Transferring digital assets under UCC Article 8
The Uniform Law Commission has recommended 2022 Amendments to the Uniform Commercial Code (the 2022 Amendments) which address, among other things, limitations on the liquidity of some digital assets under existing UCC Article 9. In particular, virtual currencies and electronic debt obligations classified as “general intangibles” or “payment intangibles” under Uniform Commercial Code (UCC) Article 9 (for convenience, this article will refer to them as Digital Assets) may currently be subject to a security interest perfected by a lender’s filing of a UCC-1 in the appropriate jurisdiction. The transfer or assignment of these Digital Assets to a new owner will often be subject to that security interest, which will travel with and continue to burden the Digital Assets even in the hands of a transferee or assignee.
While the 2022 Amendments will, if widely adopted, make it easier to transfer interests in those Digital Assets free of most third-party claims, it may be a considerable period of time before widespread adoption occurs. In the meantime, some owners and assignees of these Digital Assets, and their lenders, are turning to an alternative that already exists and is available in all 50 states and the District of Columbia – the “Financial Asset” structure available under Part 5 of UCC Article 8.
To explain the attraction and application of Part 5 of UCC Article 8, it is necessary to review the Financial Asset structure and how it may be implemented and enforced.
The Financial Asset Structure under UCC Article 8
A Financial Asset is any property that is held by a “Securities Intermediary” for another person in a “Securities Account” if the Securities Intermediary has expressly agreed with the other person that the property is to be treated as a Financial Asset under UCC Article 8. Who serves as a Securities Intermediary, and what constitutes a Securities Account, is based on the agreement of the parties – and UCC Article 8 makes it clear that such an agreement doesn’t necessarily make the Digital Asset a security for any other purpose.
A Digital Asset may therefore be designated a “Financial Asset” under UCC Article 8 as part of an agreement between the Digital Asset owner and a platform holding the Digital Asset, so long as the agreement also recognizes (i) the platform administrator as a UCC Article 8 Securities Intermediary and (ii) the collateral account/wallet where the Digital Asset is deposited as a UCC Article 8 Securities Account. Once the Digital Asset is designated a Financial Asset and is deposited in the Securities Account, the owner of the Digital Asset becomes the holder of a “Securities Entitlement” under UCC Article 8 (the Entitlement Holder) covering the Digital Asset.
Control of a Securities Entitlement under UCC Article 8
A person (a Purchaser) who takes an interest in the Securities Entitlement (by purchase, lease, discount, negotiation, mortgage, pledge, lien, security interest, issue or reissue, gift, or any other voluntary transaction) has “control” of the Securities Entitlement (and the covered Digital Asset) if any one of the following is true:
- the Purchaser is or becomes the Entitlement Holder in the records of the Securities Intermediary or
- the Securities Intermediary has agreed that it will comply with orders directing transfer or redemption of a Digital Asset covered by a Securities Entitlement originated by the Purchaser without further consent by the Entitlement Holder or
- a third party has control of the security entitlement on behalf of the Purchaser or, having previously acquired control of the security entitlement, acknowledges that it has control on behalf of the Purchaser.
This means that the owner of a Digital Asset who deposits it, or causes it to be deposited, in a Securities Account will usually become the original Entitlement Holder, and may transfer control of the Securities Entitlement (and the covered Digital Asset) to a transferee as part of a sale of the Digital Asset, or grant control of the Securities Entitlement to a secured lender in order to use the Digital Asset as collateral for a loan.
Such a transfer or pledge should usually take priority over the claims of third parties to an interest in the Digital Asset, where those third parties do not have control of the Securities Entitlement.
Attachment and perfection of a Security Interest in the Digital Asset
The interest of a secured party in a Digital Asset covered by a Securities Entitlement is generally perfected when the secured party obtains control of the Securities Entitlement, and that interest remains perfected so long as the secured party has control of the Securities Entitlement. Most significantly, a security interest in the Securities Entitlement (and the covered Digital Asset) perfected by control should usually have priority over a security interest the Securities Entitlement or the covered Digital Asset that is held by a secured party that does not have control.
Of course, even assuming a secured party obtains control, there are limitations and exceptions to the enforceability and first-priority status of any security interest. These are not necessarily specific to Securities Entitlements and are heavily dependent on the specific surrounding facts and circumstances. So the structure and timing of the creation and maintenance of the Securities Entitlement in the Securities Account, and the history of any prior transactions involving the Digital Asset that occurred before it is deposited in the Securities Account (if any), are crucial to evaluating and establishing control and priority. But, subject to that limitation and proper planning, Part 5 of Article 8 may frequently offer a viable alternative for creating and transferring interests in certain Digital Assets, at least until the 2022 Amendments come into effect.