UCC Amendments: Finally Catching Up with the Digital Assets Frenzy

The digital assets industry has grown exponentially since Bitcoin was first introduced in 2009. (Wulf Kaal, Digital Asset Market Evolution). Though the digital assets market value is infamous for its volatility, the worldwide market capitalization of digital assets reached over $3 trillion at its height in November 2021. (Joanna Ossinger, TIME). As investors and the public more frequently use cryptocurrencies, non-fungible tokens (“NFTs”), and decentralized finance, the risks associated with digital assets increase. Id. Moreover, questions arise on how the law can protect property interests that investors have in these digital assets. (Fact Sheet, The White House). Naturally, regulators and market participants look to existing legal frameworks as well as potential new laws and rules for guidance. So far, the Securities and Exchange Commission (the “SEC”) has published its analytical framework in analyzing digital assets (See SEC, Framework for “Investment Contract” Analysis of Digital Assets), President Biden has issued an Executive Order (SeeExecutive Order) directing research efforts around digital assets, and many bills related to digital assets have been introduced. (Keith Barnett et al., Troutman Pepper).

The latest updates include the Uniform Commercial Code (the “UCC”) amendments (the “Amendments”), which clarify the use of digital assets as collateral in secured transactions. (Final Act of the Uniform Commercial Code Amendment). A joint committee of the American Law Institute and the Uniform Law Commission writes the UCC, which is a uniform law attempting to streamline various commercial transactions. (See The American Law Institute). Either in whole or in part, all 50 states and the District of Columbia have adopted the UCC. (Uniform Commercial Code, Georgetown Law Library). Once the states adopt the Amendments, the UCC should provide clearer guidance on how to resolve issues around security interests and priority of claims around digital assets. (Sandra Rocks et al., Cleary Gottlieb).

Further, the Amendments update nearly every Article of the UCC and generally extend coverage of the UCC to transactions involving emerging technologies. (Final Act of the Uniform Commercial Code Amendment). Specifically, the new Article 12 classifies digital assets such as Bitcoin, Ether, NFTs and others under a new term – “controllable electronic record” (“CER”). (Deric Behar & Lawrence Safran, JD Supra). Rather than using terms such as “blockchain” or “distributed ledger,” CER is a technology neutral term that can apply to future technologies. (Sandra Feldman, Wolters Kluwer). In conjunction with relevant updates to Article 9, the new Article 12 sets out rules to govern the acquisition and disposition of security interests in a CER. Id. Under Section 12-102, CER means “a record stored in an electronic medium that can be subjected to control.” (Final Act of the Uniform Commercial Code Amendment). To be clear, CER does not include certain digital assets such as electronic chattel paper, investment property, and deposit accounts that are already covered by Article 9. (Sandra Feldman, Wolters Kluwer).

To establish priority in collateral, a secured party needs to attach its security interest and perform an act of perfection. (SeeIra Herman, Blank Rome). Just like other types of collateral under Article 9, the attachment of a security interest to a CER requires: (1) value to be given for the security interest, (2) the debtor to have rights in the collateral or the power to transfer rights in the collateral, and (3) an authenticated security agreement. Id. To properly perfect a security interest in a CER, a party may obtain control of the CER or file a financing statement. Id. A security interest perfected by control has priority over a security interest perfected by filing, even when control is established after proper filing of a financing statement. Id. To gain control, a person must (1) have power to enjoy substantially all the benefits of the CER (this power does not have to be exclusive), (2) have exclusive power to prevent others from enjoying substantially all the benefits of the CER, (3) have exclusive power to transfer control or to cause another person to obtain control of the CER, and (4) be readily able to identify itself as the person in control. (UCC § 12-105, Final Act of the Uniform Commercial Code Amendment). This section presumes exclusivity of power listed above under (2) and (3). Id. Another noteworthy provision in Article 12 is the negotiability provision, which provides that a qualifying purchaser—a purchaser for value, in good faith, and without notice of prior property claim to the CER—takes the CER free of competing property claims. (UCC § 12-104, Final Act of the Uniform Commercial Code Amendment).

Article 12 also addresses the choice of law issue with CERs. (Edwin Smith, Morgan Lewis). Generally, the CER is located in the jurisdiction as expressly stated in the CER. Id. If the CER does not state a jurisdiction, then it is located in the jurisdiction stated to govern the system in which the CER is recorded. Id. However, if the CER does not state a jurisdiction, then as a last resort, the law of Washington D.C. would apply. Id.

In adopting the UCC Amendments, each state will be able to set its own effective date. (Devika Kornbacher, Clifford Chance). It is important to point out that the Amendments will apply to pre-existing interests in CER. Id. However, a phase-in period of one year is built in to allow secured parties to act according to the new Amendments to protect their security interests. Id.

As of August 1, 2022, Iowa, Indiana, Nebraska, and New Hampshire have adopted the Amendments. (Practical Law). However, prior to the UCC Amendments coming out, some states proactively implemented their own statutory updates involving digital assets in their respective versions of the UCC. (Robert Isham III, American Bar Association). This may cause some inconsistencies, especially considering a major attribute of digital assets is the ease of transferability without regard to geographical bounds. (Ropes & Grey). Notwithstanding the potential conflict of law issues, lenders and financial institutions will, no doubt, have an easier time arranging secured lending transactions by relying on the Amendments, as a lender can perfect its security interest by obtaining control of the CER. (Lorraine McGowen, Orrick Herrington & Sutcliffe).

Although the UCC is catching up to the growing usage of digital assets, it is important to note that the UCC only covers commercial laws and only at the state level. (Ropes & Grey). To fully immerse digital assets into our economy, the laws around anti-money laundering, taxation, and securities at the federal level still have some catching up to do.