of European Property Law should instead be referred to.

Abstract:

Grotius and Von Savigny made a strict distinction between property law interests and contract law interests. This distinction still influences current European law systems, both continental and Anglo-Saxon. The Draft Common

Frame of Reference (“DCFR”) also seems to build on the same distinction. Yet a harmonisation of the private law rules concerning securities transfers would necessarily have to include both contract law and property law. First, in the case of book-entry securities, the object of the transaction is hard to classify as either purely contractual, or proprietary in nature. This holds equally true for similar,

“modern” assets such as carbon credits, i.e. emission rights, and intellectual property rights. Second, specific rules of securities law notwithstanding, contractual and property law aspects of a transfer are virtually inseparable under the general private laws of most jurisdictions, including the DCFR. Thus, more generally, and as stated above, property law harmonisation must accompany contract law harmonisation – and vice-versa.

Keywords:

Securities; financial law; property law; contract law; Draft Common Frame of Reference; DCFR; harmonisation

Electronic copy available at: http://ssrn.com/abstract=2436906

To that end, I will provide an introduction on the type of assets referred to above, viz. book-entry securities, and to the transfer of these assets, so as to show that both as regards the object of a securities transaction, viz. book-entry securities themselves, and as regards the transaction and its consequences, property law and contract law – as traditionally understood – are intrinsically intertwined. I will conclude with some remarks on the desirability of securities law harmonisation.

But first, by way of introduction, let me refer to the Comments to Article VIII – 1:101(4)(a) DCFR, which explain why the DCFR provisions of book VIII on the transfer of ownership do not apply to company shares and, in short, certificated negotiable instruments. Pursuant to these comments, the said assets are not included in the categories of assets subject to book VIII DCFR on the following four grounds:

(i) company law has been kept out entirely, so that no provisions on the acquisition of shares should be given; (ii) negotiable instruments are governed by specific rules; (iii) negotiable instruments are ‘served by specific transfer means and effects’; and (iv) ‘some of these areas are subject to international harmonisation instruments’. These four grounds will be discussed in the following.

2. WHAT ARE BOOK-ENTRY SECURITIES?

2.1 Introduction

Traditionally, securities include shares, i.e. interests of investors in an issuer, and bonds, i.e. claims of investors against an issuer. The DCFR, nor this contribution concern the investor – issuer relationship, which relationship is governed by rules that are commonly labelled as company law. The DCFR and this contribution concern the relationships between investors and third parties, which are governed by rules that are commonly labelled as private law. I would submit that the private law rules relevant to securities are autonomous and should be addressed as such. Admittedly, company law rules may influence the relationships between investors and third parties, for instance where company law forbids or limits the transfer of certain securities. But, in the same vein, rules of public law may influence the transfer of securities, for instance when public law forbids the transfer of certain securities, and no one would argue that a private law act should not prescribe the rules for the acquisition of securities on the ground that the same act should not concern public law. It is unconvincing, therefore, that the DCFR does not address the acquisition and loss of certain categories of securities, viz. shares and certificated negotiable instruments, on the ground that such would belong to the realm of company law.

Book VIII DCFR does not apply to shares and certificated negotiable instruments, and neither does it apply to book-entry securities. Pursuant to the DCFR definition of 'goods', goods are corporeal movables. Book-entry securities, or, to be more precise, interests that are evidenced by a credit-entry in a securities account, do not qualify as goods, because these interests are not corporeal (which, under the DCFR, means 'having a physical existence in solid, liquid or gaseous form'). Consequently, Book VIII does not apply to book-entry securities, for Article VIII – 1:101 states that this Book (only) applies to goods. Book-entry securities may not be 'goods', but what are they?

Matthias Haentjens, Between Property Law and Contract Law: the Case of Securities

Whereas transferable shares are (at least) as old as 1602,5 the concept of securities being credited to an account is a relatively new phenomenon. It is only since 1968, that most securities world-wide are administered this way. Prior to 1968, but certainly prior to World War II, for each and every transaction, securities certificates had to be manually transported between banks (and brokers) holding those securities for their clients. When, in 1968, the New York financial system clogged up in and securities trades took months to settle, a multi-tiered securities custody system was implemented whereby all physical certificates are held with a central securities depository (“CSD”), major banks and brokers maintain securities accounts (on behalf of clients and themselves) with the CSD, and clients/investors maintain securities accounts with the banks.6

Consequently, securities ‘owned’ are held in a securities account with a bank or broker, and the bank or broker provides periodic statements of the securities account to evidence the entitlement. Acquisition and disposal of securities can happen only through (transfer orders given to) the relevant bank or broker, as a result of which the securities designated are credited and debited to the relevant securities account. In a very similar manner, cash accounts are administered.

All this seems to have little to do with property law. Accordingly, most legal systems classify the holding of a cash account as a contractual interest. The Comments to Article VIII-1:101 DCFR state, for instance, ‘Bank account money […] being a right against the bank and not a corporeal asset.’ Most legal systems, however, treat interests in book-entry securities as property law interests. This has the following background.7

2.2 Historical and current characterisations

The custody of securities was first regarded as depositum, as was the case with the earliest custody of money.8 This Roman law term characterises the situation in which the depositor has traceable property rights in individual deposited assets9 and meant

5Conventional wisdom has it that the earliest issue of shares, in 1602, by the United Netherlands Chartered East India Company (Vereenigde Nederlandsche Geoctroyeerde Oost-Indische Compagnie) marks the beginning of the securities trade. However, it has even been argued that a lively trade in corporate shares existed in ancient Rome; U. Malmendier, Roman Shares, in The Origins of Value, 31-42 (W.N. Goetzmann & K.G. Rouwenhorst eds., 2005).

6R.D. Guynn et al., Modernizing Securities Ownership, Transfer and Pledging Laws (1996), 21-24. This centralized system of securities custody was invented as a result of yet another crisis: prompted by the postWW1 crisis, the banks of Berlin used the Kassenverein, originally established in 1850 for money transfers, as a central securities depository for the processing of securities transfers and their monetary proceeds. See U. Drobnig, Dokumenteloser Effektenverkehr, in: Abschied vom Wertpapier? Dokumentloser Wertbewegungen im Effekten-, Gütertransportund Zahlungsverkehr (K. Kreuzer ed., 1988), 17 and cf. M. Haentjens, Harmonisation of Securities Law (2007), 32-35. The three-tiered custody structure described here, is a simplified example. In practice, many more intermediaries may be interposed between the CSD and the ultimate beneficial owner/investor. The legal principles, however, remain the same.

7The following paragraphs build on my book, Harmonisation of Securities Law (2007), 33 et seq. and 256 et seq.

8R.D. Guynn et al., Modernizing securities ownership transfer and pledging laws (1996), 20.

9J. Inst. 1.3.14.3. See also G.R. Rutgers, Monografieën Nieuw BW, B37 Bewaarneming (1996), 20 and 50, n.22, and 5 and the further reference provided therein. This is still a rule of law in both civil and common law jurisdictions as regards res mobilia, Christophe Bernasconi, The law applicable to dispositions of securities held

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in practice that the custodian had to register the numbers printed on each securities certificate held for each individual investor. However, this practice involved increasingly burdensome administrative costs as the volume of securities in smaller denominations increased enormously, and eventually led to, inter alia, the 1968 paper crash referred to above.10

Many legal systems therefore replaced depositum by so-called depositum irregulare, which refers to a mixture of the Roman law concept of mutuum (loan)11 and the concept depositum just mentioned. Depositum irregulare means that through depositing securities, investors acquire a right against their custodian of the delivery of the same amount of securities of the same kind, since the individuality of the deposited assets is lost as they are held in one single pool (fungible custody).12 Thus, the custody of securities on a fungible basis is a direct result of the fact that custodians no longer administer individual securities for individual clients, but maintain pools in which all securities to which the custodian’s clients are entitled may be found.

In most legal systems however, such a commingling of securities implies the loss of ownership, which could leave the investor with a mere contractual claim against his custodian, and provide little or no protection in the case of the custodian’s insolvency.13 Different, sometimes statutory solutions have therefore been developed to deal with this problem.14 The principal distinction between the solutions contemporarily chosen is between jurisdictions that confer investors with some kind of co-property interest in their securities and still regard securities as tangible movables, and jurisdictions that have developed other views.

Co-property interests are known in civil law jurisdictions such as Germany, Spain and the Netherlands, where it is based on the Depotgesetz, the Ley del Mercado de Valores and the Wet giraal effectenverkeer, respectively. Fungible custody in Belgium and Luxembourg is based on Koninklijk Besluit (Royal Decree) no. 62 and several Règlements grand-ducal (Grand-ducal Decrees) respectively, which establish coownership in notional pools of securities.15

through indirect holding systems (November 2000) (Preliminary Document no. 1 to the Hague Conference on Private International Law), available at www.hcch.net.

10Cf. e.g. the Explanatory Notes to the Dutch Wet Giraal Effectenverkeer 1976 (Securities Giro Transfer and Administration Act, ‘Wge’): TK 1975-1976, 13 780, no. 3, 12.

11See G. Inst. 3.90 and J. Inst. 3.14 on mutuum. Cf. also article 1932 of the French Code Civil (Civil Code).

12Cf. the BIS-Glossary definition of fungibility: “a concept that characterises the method of holding securities by a or other financial intermediary in which each of a number of issues of physical or dematerialised securities are held in separate fungible pools. No owner has the right to any particular physical or dematerialised security in a particular pool, but has a right to such an amount of physical or dematerialised securities as shown in its account with a CSD or other financial intermediary.” On the precise legal meaning of fungibility in the case of securities however, there is little consensus; see e.g. Annexe VIII.11 (A. Ghozi) to the CNCT 1997 Report, 188 and R. Goode, Contract and Commercial Law: the Logic and Limits of Harmonisation, ius commune lectures on European Private Law, 2003, 211.

13Although in some jurisdictions this can be prevented contractually; R. Goode, The nature and transfer of rights

in dematerialised and immobilised securities, 4 Journal of International banking and financial law (1996), 167176.

14The following categorisation is largely based on Bernasconi (2000), loc. cit., 20 et seq.

15Of 17 February 1971, of 8 June 1994, of 7 June 1996, of 16 August 2000 and a statute of 3 September 1996. See also the EU Clearing and Settlement Legal Certainty Group Questionnaire ('EU Questionnaire') (2007), 130, available at http://ec.europa.eu/internal_market/financial-markets/clearing/certainty_en.htm.

Matthias Haentjens, Between Property Law and Contract Law: the Case of Securities

Although the precise classification of investors’ interests in securities is unclear under

French law, it is undisputed that investors do not have a co-ownership right in pools of securities. Under UK and US law on the other hand, investors enjoy a bundle of rights in rem as well as in personam against their intermediary. In the UK, accountholders’ contractual rights follow from their contract with the custodian, while their property law rights classify as co-ownership rights, which may follow from the concept of trust.16 In the US, the Uniform Commercial Code (‘UCC’) Article 8 provides investors with proprietary and contractual rights in respect of the securities to which they are entitled. Italian and Brazilian law present yet a different solution, by a legal fiction that regards custody on a fungible basis as depositum, i.e. the administration of individual assets per individual client.

2.3 Both property law and contract law interests

Although none of the national systems above classify accountholder interests as solely contractual in nature, it follows from the above that no international consensus exists on what the dogmatic nature, or legal classification of accountholders’ rights would be.17 General consensus does seem to exist, on the other hand, on what the effects of a credit in a securities account should be; from an accountholder’s perspective, these effects include the right to dispose of and to vest security interests in his securities, the right to enjoy the ‘fruits’ (i.e. dividends etc.) and the exercise of corporate actions attached to his securities, as well as the right to revendicate and retrieve his assets.

These rights are all elements of the traditional concept of ownership in European jurisdictions18 and it has therefore been argued that investors’ entitlements should be classified as constructions of (co-)ownership. In this view, accountholder entitlements that are contractual and not proprietary in nature provide less investor protection, also because, contrary to contractual interests, a proprietary entitlement may be asserted erga omnes.19

Yet investor protection may be ensured by other means than a traditional property right. A contractual right with an absolute priority or a statutory obligation of an insolvent intermediary’s liquidator such as provided for under French law20 for instance, guarantee the protection of investors’ interests in an intermediary insolvency. A prohibition for intermediaries to dispose of accountholders’ assets (without proper authorisation) would further contribute to that protection. With such rules, a contractual regime protects accountholder interests in a way that is similar to any proprietary regime, especially because a proprietary entitlement can normally, i.e. outside of intermediary insolvency situations, only be enforced against the immediate intermediary.

Moreover, an accountholder’s right of ownership with regard to his book-entry securities is not as absolute as a typical ius in rem would be. Other than an owner of

16See EU Questionnaire (2007), 143-144.

17See, e.g., Legal Certainty Group Advice (2006), 4.

18Cf. Article VIII – 1:202 DCFR.

19Than in R.D. Guynn et al., Modernizing securities ownership, transfer and pledging laws, (1996) (1996), 76.

Cf. S.L. Schwarcz, Indirectly Held Securities and Intermediary Risk, 2 Uniform Law review (2001), 295 et seq. 20 Article L. 431-6 C. mon. fin.

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corporeal assets who is – in principle – free to use and dispose of his assets as he pleases, an accountholder is dependent on his bank or broker should he wish to use or dispose of his securities. Additionally, other than in the case of corporeal assets, “possession” of book-entry securities is not possible in most legal systems, as under all European systems, possession is only possible of corporeal assets.21

Under Belgian law, for instance, accountholders enjoy a right of co-ownership with respect to the securities that their securities accounts refer to. This co-ownership right, however, may be enforced only against an accountholder’s immediate intermediary and is effective erga omnes solely in the instance of the immediate intermediary’s insolvency. In Dutch law, accountholders’ co-ownership rights are also not enforceable erga omnes. Moreover, they also differ in other aspects from the private law rules on co-ownership. In other countries, the distinction between a contractual and a proprietary interest has become so fuzzy where it concerns accountholder entitlements that authors disagree vehemently as to the correct classification. In

France, for instance, accountholders’ rights can be asserted against third parties, but the intangible character of dematerialised securities, the object of these rights, does not allow classification as a right in rem.

Because of these (and other) difficulties, the drafters of the 1994 US UCC reform decided to refrain from a property or contract law classification and to introduce the concept of ‘securities entitlement’. This sui generis concept was considered to refer most adequately to the fundamentally hybrid character of accountholder interests. UK law, where the dogmatic background is not undisputed, yields a similar result.22

2.4 Securities and the DCFR

In conclusion, an entitlement to book-entry securities has some property law aspects (such as a revendication right, for instance), but certainly also lacks typical property law characteristics (such as the possibility of possession, and to dispose without dependency on a third party).23 Possibly for this reason, the DCFR does not follow a clear course as regards (interests in) securities that are evidenced by book-entry in a securities account. On the one hand, book-entry securities are classified as

21See, e.g., Notes I.1 to Article VIII – 1:205 DCFR.

22See EU Questionnaire (2007), 143.

23As a consequence, the harmonisation initiatives that have already been initiated in this regard, viz. the Geneva

Securities Convention, the Hague Conference and the Legal Certainty Group, considered a functional approach the best course to take. In such an approach, legislation refrains from prescribing any legal classification. Although characterisation plays an important role in the private international law of many jurisdictions, the Hague Securities Convention avoids all substantive classifications and provides a conflict of laws rule that expressly caters for accountholder interests of both a purely contractual and proprietary nature. See M. Haentjens, The law applicable to indirectly held securities (2006), 97-98. The UNIDROIT instrument neither requires its participating states to characterise accountholder interests nor to implement a specific legal construct, but focuses on the effects of a credit entry and provides minimum standards with regard to these effects. In first instance, however, UNIDROIT considered the introduction of a ‘securities entitlement’ concept; see

P. Paech, Harmonising Substantive Rules for the Use of Securities held with Intermediaries as Collateral: the UNIDROIT Project, 4 Uniform law review (2002), 1160. The Legal Certainty Group ultimately copied this approach, although some members of the group expressed their strong disagreement with the position. Legal Certainty Group Advice, 3-4 and Annex to the advice of the Group (July 2006), 11-12 (Italian contribution). See also the earlier draft of the group’s advice (‘LCG Draft Advice’), 10-11, where the group considered advising the introduction of a new name for the package of accountholder rights.

Matthias Haentjens, Between Property Law and Contract Law: the Case of Securities

‘incorporeal property’ (see above, para. 2.1.2).24 Consequently, under the DCFR (unlike many jurisdictions, such as France), book-entry securities can be ‘owned’, since pursuant to the DCFR definition of ‘Property’, incorporeal assets can be owned.

Perhaps for that reason, the drafters of the DCFR have expressly included securities where the DCFR concerns rules on sale (albeit with ‘appropriate adaptations’).25 For instance, Article IV.A – 1:202 DCFR prescribes that a seller must transfer ownership to the buyer.

Moreover, securities are included in the scope of Book IX DCFR on security interests, as Book IX applies to moveable property, and incorporeal property is included in the

DCFR definition of ‘movables’.26 Book IX distinguishes between ‘financial instruments’ or ‘financial assets’ and physical securities, defined as ‘negotiable instruments and documents’ and ‘certificated shares and bonds’. For instance, pursuant to Section IX – 3:204 DCFR, security rights in book-entry securities are made effective (against third parties) by ‘control’.27

On the other hand, however, under the DCFR (as under most jurisdictions), bookentry securities cannot be ‘possessed’.28 Moreover, securities are excluded from the scope of book VIII DCFR, although this book concerns the acquisition and loss of ownership (and book-entry securities can be 'owned' under the DCFR).29 Unfortunately, no reasons for this choice are given, so that one can only guess at the drafters' motives. They might be driven by the hybrid nature of book-entry securities and the interests therein.

3. HOW ARE BOOK-ENTRY SECURITIES TRANSFERRED?

3.1 Introduction

As stated above, the DCFR does not address the acquisition and loss of ownership of book-entry securities, nor of company shares and certificated negotiable instruments, inter alia on the grounds that the latter types of assets are governed by specific rules and that these assets are ‘served by specific transfer means and effects’. It follows from the preceding paragraphs in which the hybrid nature of book-entry securities has been explained, that a transfer of book-entry securities is not a traditional, property law transfer of corporeal assets. But are book-entry securities governed by specific rules and ‘served by specific transfer means and effects’?

24See Article IV.A – 1:101(2)(b) and (c) DCFR. Interestingly, no distinction is made here between certificated securities and book-entry securities, whereas the DCFR does distinguish between physical money, i.e. banknotes and coins, and bank account money. See, e.g., Comments F (Money) to Article VIII – 1:101.

25See also, e.g., Article IV.A – 1:101(2)(b). We must therefore understand Article IV.A – 1:202 DCFR where it reads “the seller, undertakes to another party, the buyer, to transfer the ownership of the goods” so as to mean “the seller, undertakes to another party, the buyer, to transfer the ownership of the incorporeal assets," where it regards book-entry securities.

26Article IX – 1:101. See also, e.g. Article IX – 1:201(7) and IX – 3:204.

27Following the UCC as an example, pursuant to Article IX – 3:204(2) DCFR, ‘control’ is effectuated by instruction to the financial institution maintaining the relevant securities account, by book-entry into a special account, or if the secured creditor is the financial institution just mentioned. If control has been established, the security right so vested takes ‘super-priority’ over all other security rights, even if the latter have been vested earlier; Article IX 4:102 DCFR.

28See, e.g., Comment to Article IX – 2:111 DCFR and Comment B to Article IX - 2:302 DCFR.

29Article VIII – 1:101(4)(a) DCFR.

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First, this question demands a further investigation of how book-entry securities are transferred in practice. To establish a transfer of book-entry securities, both transferor and transferee usually give a transfer order to their respective banks to dispose of and to acquire, respectively, certain designated securities. In a simplified fact pattern, a transaction is subsequently concluded on a market by representatives of the banks. Finally, the securities account of the transferor is debited and the account of the transferee is credited. Transferor and transferee commonly are unaware of each other’s identity and between the respective debit and credit entries usually lie – at least

– three business days.

3.2 Governed by specific rules?

A securities transfer as just described seems fully contractual in nature: it is initiated by a transfer order, services are subsequently carried out which result in an agreement of sale, and in conclusion of the transactions, the interests of the transferor are extinguished by means of a debit-entry, while the rights of the transferee are created by means of a credit entry. In short, a transfer of securities by book-entry closely resembles a bank money transfer. Most legal systems acknowledge that a bank money transfer does not classify as an assignment of a claim (against the bank).30 But many legal systems classify a securities transfer as a transfer of ownership of the securities in question from transferor to transferee.

Under German and Dutch law for instance, a book-entry securities transfer is generally classified as a (property law) transfer of the book-entry securities, i.e. a transfer of the (co-)ownership right in the securities.31 In many jurisdictions, including France, the Netherlands and the UK, however, it has been argued that a closer analysis of, especially, a securities transfer between clients of different account providers shows that the transferee does not acquire the very same (accountholder) interest which the transferor had, but obtains a new interest against his own account provider.32 Thus, a securities transfer by book-entry would involve the cancellation of the transferor’s interests and the subsequent creation of corresponding interests in the transferee’s name, and could therefore be classified as a novation, rather than as a transfer.

Yet the classification as a novation is not generally accepted, so that most legal systems apply property law principles of general private law on transfers, as if a book-entry securities transfer would concern a transfer of (certain interests in) assets (rather than novation). These principles include, first, the property law principle that a transferee can only acquire what his transferor has to transfer (nemo dat quod non habet). This principle is also applied in the DCFR.33 As a result of this principle, transferees that

30But cf. Article III – 5:101(2) DCFR. It is not entirely clear, however, whether this provision includes securities transfers by book-entry, which are necessarily subjected to the requirement that creditand debit entries have taken place.

31See, e.g., J. Benjamin, Interests in securities, a proprietary law analysis of the international securities markets

(2000), 155, n. 38, R. Goode, Legal problems of credit and security (3d ed. 2003), 215, n. 40, J.H. Dalhuisen & L.D. Van Setten (2003), Zekerheid in roerende zaken en rechten (2003), 124, M. Haentjens, Privaatrechtelijke aspecten van giraal effectenverkeer, 6582 Weekblad voor Privaatrecht, Notariaat en registratie, 472-481 (2004), 478481, B.F.L.M. Schim (2006), Giraal effectenverkeer en goederenrecht (2006), 133 et seq.

32EU Questionnaire (2007), 165-171.

33Article VIII – 2:101(1)(c) DCFR, Comments H(c) to the same, and Comments (A) to Article VIII – 3:101.