Account control agreement

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also known as a tri-party collateral arrangement; an arrangement wherein a debtor pledges collateral to a custodian to hold it for that pledgor, but subject to a security in favour of a pledgee. The agreement generally provides that neither party may instruct the custodian to do anything with the asset without the other's consent, except in the direst of circumstances.

Indemnity

Even in those dark days the custodian will be reluctant to do anything and may ask for an indemnity. Why would you indemnify the Custodian for actions it takes under an account control agreement?

The logic runs something like this:

• Custodian is in the middle. It has no skin in the game.
• If there’s an enforcement event and Pledgee wants to take control of the collateral:
  • Things will be moving super-fast
  • Pledgee will want Custodian to act quickly and to not stand on ceremony.
• If Pledgee instructs Custodian wrongly then:
  • Pledgee is in the wrong (Q.E.D.)
  • Pledgee benefits, because Custodian does what it wants and Pledgee gets the collateral
  • Pledgor loses, because Custodian does what Pledgee wants and Pledgee gets the collateral
  • Custodian is arguably complicit in Pledgee's wrongdoing, but
    • Pledgee started it;
    • Custodian has no skin in the game;
    • Custodian may well have no knowledge one way or another;
    • Things will be moving super-fast.
• If Pledgor loses any money as a result:
  • The Pledgor has an open-and-shut action against Custodian (Q.E.D.)
  • The Pledgor has no action against Pledgee.
• Doubtful Custodian has a contractual breach claim against Pledgee, because it was complicit in the breach. Therefore:
  • Custodian can only recover against Pledgee by way of indemnity – since Pledgee hasn't breached.
  • Practically if Pledgee doesn’t give the indemnity, expect two consequences:
    • Custodian will refuse point blank to follow Pledgee's instructions to take control, or
    • Custodian will insist on an indemnity from Pledgee anyway before taking any action.
• Pledgee can control the liability under the indemnity easily:
  • Don’t take control of the collateral when it is not entitled to
  • The liability is in any case determinate – it is the contractual damages that the Pledgor can claim from Custodian as a result.
    • Assuming Pledgee doesn’t go bust, Pledgee can return the collateral and maybe suffer some buy in costs but that’s realistically it.
    • Pledgee would have exactly the same liability if it held the collateral itself as Custodian and didn’t return it when Pledgor was entitled to it.

See also

• Custodian
• Indemnity
• Pledge
• Security