What Is an Account Control Agreement?
Each day, we conduct transactions and activities that impact on our bank accounts. From the funds we deposit and withdraw, to how we write checks and pay bills, how we manage funds has a significant impact on the involved financial institutions. One unilateral, business-oriented function over which a financial institution can exercise a level of control over a party’s accounts is the Control Agreement. A Control Agreement is a binding tri-partate agreement with a party holding a Deposit or Deposit Account. The Depositor ("Pledgor") pledges its account assets to the Secured Party for a secured loan or advance . The Account Bank agrees to share its notices and information regarding the pledged accounts with the Secured Party. The Control Agreement will designate or describe the collateralized accounts, specify the amount of the advance or collateralized loans, and establish the procedures for the institution to follow upon the obligation or loan becoming due. Such agreements can be used to secure single loans or continuing credit arrangements and are suitable for use with deposit accounts, money market accounts, passbook accounts and certificates of deposit, among others.
Essential Features of Account Control Agreements
There are three parties to an account control agreement:
- the "Depositor" or "Customer", generally the owner of the Lock Box Account;
- the "Secured Party", generally a bank or financial institution; and
- the "Depository Bank", the bank in which the Lock Box Account is maintained.
The customer owns the account at the depository bank. The customer authorizes the depository bank to follow any and all instructions concerning the account, without requiring the depository bank to examine the terms of any instrument or agreement, or requiring the depository bank to examine the validity of any instructions. No other person or entity has authority to initiate or direct transfers with respect to the account. The customer acknowledges and allows that any agreement previously executed that pertains to the account is terminated without further obligation or liability of the customer to the other parties. The customer agrees not to revoke or modify the agreement without the written consent of the lenders. The owner’s signature must be notarized or executed by an authorized officer of the owner.
The Secured Party must have a security interest in the account and be the bank’s customer for purposes of the UCC. The Secured Party generally notifies the depository bank that the Secured Party has a security interest in the account and encloses a copy of the security agreement that demonstrates the security interest. The security agreement states that the customer has granted a security interest in the account to the Secured Party and that the deposit bank will comply and give instructions to the secured party upon demand by the secured party. The security agreement gives the secured party control over the account.
Different Types of Account Control Agreements
Many banks make some version of the "Form NCA" available for their customers. The Form NCA typically has blanks to be filled in, but is otherwise in substantially the same form used by the bank for all of its customers. Larger banks and particularly those affiliated with larger financial institutions may have their own forms of account control agreement. Sometimes the bank will provide a form of account control agreement for securities accounts based on the idea that agreements for securities accounts require different provisions than agreements for cash accounts.
One generalized division that is often useful for describing account control agreements is that between "partial control" account control agreements and "complete control" account control agreements. In a "partial control" account control agreement, the secured party must deliver an instruction to the bank in order to obtain access to the account. This instruction is sometimes called a "control instruction," "standby order," "security instructions," or "security order". At some point after delivery of an instruction, in most circumstances set forth in the account control agreement itself, the bank must either honor the written instruction or refuse the instruction and terminate the convenience. In a "complete control" account control agreement, on the other hand, the account holder agrees that the bank is exonerated from liability in advance for acting pursuant to a written instruction delivered to the bank by the secured party; and the bank is required by the control agreement to act without requiring a further instruction from the secured party.
How Do Account Control Agreements Function?
Account Control Agreements ("ACAs") are used by financial institutions to perfect their security interests in deposit accounts. However, even more important is how the ACA works to direct what occurs with the funds in the deposit account; who may withdraw the money; whether interest is paid on the account; whether certain individuals have signing authority over the account; and whether the financial institution must communicate with the parties with an interest in the account before interacting with the account.
An ACA creates a tripartite relationship between the financial institution, the debtor and the secured party. The secured party will request that the financial institution sign an agreement that is, essentially, a notice of security interest in the deposit account being held by the financial institution. The secured party (the secured party should be the lender, although it is not uncommon for the secured party to be a third party) will obtain the signature of the debtor on the ACA and send it to the financial institution along with a request that the financial institution sign. [Note: It is important that the debtor sign the ACA, so that they can be deemed to consent to the bank’s reclassification of the debtor’s deposit account as a "security entitlement"]. The financial institution will then sign the ACA and any funds currently in the deposit account will be subject to this tripartite relationship.
In situations where the ACA has been signed and funds are already in the deposit account, the tripartite relationship demonstrates that, unless the parties to the ACA consent, the financial institution may only allow withdrawals from the account as directed by both the debtor and secured party. When the funds are in the account at the time the ACA is executed, the tripartite relationship works to direct the application of interest payments to the deposit account or secure party. Further, as long as the parties to the ACA continue to agree on how the funds are allocated, the ACA will remain unchanged.
If the ACA becomes operational because the parties are now acquiring trade payables by financial institution credit, the tripartite relationship will ensure the payment of interest on funds directed by the parties to the secured party and the financial institution. The tripartite relationship between the financial institution and the secured party, whether through a security interest, collateral assignment or otherwise, will ensure the priority of a creditor’s interest over other creditors of the debtor. Whether the funds are held in the account at the execution of the ACA or added after the physical execution of the ACA, the funding timeline will determine when and where the funds will go.
The Advantages of Implementing Account Control Agreements
The use of Account Control Agreements ("ACA") can provide significant benefits to a lender or borrower. The ability of a lender to access funds, invest in investments or pay down debt may be enhanced by the lender’s ability to control deposits. Such access contributes to greater overall liquidity for a borrower. For example, in the event an agent lender is considering a liquidation, the ability to access funds from accounts to which it has been granted control may enhance overall value. Account Control Agreements can also be beneficial to a borrower, including cases where advanced notice of the exercise of control may trigger obligations to third parties under a line of credit agreement .
Without an Account Control Agreement, deposit accounts may be subject to claims of the account borrower’s creditors (sometimes even if both the borrower and the depositor are the same party), subject to enforcement of attachment proceedings or execution based on a final judgment. Even if a lender has a security interest in a deposit account and perfected it, actions of the deposit account borrower such as a closing of such a deposit account could significantly impair the ability of a lender.
The presence of an Account Control Agreement can also facilitate access to secured financing including deposits (even those that are governed by Article 9 of the UCC). Account Control Agreements are used more often because they provide significant benefits to both borrowers and lenders.
Legal and Compliance Implications of Account Control Agreements
Both debtors and custodians cannot afford to pretend that these agreements are anything other than a security interest that has material legal effect. In fact, because each agreement requires consent of the collateral holder (i.e., the debtor’s custodian), the agreement effectively amounts to a tri-party agreement in which the debtor, the secured party and the collateral holder are obligated to participate. The bottom line is that these agreements cannot be drafted by accountants and chased and managed by collection persons. These agreements are serious business and are governed by Article 9 of the UCC (in the USA) and require close attention to the requirements of Article 9 in addition to the terms of the agreement itself.
Requirements. First, a complete account control agreement typically requires the creditor to set up a lock box, which can be complicated because the bank will require an account opening and all related documents. Second, bank secrecy laws apply, so the debtor and the specified cash collateral account and the related relationship manager at the debtor’s bank should be aware of and have necessary permissions from the debtor to talk to the creditor, the secured party. Third, the secured party’s bank should open a similar lock box account to receive proceeds for deposit and credit for the creditor’s benefit. Fourth, the debtor and its bank should confirm that there are no "stop payment" instructions.
Consequences of Incomplete Agreement. If the agreement is unsigned, it will not be valid. If the agreement is incomplete – i.e., there is no lock box established, or there is no agreement with the third party, or there is an incomplete reference to lockbox agreements in the agreement itself – then the security interest may not start to attach proper notice to the collateral so that the secured party has priority over other creditors. It is important to take the time to make certain the agreement is correct. There have been cases where secured parties who relied on agreements similar to those typically obtained have lost their priority in favor of margin lenders under circumstances where the agreements and the terms of the applicable UCC sections have not been quite right.
Compliance. In a similar vein, debtors and custodians should not ignore the other two requirements of complying with an account control agreement. One is to understand confidentiality and privacy rules relating to information management and sharing, including CCPA and GCIP. The other is to ignore confidentiality as it related to the lock box accounts. An account control agreement with a provision specifying that the debtor and its third-party collection officers have no rights to the funds in the lock box is not uncommon, but it may run afoul of certain privacy laws and other financial laws. It also may not be enforceable if it is deemed unconscionable.
Common Issues with Account Control Agreements and Solutions
As with any legal instrument, there are potential pitfalls to account control agreements.
Disputes. Although the agreement itself may be very clear, disputes can arise between the business and its account bank, the assignee and the assignee’s lender. The most common triggers for disputes are: (1) an assignee’s failure to give timely notice of its assignment; (2) an assignee’s failure to give a bank timely notice of the existence of an account control agreement; or (3) the existence of multiple control agreements on the same account. These types of disputes may be resolved through a written agreement among the parties, or a court order entered by a court of competent jurisdiction.
Operational Difficulty. Account control agreements are particularly useful for senior lenders who have taken unsecured loans with the expectation that their lien will be perfected by the execution of an account control agreement. If a borrower could avoid signing an account control agreement, and still allow the senior lender to participate in the same loan, then the value of the account control agreement as a perfecting tool diminishes. For senior lenders, the failure of the borrower to execute an account control agreement with an upstream borrower is a particularly troubling event and presents an opportunity for the borrower, but not the senior lender, to reorganize its debt position in favor of a new lender or another maneuver that has the potential to disadvantage the senior lender.
A lender who fails to request an account control agreement or who allows a borrower to explain away the absence of an account control agreement will turn an effective lien into a mere unsecured loan.
Wrap Up: The Evolution of Account Control Agreements
As technology continues to drive the development and delivery of financial products and services, account control agreements are likely to evolve into more sophisticated and technologically-advanced instruments that allow parties to more easily and efficiently comply with evolving due diligence standards and regulatory requirements. Developments in areas such as machine learning and predictive analytics may enhance the ability to tailor these agreements to the specific needs of the parties while reducing administrative burdens and third-party risks. Adapting ACA practices to meet the challenges presented by new technologies will likely continue for years to come as market participants , regulators, prospective customers, and other stakeholders continue to work to adapt to technological advancements in the financial services industry.