A new Article 12 and amendments to Article 9 regarding “controllable electronic records” would govern transactions and security interests in digital assets.
On July 13, 2022, the Uniform Law Commission (in partnership with the American Law Institute) approved amendments intended to modernize the Uniform Commercial Code (UCC). The amendments principally cover transactions involving emerging digital asset technologies such as virtual (non-fiat) currencies, non-fungible tokens (NFTs), and digital assets with embedded payment rights, although a handful of unrelated updates are also included. Importantly, a new UCC Article — Article 12 — is dedicated to governing transfers of most digital assets, including sales and financings as well as security interests and competing claims in those assets. Related amendments to UCC Article 9 would govern transfers of payment rights.
“Controllable Electronic Records” Under New Article 12
Digital assets are classified under a new term: “controllable electronic record” (CER), i.e., a “record” in an “electronic” medium that is subject to “control.” CERs would include Bitcoin, Ether, NFTs, and a variety of other digital assets.
Under Article 12 (and corresponding amendments to Article 9), a party may perfect a security interest in certain CERs through control of the CER. The three hallmarks of control are that they give a person:
- The power to enjoy “substantially all the benefit” of the CER (such as through use as a medium of exchange by spending or exchanging the CER for another CER)
- The “exclusive” power to prevent others from enjoying “substantially all the benefit” of the CER, and
- The power to transfer control or to cause another person to obtain control of the CER.
To demonstrate control, all three factors must be present. A person’s power to prevent others from enjoying “substantially all the benefit” of the CER and to transfer control of the CER is a rebuttable presumption of exclusivity.
Importantly, even if these powers are shared (e.g., through a multi-signature wallet, or if changes occur automatically as part of the protocol built into the system in which the CER is recorded), the exclusivity requirement is deemed satisfied. A person may also obtain control through another person who has control if the other person acknowledges that it has control on behalf of the first person.
In addition, Article 12:
- Establishes that a person must be able to readily identify itself to a third party as the person having control, whether by name or use of a cryptographic key or account number.
- Extends to CERs many of the attributes of negotiability (i.e., the CER is capable of being transferred in such a way as to cut off competing property claims). A voluntary good-faith purchaser for value, without notice of a property claim to the CER, obtains control of that CER. Furthermore, if the purchaser is a “qualifying purchaser,” the purchaser benefits from the “take-free” rule, i.e., interest is taken free from competing property claims. As with negotiable instruments and investment property, the filing of a financing statement is not considered notice of a property claim to the CER in and of itself.
- Facilitates secured lending against CERs by clarifying that the normal UCC rules for attachment will continue to apply to security interests in CERs. Furthermore, a security interest in a CER, a controllable account, or a controllable payment intangible may still be perfected by the filing of a financing statement. However, a security interest in a CER perfected by control has priority over a security interest in the CER perfected only by filing.
- Updates the definition of “control” of chattel paper in electronic form by expanding it to align with the definition of control for a CER.
Choice of Law
The choice of law rules for CERs generally provide that a CER may specify its jurisdiction in the CER or in a record logically associated with the CER and, if so, that will govern. If a particular jurisdiction is not provided for, the jurisdiction expressly provided for as the CER’s jurisdiction by the system in which the CER is recorded will govern. A series of other default rules take effect if neither of the foregoing apply, ultimately providing for Washington, D.C., to apply if no other rules are applicable.
What Is Excluded?
If a digital asset is not subject to control (as defined above), it falls outside of the definition of a CER for UCC purposes.
Article 12 also excludes digital assets that are already subject to commercial law, such as electronic chattel paper, electronic documents, investment property, transferable records under the federal E-SIGN law or the Uniform Electronic Transactions Act, deposit accounts, and electronic money.
The amendments clarify that adoption by a government of a preexisting CER (e.g., El Salvador adopting Bitcoin as legal tender) does not make that CER “money” for UCC purposes. All existing digital assets are therefore excluded from the definition of money as they existed and operated as a medium of exchange prior to government adoption. Central bank digital currencies (CBDCs), although not specified, are presumably included in the definition of money, as they do not exist or function as a medium of exchange prior to adoption by the issuing government.
Ramifications and Conclusion
Article 12 impacts many participants in the digital asset and NFT space, as well as financial institutions, investment banks, and lenders that deal in CERs.
Notably, the amendments only address state commercial law rules. They do not address the federal or state regulation or taxation of digital assets, or laws relating to banking, money transmitters, anti-money laundering, data privacy, or cybersecurity.
The individual US states may now adopt Article 12 as is, or with modifications as non-uniform versions. The transition rules for the amendments provide for a period during which parties to a transaction will retain their priorities existing on the effective date of a state’s enactment of the amendments. Parties to transactions should therefore be aware of the amendments and especially whether the state governing their transactions has enacted or plans to enact the UCC amendments, and should adjust accordingly.