The Uniform Commercial Code Amendments on Digital Assets: Where Do Things Stand? | Orrick, Herrington & Sutcliffe LLP
Delaware recently joined nine states in approving changes to the Uniform Commercial Code (UCC) involving digital assets. Another 15 states and Washington, D.C. are considering the changes.
The Uniform Law Commission urged states in 2022 to change commercial law governing the transfer of these digital assets. The Commission recommended changes that govern transfers (whether as a sale or as a financing) of digital assets, including cryptocurrency, digital tokens and non-fungible tokens.
The proposed changes also include the enactment of a new chapter (Chapter 12) to the UCC and conforming changes to other UCC chapters to address the perfection, priority and choice of law rules applicable to virtual currency (defined as electronic money) and other forms of digital assets.
Adopting Chapter 12 will reduce risks among claimants to digital assets a purchaser acquires, whether as a buyer or secured lender. It also will specify the rights in the assets.
2022 Amendments: Where Are We?
On August 18, 2023, Delaware became the latest state to enact the 2022 Amendments, joining Alabama, Colorado, Hawaii, Indiana, Nevada, New Hampshire, New Mexico, North Dakota and Washington. Legislators in New York, California, the District of Columbia and 13 other states have introduced bills to enact the 2022 Amendments.
What is New?
Article 12 introduces a few new terms. Here are four terms you’re likely to hear:
- Controllable electronic record (CER): A record of information that is stored in electronic form and is susceptible to control and that a person can demonstrate s/he has the power to “use.”
- Controllable account: An account that is evidenced by a controllable electronic record and the account debtor (obligor) obligated on the account has agreed to pay the person that has control of the controllable electronic record.
- Controllable payment intangible: A payment intangible evidenced by a controllable electronic record and the account debtor (obligor) obligated on the payment intangible has agreed to pay the person who has control of the controllable electronic record.
- Electronic money: Money (i.e., a medium of exchange authorized or adopted by a domestic or foreign government or by an intergovernmental organization) that exists in electronic form.
What Assets are Involved?
Many types of digital assets will be affected by the 2022 Amendments. These include the following:
Are These Changes Effective Now?
With their enactment, the 2022 Amendments are now effective in many states, including Delaware. The effective date of the 2022 Amendments varies by state.
How Will the Changes Affect Pre-existing Transactions and Liens?
- Impact on Pre-existing Transactions: Security interests in digital assets that were perfected prior to the effective date will remain enforceable after the adoption of the 2022 Amendments.
- Priority of Pre-existing Liens May Change – Adjustment Date Priority Change: The 2022 Amendments provide a grace period to give lenders who hold a security interest in digital assets perfected under the pre-Article 12 rules (e.g., by filing a financing statement) time to renegotiate terms as necessary to ensure their security interests remain protected and their lien priorities remain preserved. This period is referred to as the “adjustment date.”
- Under the 2022 Amendments, the adjustment date is July 1, 2025, or, if later, the date that falls one year after the actual date on which the act adopting Article 12 takes effect in the relevant state.
- On the adjustment date, new priority rules may override pre-effective date established priorities in digital assets and virtual currency. In other words, a secured party, even if junior to a pre-effective date lender, may have priority over a senior secured party if the senior secured party fails to obtain control prior to the adjustment date and the junior secured party obtains “control.”
Do You Have Control?
Control is the functional equivalent of “possession” of the digital asset. A purchaser/secured party has control of the digital asset/controllable electronic record if that party:
- Can demonstrate that the controllable electronic record (digital asset) or the system on which the digital asset is recorded readily identifies the person as having the power to reap substantially all of the benefits. The person can demonstrate having that power if the CER or the system in which the CER is recorded identifies the purchaser/secured party by name (or the person holds the private key, and the private key is required to access the benefit of the CER).
- Demonstrates the ability to prevent others from availing themselves of substantially all the benefits of the digital asset and the ability to transfer control of the digital asset to another person or cause another person to obtain control of a CER that is derived from the digital asset.
Alternatively, a purchaser/secured party will have control of the digital wallet (also referred to as the “securities account” in which the digital asset is held) if, among other things:
- The secured party, debtor and securities intermediary that maintains the digital wallet enter into an agreement (i.e., a control agreement) in which the securities intermediary agrees to comply with instructions originated by the secured party directing disposition of the financial assets (including the digital assets) held in the securities account without further consent by the debtor.
- In this case, the parties enter into an express agreement that the digital assets held in the digital wallet will be treated as a “financial asset,” and these assets will be credited to the account. If the parties agree to treat a digital asset as a financial asset and the digital asset is in fact held in a securities account, the rules applicable to “controllable electronic records” under Article 12 would not apply to the purchaser/secured party’s interest in the financial asset. ;Instead, the existing applicable rules under UCC Articles 8 and 9 would apply to the transfer of the assets held in the securities account.
Purchasers, Lenders and Investors: Are You Prepared for the 2022 Amendments?
Here are six key issues and related questions that purchasers, lenders and investors with interests in digital assets may want to consider:
- Identify the Digital Asset’s Choice of Law. Review the documents governing the digital asset (i.e., the electronic promissory note, electronic chattel paper, LLC token, Bitcoin, etc.).
- Does the document specify whether a particular state law governs? If not, does the system on which the digital asset is recorded specify a state law?
- If the document (or system) is silent, the law of the District of Columbia will apply. (If the District has not adopted the new rules, the proposed official rules will apply). Is that okay for the lender, purchaser, investor’s purposes?
- Control of Digital Asset. Does the system on which the digital asset is recorded identify you as the purchaser/secured party? Are you able to transfer the digital asset? Do you have the cryptographic key or account number to control the transfer of the digital asset?
- Monitor/Update Collateral Perfection. Consider updating documents with your borrowers/sellers to provide you control of any digital assets that your borrower/seller owns or may own. Lenders or secured parties with pre-existing security interest perfected by filing in general intangibles may lose priority on the adjustment date to a party who obtains control over the digital assets. Pre-existing liens could become subordinate if you don’t act by the adjustment date (July 2025).
- Update Transfer Notices to Obligors (Deflection Notices).
- Monetizing Controllable Accounts/Controllable Payment Intangibles. For accounts and payment intangibles representing interests in a digital asset, has the obligor on an account or payment intangible to be transferred agreed to pay only the person in control of the electronic record? If so, such an agreement can facilitate monetizing the controllable account or controllable payment intangible. The 2022 Amendments provide that a qualifying purchaser (other than a secured party) of a controllable account or a controllable payment intangible will take their interest free of third-party claims in the controllable account or controllable payment intangible. A qualifying purchaser is one that obtains control of the controllable account or controllable payment intangible for value, in good faith and without notice of any claim of a property interest in the controllable electronic record.
- Chattel Paper. Is the agreement(s) containing a monetary obligation and security interest in writing (i.e., a lease or financed property purchase)? How many originals of the writing exist? Who has the original agreements? Do you have all tangible copies? Do the agreements provide for the agreements to be converted into electronic documents? If so, what happens to the original paper copy? For electronic chattel paper, are you able to identify each electronic copy as authoritative or nonauthoritative? On the system on which the electronic chattel paper is recorded, are you identified as the assignee of each authoritative copy? Do you have the exclusive power to prevent others from adding or changing an identified assignee and to transfer control of the authoritative copies?