The UCC and Emerging Technologies: Proposed Amendments

Dechert LLP

The Uniform Law Commission and the American Law Institute have recently approved and recommended for enactment in all states and U.S. territories amendments to the Uniform Commercial Code to address emerging technologies, like cryptocurrency, blockchain, artificial intelligence, and non-fungible tokens, among others. Market participants, legal practitioners, and other stakeholders should remain alert and keep current on the incorporation of these amendments into state laws and their effects on transactional, commercial and financing practices.

Background


Emerging technologies, such as bitcoin, blockchain and non-fungible tokens (“NFTs”), have led to the creation of massive alternative investment vehicles, additional portfolio diversification as well as expansion of the universe of types of collateral available for secured transactions. Since the introduction of these emerging technologies, market participants and legal practitioners have had to navigate a myriad of unsettled legal questions, which adversely affected the expansion of the digital economy due to the lack of clarity and uniformity.

Current rules and legislation were formulated when the existence of these technologies was not even envisioned. Since 1951, all U.S. states and territories have adopted versions of the Uniform Commercial Code (“UCC”). Even as amended over time, the UCC continues to fall short on providing clear rules for dealing with digital assets. Issues regarding the creation, perfection, enforcement, and priority of security interests in digital assets are not plainly addressed by the UCC as adopted in most states.1

Under existing law, secured creditors have faced difficult UCC Article 9 perfection issues in connection with liens in cryptocurrency, other digital assets and electronic contract rights, and especially with respect to those over which the secured creditor is given exclusive electronic access and other rights in connection with its lien.

First, parties to secured transactions involving such collateral have faced uncertainty as to which "category" of UCC collateral is even implicated. Is cryptocurrency "money"? Is it a "general intangible"? Is it "property" and thus a potential "financial asset" that may be held in a securities account? The market suspected what the answers to these questions should be, but its suppositions were untested and therefore significant risks persisted. Identifying the correct collateral "category" for UCC purposes is a fundamental first step in determining how such assets, as collateral, are to be treated.

Second, when a secured creditor is given a lien over collateral consisting of cryptocurrency and other digital assets or electronic contract rights, the secured creditor expects that the perfection of its lien in such collateral should reflect its rights and effective control over it, to the extent it has been granted such rights. But under existing law, this expectation has often been met with frustration, due to the absence of a UCC Article 9 concept of "electronic general intangible" (or the like), which would provide, in the arena of electronic contract rights generally, similar benefits (and the certainty) that already exist for secured creditors under current law in the arena of electronic chattel paper.

The 2022 Amendments


Recognizing the above-mentioned reality, in 2019, the Uniform Law Commission (“ULC”) and the American Law Institute (“ALI”), appointed a Joint Study Committee on the Uniform Commercial Code and Emerging Technologies (the "Emerging Technologies Committee") to evaluate potential UCC adaptation.

For more than two years, the Emerging Technologies Committee – including more than 300 observers (market participants, law firms, academics, judges, governmental agencies and others) – worked on analyzing and drafting proposed amendments to the UCC. In May and July 2022, ALI and the ULC, respectively, approved the proposed amendments. Once approved by both bodies, the ALI and ULC sent the proposed amendments to states and U.S. territories in July 2022.

These amendments (the “2022 Amendments”) address many of the issues and uncertainties described above by, among other things, creating a concept of “Controllable Electronic Record” (“CER”) in a new UCC Article 12 and specifically addressing intangible digital assets (whether currently known or unknown) in several existing UCC provisions (including in amendments to Articles 1, 2, 2A, 3, 4, 4A, 5, 7, 8, and 9). The 2022 Amendments recommend states adopt a uniform effective date of either January 1 or July 1, 2025, to maximize the number of states that will have the opportunity to enact the 2022 Amendments and to provide appropriate notice of the changes to those subject to their jurisdiction.

Controllable Electronic Records

The 2022 Amendments do not focus on a single section of the UCC, but instead endeavor to comprehensively modernize it with respect to the novel characteristics of digital assets. One of the most significant amendments is the creation of the CER concept in the new proposed Article 12, allowing secured creditors with liens in CERs, who have been granted certain exclusive access and related rights in connection with their collateral, to unambiguously achieve proper perfection and effective control.

A CER is any intangible digital asset that has characteristics enabling it to be subjected to control, so that it may be perfected by control. A secured creditor can establish control under the proposed amendments when

“(1) the electronic record, a record attached to or logically associated with the electronic record, or a system in which the electronic record is recorded gives the person:

(A) the power to avail [themselves] of substantially all the benefit from the electronic record; and

(B) exclusive power … to:

(i) prevent others from availing themselves of substantially all the benefit from the electronic record; and

(ii) transfer control of the electronic record to another person or cause another person to obtain control of another controllable electronic record as a result of the transfer of the electronic record; and

(2) the electronic record, a record attached to or logically associated with the electronic record, or a system in which the electronic record is recorded enables the person readily to identify itself in any way, including by name, identifying number, cryptographic key, office, or account number, as having the powers specified in paragraph (1).”2

A CER would specifically exclude, among other things, a deposit account, an electronic copy of a record evidencing chattel paper, an electronic document of title, electronic money and investment property.

The proposed UCC Article 12 also sets forth rules for the transfer of property rights in CERs, allowing their acquisition by a “qualifying purchaser” free of competing property rights, which, in addition to the rules related to the attachment, perfection, enforcement, and priority of security interests in CERs, creates a true “legal regime” for these assets.3

Although the prototypical CER is bitcoin and other cryptocurrency, the new UCC Article 12 has been designed to work as well for technologies that have not even yet been developed, providing rules intended to apply to various (currently known or unknown) intangible digital assets.4

It remains to be seen what impact the 2022 Amendments will have on state laws, the development of the digital economy, and transactional, commercial and financing practices. But at a minimum, market participants should pay close attention to the adoption of the 2022 Amendments by the states and U.S. territories.

 

Footnotes

1) Wyoming amended its UCC provisions in 2019 to address some of the issues relating to digital assets, including adding sub-categories for digital consumer assets, digital securities and virtual currency. See Wyo. U. Com. Code (Wyo. Stat. §§ 34-29-101-106).

2) U. Com. Code & Emerging Techs., § 12-105(a).

3) U. Com. Code & Emerging Techs., Prefatory Note to Article 12 at 250.

4) New Article 12 “aspires to apply to electronic assets that may be created using technologies that have yet to be developed, or even imagined.” Id.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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