Property and Contract: Toward a Clearer Understanding of the Hague Convention on the Law Applicable to

Certain Rights in Respect of Securities

Prof. James S. Rogers

© 2004 James Steven Rogers. All rights reserved.

Illinois Inc.

DTC

New YorkBank

EuropeanICSD

(Belgium)

French Bank

AustralianInvestor

What we “know” in writinghypothetical scenarios

Common Hypothetical Holding Pattern

Illinois Inc.

DTC

New YorkBank

EuropeanICSD

(Belgium)

French Bank

AustralianInvestor

What Australian Investor actually knows

Common Hypothetical Holding Pattern

“Page 37” Problem

SecuritiesDepository(Ruritania)

AtlantisFirm

BatavianFirm

SellerAtlantis

BuyerBatavia

Hague Convention analysis:Law of “Securities Intermediary’s Jurisdiction” Governs

Seller-Atlantis Firm — Atlantis LawAtlantis Firm-Sec Depository — Ruritanian LawSec Depository-Batavian Firm — Ruritanian LawBatavian Firm-Buyer — Batavian Law

International Sales Transaction

Global Trading Co.(Ruritania)

ExporterAtlantis

ImporterBatavian

ManufacturerAtlantis

BuyerBatavia

Same tractorNot same “transaction”

Hague Conv.

NOT covered by Hague Conv.

Legal Issues in Securities Transactions

Betty buys 1000 shares Acme through her Firm

“Trade”• “Execution” of tradeMeans only that Betty’s Firm (commonly as agent for undisclosed principal, Betty) has entered into a contract for purchase of securities.• Contract issues between Betty and Firm• Regulatory issues affecting relationship between Betty and Firm

“Settlement”•Three aspects of “the transaction”

• Contract for exchange of securities and money• Payment of the money• Delivery of the securities

Contract vs Performance—Ordinary Goods

Owner(Carolia)

X(Batavia)

Owner sues Buyer to recover coalConflict of Laws IssuesMaybe Batavian lawMaybe Carolian LawNOT law governing Contract for sale of coal

between Seller and Buyer

SellerAtlantis

BuyerBatavia

Contract for sale of coal

Contract vs Performance— Securities Transaction settled by delivery of physical bearer certificate

Owner(Carolia)

X(Batavia)

Owner sues Buyer to recover securitiesConflict of Laws IssuesMaybe Batavian lawMaybe Carolian LawNOT law governing Contract for sale of securities between Seller and Buyer

SellerAtlantis

BuyerBatavia

Contract for sale of securities

“Page 37” Problem--RevisitedSecuritiesDepository(Ruritania)

AtlantisFirm

BatavianFirm

SellerAtlantis

BuyerBatavia

Hague Convention AnalysisHague Convention applies ONLY to “property” issues in

performance of contracts for sale of securitiesFor Hague Convention purposes THERE REALLY IS NO

“transaction” between Seller and BuyerRather, for Hague Convention purposes, the “transaction”

depends on how the sales contract(s) is(are) PERFORMED

Contract Issues in Securities TransactionsThe Illusory Simplicity of Hypotheticals

SecuritiesDepository(Ruritania)

AtlantisFirm

BatavianFirm

SellerAtlantis

BuyerBatavia

What does Seller Know?

Contract Issues in Securities TransactionsThe Illusory Simplicity of Hypotheticals

SecuritiesDepository(Ruritania)

AtlantisFirm

BatavianFirm

SellerAtlantis

BuyerBatavia

What does Buyer Know?

Contract Issues in Securities Transactions“Dealer Trade”

Firms are acting as Dealers (principals)There IS NO contract between Seller and BuyerThere are three entirely separate contracts

1. Seller – Atlantis Firm2. Atlantis Firm – Batavian Firm3. Batavian Firm – Buyer

SecuritiesDepository(Ruritania)

AtlantisFirm

BatavianFirm

SellerAtlantis

BuyerBatavia

Firms are acting as Brokers (agents for undisclosed principals)

What law governs the contract issues?Seller – Atlantis Firm (rights arising out of transaction in which

Atlantis Firm acted as agent for Seller)

Batavian Firm – Buyer (rights arising out of transaction in which Batavian Firm acted as agent for Buyer)

Atlantis Firm – Batavian Firm (rights arising out of transaction in which Atlantis Firm contracted with Batavian Firm)

Contract Issues in Securities Transactions“Broker Trade”

SecuritiesDepository(Ruritania)

AtlantisFirm

BatavianFirm

SellerAtlantis

BuyerBatavia

Firms are acting as Brokers (agents for undisclosed principals)

Contract Issues in Securities Transactions“Broker Trade”

SecuritiesDepository(Ruritania)

AtlantisFirm

BatavianFirm

SellerAtlantis

BuyerBatavia

Atlantis LawSeller – Atlantis Firm (rights arising out of transaction in which Atlantis Firm acted as agent for Seller)

What law governs the issues that might actually arise?

Firms are acting as Brokers (agents for undisclosed principals)

Contract Issues in Securities Transactions“Broker Trade”

SecuritiesDepository(Ruritania)

AtlantisFirm

BatavianBroker

SellerAtlantis

BuyerBatavia

Batavian LawBatavian Firm – Buyer (rights arising out of transaction in which Batavian Firm acted as agent for Buyer)

What law governs the issues that might actually arise?

Firms are acting as Brokers (agents for undisclosed principals)

Contract Issues in Securities Transactions“Broker Trade”

AtlantisFirm

BatavianFirm

SellerAtlantis

BuyerBatavia

Atlantis Law

Atlantis Firm – Batavian Firm (rights arising out of transaction in which Atlantis Firm contracted with Batavian Firm)

What law governs the issues that might actually arise?

Trade made on Atlantis Exchange

AtlantisExchange

BatavianExchangeErehwon

Exchange

Trade made on Erehwon Exchange

Trade made on Batavian Exchange Batavian Law

Erehwon Law

Which law determines whether Buyer gets good titleCould it be law that would govern a hypothetical contract

between Seller and Buyer?Remember– Buyer DOES NOT KNOW who Seller is

Property Issues in Securities Transactions

SecuritiesDepository(Ruritania)

AtlantisFirm

BatavianFirm

SellerAtlantis

BuyerBatavia

Hague Convention RuleWhether anyone can assert adverse claim against Buyer

is determined by law governing Batavian Firm-Buyersecurities account

That’s the ONLY law that is knowable to Buyer

Issue is not just access to information

Property Issues in Securities Transactions

SecuritiesDepository(Ruritania)

AtlantisFirm

BatavianFirm

SellerAtlantis

BuyerBatavia

In simplified hypothetical world, we assume that certain securities move through the settlement system from Seller to Buyer

Property Issues in Securities Transactions

SecuritiesDepository(Ruritania)

AtlantisFirm

BatavianFirm

SellerAtlantis

BuyerBatavia

Suppose trade made on Ruritanian Exchange and Exchange Rules says securities firms settle on net basis

Seller may deliver to Atlantis Firm

Atlantis Firm makes Net Delivery to Batavian FirmBatavian Firm may deliver to Buyer

Property Issues in Securities Transactions

SecuritiesDepository(Ruritania)

AtlantisFirm

BatavianFirm

SellerAtlantis

BuyerBatavia

Suppose trade made on Ruritanian Exchange and Exchange Rules says securities firms settle on net basisSuppose that in the aggregate all trades by Atlantis Firm and Batavian Firm add up, so there is no NET deliver or receive obligation

How could the shares Buyer got have come from Seller??

Property Issues in Securities Transactions

SecuritiesDepository(Ruritania)

AtlantisFirm

BatavianFirm

SellerAtlantis

BuyerBatavia

Suppose trade made on Ruritanian Exchange and Exchange Rules says securities firms settle on net basisSuppose that in the aggregate Atlantis Firm RECEIVES and Batavian Firm DELIVERS

How could the shares Buyer got have come from Seller??

Contract vs Property Issues in Securities Transactions

ErehwonSecuritiesDepository

AtlantisFirm

BatavianFirm

SellerAtlantis

BuyerBatavia

RuritanianExchange

There’s no reason to assume that the Exchange through which the contract is formed and the Depository through which the contract is performed need be governed by the same law

Suppose Atlantis Firm and Batavian Firm enter into the contract through the facilities of the Ruritanian Stock Exchange

BUT suppose that the rules of the Ruritanian Stock Exchange permit (or require) contracts made on that exchange to be SETTLED through the Erehwon Securities Depository

Property Issues in Pledge Transactions

BatavianBank

BorrowerAtlantis

LenderBatavia

Suppose Batavian Lender agrees to lend to Atlantis Borrower, provided that a certain quantity of securities are deposited in a pledge account that Batavian Lender establishes with Batavian Bank

Pledge Agreement

Pledge account

Atlantis Borrower might cause securities to move to the pledge account at Batavian Bank from various sources

AtlantisFirm

CaroliaFirm

ErehwonFirm

From Borrower’s account at Atlantis Firm

From Borrower’s account at Carolia Firm

From Borrower’s account at Erehwon Firm

Property Issues in Pledge Transactions

BatavianBank

BorrowerAtlantis

LenderBataviaPledge Agreement

Pledge account

AtlantisFirm

CaroliaFirm

ErewhonFirm

What does Batavian Lender need to know to do the deal?

Hague Convention accomplishes the objective of having a single lawThe law governing pledgee’s rights is determined byLAW GOVERNING LENDER’S ACCOUNT WITH BATAVIAN BANK