Support for the Uniform Special Deposits Act

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SUMMARY

The Commercial Law and Uniform State Laws Committee issued a report in support of enacting the Uniform Special Deposits Act in New York as promulgated by the Uniform Law Commission in 2023 (the “Act”). The Act provides statutory recognition and protections for a useful type of bank account intended to fund a future payment to beneficiaries where the payment is contingent, unlike a general demand deposit account, the balance of which is accessible at the discretion of the depositor. Under the Act, a deposit that meets the statutory requirements specified in Section 5 of the Act (a “Special Deposit”) is protected from interference by the depositor and any beneficiary, or any of their creditors or successors, until the occurrence of the contingency triggering the bank’s disbursement obligation. The Act states what provisions in the account agreement are required to qualify an account as a Special Deposit entitled to the protections of the Act. It further specifies, with respect to the Special Deposit, the rights and obligations of the bank, depositor, beneficiaries (and creditors and successors of the depositor and beneficiaries) vis-à-vis each other. Disbursement of funds from a Special Deposit under the Act will generally not be interrupted by reason of intervening events such as service on the bank of creditor process, the bankruptcy of a depositor or a beneficiary, or the exercise of setoff rights by the bank at which the deposit is made. This new Special Deposit should be distinguished from long-recognized common law special deposits, which have generally been considered by New York courts in the context of protecting the depositor from dilution by claims of other bank creditors in the event that the bank becomes insolvent. Common law special deposits are unaffected by the Act and may coexist with the new Special Deposit opt-in. The rules of the Act apply only to deposits which meet the specific statutory definition for a Special Deposit under the Act. Thus, the courts can continue to recognize and apply the case law governing common law special deposits to accounts which are not Special Deposits.

REPORT

REPORT BY THE COMMITTEE ON COMMERCIAL LAW AND UNIFORM STATE LAWS

SUPPORT FOR THE UNIFORM SPECIAL DEPOSITS ACT

I. Executive Summary

The New York City Bar Association (“City Bar”) Committee on Commercial Law and Uniform State Laws (the “Committee”) endorses enactment in the State of New York of the Uniform Special Deposits Act promulgated by the Uniform Law Commission (the “ULC”) in 2023 (the “Act”).[1] The ULC promulgated the Act after three years of extensive study and analysis by commercial law and banking law experts and observers, who had concluded that greater clarity was needed in the law of special deposits and drafted a model law recommended for enactment in all states that was tailored to provide that clarity.

The Act provides statutory recognition and protections for a useful type of bank account intended to fund a future payment to beneficiaries where the payment is contingent, unlike a general demand deposit account, the balance of which is accessible at the discretion of the depositor. Under the Act, a deposit that meets the statutory requirements specified in Section 5 of the Act (a “Special Deposit”), as set forth and further discussed in Section IV of this Report, is protected from interference by the depositor and any beneficiary, or any of their creditors or successors, until the occurrence of the contingency triggering the bank’s disbursement obligation. An illustrative, non-exhaustive list of potential uses of Special Deposits is set out in Section 2(10) of the Act and is further described below in Sections IV and V.

The Act states what provisions in the account agreement are required to qualify an account as a Special Deposit entitled to the protections of the Act. It further specifies, with respect to the Special Deposit, the rights and obligations of the bank, depositor, beneficiaries (and creditors and successors of the depositor and beneficiaries) vis-à-vis each other. Disbursement of funds from a Special Deposit under the Act will generally not be interrupted by reason of intervening events such as service on the bank of creditor process, the bankruptcy of a depositor or a beneficiary, or the exercise of setoff rights by the bank at which the deposit is made.

This new Special Deposit should be distinguished from long-recognized common law special deposits, which have generally been considered by New York courts in the context of protecting the depositor from dilution by claims of other bank creditors in the event that the bank becomes insolvent.  The Act does not address the insolvency of the depository bank. Common law special deposits are unaffected by the Act and may coexist with the new Special Deposit opt-in.  The rules of the Act apply only to deposits which meet the specific statutory definition for a Special Deposit under the Act. Thus, the courts can continue to recognize and apply the case law governing common law special deposits to accounts which are not Special Deposits. In fact, a single account could arguably satisfy the requirements for both and therefore be entitled to the protections of both Special Deposits and, to the extent not inconsistent with the Act, common law.[2] Section II of this report describes the differences between common law special deposits and those under the Act in greater detail and explains why the common law governing special deposits should be supplemented by the clear rules of the Act. As described in Section III, the Act does not affect otherwise applicable law to the extent not inconsistent with the Act, particularly consumer protection law and the law governing payment of depositor claims in the event of the bank’s insolvency.

Enactment of the Act will impose no cost on the New York government or taxpayers but will provide substantial benefits to New York. Section IV summarizes the provisions of the Act in detail, and Section V summarizes the benefits of the Act. The Act will make available a type of account that can protect consumers who are required to escrow funds in connection with agreements to purchase real property or to provide security deposits for performance of their leases, and the Act can protect employees whose employers use Special Deposits to satisfy their salary, IRA and 401(k) obligations. The Act will also provide businesses with a type of account that can protect funds deposited by financial institutions as collateral for, or otherwise in support of, the clearing or settlement of financial transactions or deposited by businesses of all types and sizes to discharge their obligations in a variety of other commercial transactions. Section V describes in more detail the beneficial uses of Special Deposits.

Enactment also will help protect New York’s position as a preeminent financial center and the jurisdiction of choice for financial transactions and related litigation and will minimize the risk that New York-centered financial institutions may migrate banking, clearing or settlement operations to other enacting States to take advantage of the Act as enacted in those States. Section VI describes how institutions in the New York financial markets may take unique advantage of the use of Special Deposits, and finally, Section VII summarizes the disadvantages for New York if New York fails to enact the Act.

II. New York Common Law Affecting Special Deposits Does Not Provide Adequate Certainty and Protection

The current law on special deposits in New York and other states is non-statutory common law. This common law is used primarily to decide cases in which the bank has failed and a bank depositor asserts that it is not merely a general unsecured creditor of the insolvent bank, but is entitled to priority treatment because the bank held its deposit in a fiduciary capacity or as some form of quasi-bailment of property.[3] As a result, much of the relevant case law is focused, first, on the question of whether the bank held the deposit as a fiduciary.[4] This fiduciary duty might arise, variously, from statute or common law.[5] Alternatively, it might arise from an express or implied contract. In addressing this question, the courts often wrestle with complex situations in which the fiduciary duty was not express but was argued to have been implied by or to be inferred from conflicting circumstances.[6] Second, if no fiduciary duty was found to exist, it does not matter that the bank knew that the deposit was intended by the depositor for some “specific purpose;” it had to be a segregated or identified fund for that specific purpose to qualify as a special deposit.[7] In short, there is often uncertainty as to when a deposit qualifies as a common law special deposit in the absence of a fiduciary duty. Third, even when such a fiduciary duty exists, the courts only award relief to the extent that the “special” deposit can be traced to unencumbered assets of the insolvent bank, thereby embroiling the courts in complex issues of tracing.[8] Fourth, a common law special deposit provides rights only to the person to whom the bank owes its fiduciary duty. This usually is the depositor but may be a designated beneficiary of the deposit where the depositor had relinquished control of the deposit and the bank had become the agent or trustee for the beneficiaries.[9]

New York common law of special deposits may be useful or necessary to protect against diminution of the account by reason of the bank’s insolvency. However, if the parties are trying to use a common law special deposit for the purpose of ensuring that the deposit will be applied to its specific purpose when the disbursement contingency arises and that the disbursement will not be disrupted by bank setoff, creditor process or bankruptcy of the depositor or a beneficiary, then the four features of New York common law discussed above make it difficult for the parties to achieve that certainty under existing law.

In addition, there seems to be some uncertainty how courts in New York would apply the common law to find that a bank had effectively waived its right of setoff in connection with a special deposit, with New York state courts finding a waiver based on the bank’s acquiescence in the depositor’s specific purpose for the deposit and federal courts sitting in New York requiring the bank to have agreed to segregate the funds.[10] Where a bank accepts a deposit with knowledge of the depositor’s special purpose, it would be useful to have greater clarity as to whether or not the bank has waived or limited its right to setoff. The Act provides that certainty.

The Act is focused entirely on creating a form of deposit that is useful for completing such contingent payments, without becoming embroiled in the other issues raised by common law special deposits.  Therefore, the Act does not entitle a depositor to preferential treatment in the event of bank insolvency; this is a matter left to federal and state bank insolvency law. The Act also does not depend on, or give rise to, any fiduciary duty by the bank to the depositor or beneficiaries; the bank’s contractual obligation to disburse the deposit as provided in an account agreement that meets the requirements of the Act is sufficient. For these two reasons, the establishment of a Special Deposit under the Act does not depend on whether the bank owes a fiduciary duty, and there is no need to trace the proceeds of the deposit. However, the Act does not prohibit a bank from undertaking fiduciary duties; such an undertaking is simply not a requirement for obtaining the protections of the Act.

Furthermore, the Act does not recognize an implied “special deposit.” Instead, the Act requires a record in which the bank expressly agrees that the deposit is held as a Special Deposit subject to the terms of the Act. The Act further clarifies that if the bank agrees that the deposit is a Special Deposit, it is thereby limiting its rights of setoff to those permitted by the Act. Additionally, it is essential that the deposit agreement identify the permissible purpose of the Special Deposit, specify the contingency that will trigger the bank’s obligation to disburse the Special Deposit and provide a means for the bank to identify the beneficiaries.

In short, a deposit may be a Special Deposit even though it would not be a special deposit under the common law in the event the bank becomes insolvent. Once the Act’s conditions are satisfied (including that the parties agree that their deposit should be governed by the Act), the Act’s protections against interruption of disbursement become effective whether or not the account is a special deposit under common law. These protections apply to disruptive actions that might be taken by the bank itself (e.g., setoff), the depositor or a beneficiary, or the creditors or other successors of the depositor or a beneficiary.

III. Scope and Limitations of the Act

The Act is designed to supplement, rather than disrupt, existing law. More specifically, it is intended to complement New York’s general deposit law and its existing common law concerning general and special deposits to the extent that the law is not contrary to a provision of the Act. The Act provides an “opt-in” structure; it governs only when an account agreement provides that the deposit is to be governed by the Act and which otherwise satisfies the requirements of the Act for a Special Deposit. It does not apply to a general deposit or to a common law special deposit that does not comply with the Act. It also does not apply to accounts established with non-banks, and payments made using such accounts, and it does not apply to bank accounts not denominated in money, securities accounts, safe deposits, or physical asset safekeeping accounts. Finally, it does not address the rights of depositors of insolvent banks.

In addition, under Section 14 of the Act, other law supplements this Act, except to the extent inconsistent with the Act. The other laws include New York’s Uniform Commercial Code, consumer protection law, law governing deposits generally, law related to escheat and abandoned or unclaimed property, and the principles of law and equity, including law related to capacity to contract, principal and agent, estoppel, fraud, misrepresentation, duress, coercion, mistake, and bankruptcy.

IV. Summary of Main Provisions of the Act

A. Requirements for a Special Deposit

Under Section 5 of the Act, a deposit is a Special Deposit if it is:

(1) a deposit of funds in a bank under an account agreement;

(2) for the benefit of at least two beneficiaries, one or more of which may be a depositor;

(3) denominated in a medium of exchange that is currently authorized or adopted by a domestic or foreign government;

(4) for a permissible purpose stated in the account agreement; and

(5) subject to a contingency.

Whether an account is a Special Deposit will be determined largely, if not entirely, by the terms of the account agreement and supplementary agreements, rather than (as may be the case for common law special deposits) extrinsic factual circumstances. The key to the identification of a Special Deposit is that the deposit is established under an “account agreement.” That term is defined as an agreement in a record between a bank and one or more depositors that states the intention of the parties to establish a Special Deposit governed by the Act. This “opt in” feature ensures that only a deposit that the relevant parties intend to be covered by the Act will actually be a Special Deposit governed by the Act.

If the parties agree to statutory Special Deposit treatment under the Act, the account agreement must also provide for deposits to the account to be used for a “permissible purpose” and be disbursed upon the occurrence of a specified “contingency.” The disbursement contingency will necessarily be closely related to and inform the particular permissible purpose. “Permissible purpose” is defined to mean “a governmental, regulatory, commercial, charitable, or testamentary objective of the parties stated in an account agreement.”

The definition of permissible purpose in Section 2(10) of the Act also includes a non-exhaustive list of examples of such purposes. For example, a permissible purpose would include (a) holding funds in escrow, including for a purchase and sale, lease, buyback, or other transactions, (b) holding funds as a security deposit of a tenant, (c) holding funds that may be distributed to a person as remuneration, retirement or other benefit, or compensation under a judgment, consent decree, court order or other decision of a tribunal, (d) holding funds for distribution to a defined class after identification of class members and their interest in the funds, (e) providing assurance with respect to an obligation created by contract, such as earnest money, to ensure a transaction closes, (f) settling an obligation that arises in the operation of a payment system, securities settlement system, or other financial market infrastructure, (g) providing assurance with respect to an obligation that arises in the operation of a payment system, securities settlement system, or other financial market infrastructure, or (h) holding margin, other cash collateral, or funds that support the orderly functioning of financial market infrastructure or the performance of an obligation with respect to the infrastructure.

Section 6 provides that funds deposited after the bank[11] or a court has determined that the account does not serve a “permissible purpose” are not protected by Sections 8 through 11 (discussed below), and Comment 8 to Section 2 of the Act states that “a special deposit established for the purpose of defrauding or evading creditors until funds are disbursed would not be a permissible purpose” under the Act.  The Comment is supported by Section 3(c)(2) of the Act discussed below. Thus, Special Deposits cannot be used to hinder, delay, or defraud the depositor’s creditors.

A Special Deposit must also be for the benefit of at least two beneficiaries, one or more of which may be a depositor. A beneficiary is a person identified as such in the account agreement or, if not identified as a beneficiary in the account agreement, who may be entitled to payment from the Special Deposit upon the occurrence of a contingency specified in the account agreement or on termination of the Special Deposit. Not uncommonly, the depositor is a reversionary beneficiary entitled to return of funds not required to be used for the permissible purpose or entitled to return of undisbursed funds upon termination of the Special Deposit. A “contingency” is an event or circumstance specified in an account agreement that is not certain to occur but must occur before the bank is obligated to pay a beneficiary. Finally, the first and third clauses of Section 5 of the Act require that the deposit be a deposit of funds, denominated in a medium of exchange that is fiat currency of some government. Therefore, the bank’s disbursement obligations cannot relate to any other form of property.

B. Limited Property Interest of Depositor or Beneficiary in Deposit

Section 8 of the Act provides that neither a depositor nor a beneficiary has a property interest in a Special Deposit. Any interest with respect to a Special Deposit is only in the bank’s contingent obligation to disburse the Special Deposit once its obligation to pay such beneficiary has arisen (i.e., the specified contingency is met) and becomes known to the bank. The nature of such a right to payment, including its transferability, would be determined under applicable law other than the Act.

C. Limited Enforceability of Creditor Process; Injunctions Against Bank

Section 9 of the Act provides that creditor process with respect to a Special Deposit is not enforceable against the bank holding the Special Deposit other than with respect to an amount that the bank is then obligated to pay a beneficiary (including the depositor) at the time the process is served, if the process (1) is served on the bank, (2) provides sufficient information to permit the bank to identify the depositor or the beneficiary and (3) gives the bank a reasonable opportunity to act on the process before it disburses funds to the beneficiary.

Section 10 of the Act provides that a court may enjoin, or grant similar relief that would have the effect of enjoining, a bank from paying a beneficiary (including the depositor) only if payment would constitute a material fraud or facilitate a material fraud with respect to the Special Deposit.

However, creditors of any person who funds a Special Deposit are not left without protection in the case of abuse of the Act. Section 3(c)(2) of the Act confirms that the Act does not affect the voidability of a deposit or transfer that is fraudulent or voidable under other law, including the Uniform Voidable Transactions Act adopted as Article 10 of New York’s Debtor & Creditor Law. Accordingly, a transfer of funds to a Special Deposit may still be set aside if the transfer was made with the intention of the transferor to hinder, delay or defraud the transferor’s creditors or the transfer was otherwise voidable under laws designed to protect creditors of the transferor.

D. Limitations of Bank’s Rights of Recoupment and Set Off

Section 11 of the Act provides that, except in certain circumstances as described below, a bank may not exercise a right of recoupment or set off against a Special Deposit. In addition to discharging an obligation to pay a beneficiary when the obligation arises (i.e., when the contingency specified in the account agreement occurs and the bank has knowledge of the occurrence), if the account agreement so authorizes, a bank may debit the Special Deposit for overdraft fees, costs incurred by the bank that relate directly to the Special Deposit or to reverse an earlier credit posted by the bank under circumstances warranted under other applicable law. The bank may also exercise a right of recoupment or set off an obligation owed to the bank by a beneficiary (including the depositor) against funds from the Special Deposit that the bank has become obligated to pay that beneficiary (which, once again, would be only after the contingency occurs and the bank has knowledge of the occurrence).

E. Protections for the Bank

The Act provides some important protections for a bank to encourage banks to offer Special Deposits to their customers. Section 12 of the Act states that a bank (unless otherwise agreed) does not have a fiduciary duty to any person with respect to a Special Deposit. While the bank is obligated to the class of beneficiaries of a Special Deposit, a debtor/creditor relationship with any particular beneficiary does not arise until the bank becomes obligated to pay that particular beneficiary. The bank has a duty to beneficiaries to comply with the account agreement and the Act. If the bank does not comply, the bank may be liable to a depositor or beneficiary only for damages proximately caused by the noncompliance. The bank may rely on records presented in compliance with the account agreement to determine whether the bank is obligated to pay a beneficiary. If an account agreement requires payment on presentation of a record, the bank must determine within a reasonable time whether the record is sufficient to require payment. If the account agreement requires action by the bank on the basis of a presented record, the bank is not liable for relying in good faith on the genuineness of a presented record that appears on its face to be genuine. Unless the account agreement provides otherwise, the bank is not required to determine whether a permissible purpose stated in the agreement continues to exist.

The Act sets a default rule that a Special Deposit terminates five years after the date the Special Deposit was first funded. If the bank cannot identify or locate a beneficiary entitled to payment at the time of termination, the bank must pay the balance to depositors who shall be beneficiaries. These provisions may be modified by the account agreement. A bank that disburses the remaining balance in compliance with the foregoing has no further obligations with respect to the Special Deposit.

F. Choice of Law and Forum Selection

Section 3 of the Act permits the parties to an account agreement to elect the application of the Act to a deposit by so stating in the account agreement, regardless of whether a party to the account agreement or a transaction related to the special deposit, or the special deposit itself, has a reasonable relation to the State of New York. A similar rule applies to the selection of a forum in New York for settling a dispute arising out of the Special Deposit.

G. Variation by Agreement

Section 4 of the Act provides for variation of the Act by agreement of the parties. Pursuant to Section 4, however, the effect of Sections 2 through 6, 8 through 11, and 14 may not be varied by agreement, except as provided in those sections. The effect of Sections 7, 12, and 13 may be varied by agreement, subject to the parameter that a provision in an account agreement or other record that substantially excuses liability or substantially limits remedies for failure to perform an obligation under the Act is not sufficient to vary the effect of a provision under the Act. Section 4 also clarifies protections for beneficiaries from amendments by account agreement signatories.

H. Transitional Provision

Section 16 of the Act provides that the Act applies to (i) a Special Deposit made under an account agreement executed on or after the effective date of the Act or (ii) a deposit made under an agreement executed before the effective date of the Act if all parties entitled to amend the agreement agree to make the deposit a Special Deposit and the deposit referenced in the amended agreement satisfies the criteria in Section 5 of the Act.

V. Benefits of the Act

Unlike the common law, the Act does not recognize an implied Special Deposit. It avoids uncertainty by not leaving the matter to case-by-case adjudication involving extrinsic circumstances and after-the-fact claims. The Act requires a record of contractual agreement to the application of the Act and compliance with the Section 5 requirements, rather than a subsequent court determination that the bank owes express or implied fiduciary duties to the depositor. That agreement evidences the bank’s express limitation of its right of recoupment or setoff. The Act does not require tracing of account proceeds. The Act provides express protections to both the depositor and the beneficiaries of the intended purpose of the deposit, not merely to the depositor. The Act imposes clear duties on the bank to disburse the deposit and protects the bank against unintended fiduciary or implied duties. The Act expands the protections of a Special Deposit to all deposits specified as such and subject to disbursement to identifiable beneficiaries on a specified contingency and not merely to deposits which the bank has agreed to hold as trust funds in segregated accounts.

All of these features will benefit transacting parties by providing greater certainty with respect to a number of special deposit related issues, the resolutions of which may otherwise be uncertain. The Act does so while still preserving for the transacting parties a high degree of freedom of contract and the ability to continue using existing arrangements without disruption (unless the parties choose to amend their existing arrangements to take advantage of the protections provided by the Act).

A. Identification of a Special Deposit

The Act renders the elements required for a common law special deposit irrelevant. A deposit is a Special Deposit if the account agreement meets the requirements provided in Section 5 of the Act and the account agreement expressly provides, as required by Section 3(a) of the Act, that the special deposit is governed by the Act. The Comments to Section 12 of the Act also make clear that the law of bailment, trust or custody is not relevant to a Special Deposit. The relationship between the bank and the depositor and beneficiaries is that of debtor-creditor unless otherwise agreed in the account agreement.

The Act does not abolish common law special deposits. Instead, the Act provides clear codified rules and protections without implicating any unnecessary issues to which common law special deposits may be subject.

B. Bankruptcy Remoteness

The Act also provides greater certainty to transacting parties by providing a statutory basis to negate a claim, if a depositor or beneficiary were to become subject to a case under the federal Bankruptcy Code, that the Special Deposit is property of the bankruptcy estate or subject to a bankruptcy stay or turnover order.

Section 8 of the Act provides that the depositor has no rights in the deposit except the depositor’s specified contingent rights as a beneficiary and that a beneficiary has no rights in the Special Deposit itself. The right of a beneficiary (including a depositor as beneficiary) is only in the obligation of the bank to make payment upon occurrence of the specified contingency, not any right in the underlying deposit. No enforceable obligation against the bank exists prior to occurrence of the relevant contingency.^[12]

The clarifications provided in Section 8 are important in a bankruptcy case.  Under the federal Bankruptcy Code property rights are determined by non-bankruptcy law, usually state law, absent a compelling federal interest to the contrary. Butner v. United States, 440 U.S. 48 (1979).  A trustee or other estate representative in a bankruptcy case of a depositor or beneficiary will be bound by the terms of the Act that circumscribe the beneficiary’s rights, with the result that the Special Deposit itself should not be an asset of the bankruptcy estate.^[13]

C. Protection from Creditor Process

As discussed above in Part IV.C of this report, Section 9 of the Act clarifies to what extent a creditor of a depositor or beneficiary has recourse to the Special Deposit to satisfy any claim owing to the creditor. Section 9 provides important statutory protections to the beneficiaries which might not otherwise be available to a common law special deposit if a court were to impose the asset segregation/trust requirement for a common law special deposit. These legal protections also might not be available even to a beneficiary of a common law special deposit over which the depositor had maintained control, leaving the depositor’s rights subject to attachment by the depositor’s creditors. The legal effect of an assignment of rights by a beneficiary on persons other than the bank while the beneficiary’s rights remain contingent, or of process served by a creditor of a beneficiary, before the bank becomes obligated to pay such beneficiary are matters left to other applicable law.

D. Strength of the Bank’s Promise to Pay

Sections 10 and 12 of the Act provide certainty to transacting parties as to the strength of the bank’s promise to pay the beneficiary. Section 12 of the Act states that the bank has a duty to the beneficiary to comply with the account agreement and allows for actual damages against the bank in the case of the bank’s failure to comply. Section 10 limits injunctive relief against a bank with respect to a Special Deposit to circumstances in which fraud has occurred or the facilitation of a material fraud would occur. Even in that case the traditional elements for obtaining equitable relief in the form of an injunction must be met. The two sections together render the bank’s promise to pay the beneficiary a solid one, similar to the promise of a bank obligated to honor a draw on a letter of credit when proper presentment is made.

E. Protection from Bank Setoff Rights

As discussed in Part IV.D of this report, Section 11 of the Act provides needed guidance as to the limited extent a bank may recoup or set off against the Special Deposit for amounts owed to the bank in the administration of the deposit.

F. Freedom of Contract

The key statutory protections providing certainty to beneficiaries, depositors, the creditors of each, and to the bank are protected from impairment by Section 4 of the Act, which precludes the account agreement from (i) varying the effect of Sections 2 through 6, 8 through 11 and 14 or (ii) varying the effect of Sections 7, 12 or 13 so as to substantially excuse liability or limit remedies for failure to perform a statutory obligation. Nevertheless, the benefits of freedom of contract are recognized by provisions in various individual sections permitting contractual variance. Further, the “opt-in” framework of the Act ensures that contracting parties retain the autonomy to decide whether they wish their transaction to be governed by the Act at all.

VI. Examples of How a Special Deposit May Be Used in New York

The definition of “permissible purpose” in Section 2(10) of the Act contains a non-exclusive list of examples of transactions for which the Act may be useful.  However, that list is not exhaustive.

A prime example of the use of a Special Deposit would be to facilitate the funding of interest, sinking fund and principal payments by the issuer of publicly traded notes or bonds. The issuer and its paying agent bank would agree to the opening of a Special Deposit account into which the issuer would wire the upcoming payment, subject to the paying agent’s agreement to transfer the deposit to the registered holder of the security—such as Depository Trust Company (“DTC”)—on the contingency related to a payment becoming due and payable. In the event of the issuer’s insolvency after deposit, the Special Deposit would be immune from process by the issuer’s creditors, recoupment or setoff by the paying agent bank or claims that the funds constitute part of the issuer’s bankruptcy estate in a bankruptcy proceeding, and the paying agent could not be enjoined from further transfer to the registered holder of the bonds or notes once the contingency is satisfied. The registered holder, if a custodian—such as DTC—for beneficial owners or security entitlement holders, in turn, could, itself use Special Deposits with its bank to effect subsequent transfers to its participants or beneficial owners. Such Special Deposits might also be documented so as to constitute common law special deposits, protected against the insolvency of the bank serving as paying agent or other intermediary.

Another primary example of a permissible purpose would involve a payment system operator who would use Special Deposits to facilitate funds transfers between financial institution participants. Rather than having its participants prefund general deposits at the operator’s bank, which would be subject to risk of the possible insolvencies of the operator or the participating financial institutions, bank recoupment or setoff or creditor process against the operator or depositing banks, the payment system operator would have the financial institutions participating in the network prefund each day a Special Deposit at the operator’s bank. These financial institutions would be identified as potential beneficiaries and would be entitled to disbursement at the end of each day on the contingency of the bank’s receiving computation from the operator as to the appropriate distributions to each beneficiary. Such Special Deposits might also be documented so as to constitute common law special deposits, which would be protected against the insolvency of the operator’s bank.

If the conditions for a Special Deposit were satisfied, the Act might also be useful for other types of transactions, such as (a) cash management arrangements among companies in a group by which funds of the group are consolidated for more efficient treasury investing, (b) tax sharing arrangements among companies in a consolidated tax group, (c) deposits of funds to pay commissions to consignors or commission merchants on sales of goods by retailers, (d) planning for the special needs of family members, and (e) a deposit of funds to support issuance of a stablecoin denominated in money and to fund redemption payments made to holder of such stablecoins. In each of these situations and others the protections afforded to the Special Deposit will be attractive to transacting parties within the rules circumscribed by the Act.

VII. Adverse Consequences of Failing to Enact the Act in New York

Enactment of the Act imposes no cost on New York or its residents. But failure to enact the Act in New York could impair New York’s position as the preeminent financial center and the jurisdiction of choice for financial transactions and related litigation. A key purpose of the Act is to protect and bring greater certainty to broad swaths of daily financial transactions–including securities settlements, payment systems, and margin or other security arrangements–that are critical parts of the infrastructure of United States financial markets. These operations are centered in New York, and financial market infrastructure and other financial institutions handle trillions of dollars of such transactions every day. Their agreements and system rules typically are governed by New York law and choose a New York forum for resolution of disputes. If the Act is enacted in other jurisdictions but not New York, the transactions may well migrate from New York to enacting states. Banks and financial market infrastructures could move their Special Deposits to enacting states to take advantage of the Act’s benefits and also choose an enacting state as the governing law for their contracts and rules as well as for the forum for any related litigation. The resulting reputational and commercial loss to New York could be substantial.

Moreover, failure to enact the Act in New York will not just impact large financial market participants. The failure also may disproportionately disadvantage New York’s consumers and small business owners. These persons commonly use various types of escrow arrangements, some of which may qualify as common law special deposits, with the attendant legal uncertainties discussed above. A Special Deposit could clarify the rights of such consumers and small business owners, but, absent enactment, the protections provided to beneficiaries of Special Deposits will not be easily available to New York residents.

Furthermore, those New York consumers may be misled as to their protections under existing New York law. These are people who, often unrepresented by counsel, may find themselves required under the terms of a transaction to deposit funds into something which may be labelled a “special deposit” governed by New York law, but which fails to satisfy New York’s common law rules for any of the protections of a special deposit and which provides no third-party beneficiary rights. Unsophisticated parties may, understandably, assume that mere designation of a New York bank account as a “special deposit” means that the funds are immune from creditor legal process or bankruptcy filing against the bank customer, or the bank’s recoupment or setoff of the account to satisfy the depositor’s debt. In contrast, larger and more sophisticated parties will be able to protect themselves by negotiating a governing law clause which selects the law of an enacting state and electing to opt into coverage under the Act as enacted in that state.

Failure to enact the Act in New York would deprive New York consumers, businesses, financial institutions, and deposit beneficiaries of a new and versatile tool to facilitate many types of transactions. It would leave them with a common law special deposit that is of little or no utility in providing the protections provided by the Act for the reasons set out in Section II. As noted, the Act promises to benefit consumers and businesses by providing a clear and codified mechanism for a wide variety of important financial transactions, including real estate escrows, securities settlements, security deposits, and the funding of pension and other business obligations, without imposing any of these mechanisms on parties unless they choose to “opt in” to application of the Act. The Act protects all parties to a Special Deposit from unnecessary risks of creditor process, bankruptcy and bank recoupment and setoff claims, risks that are all present under existing New York law. The potential for these benefits and protections may be lost to New Yorkers if New York fails to enact the Act.

VIII. Recommendations of the Committee

For all of the above reasons, the Committee supports and recommends the enactment of the Act in New York.

Curt Mechling, Chair
Commercial Law and Uniform State Laws Committee

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