ULC approves important new amendments to the Uniform Commercial Code for state adoption

Last fall, we described the ongoing effort by the Uniform Law Commission (ULC) and the American Law Institute (ALI), as the joint sponsors of the Uniform Commercial Code (UCC) to draft proposed amendments to the UCC.  That drafting effort has now been completed, and during its July meeting, the ULC approved Amendments to the Uniform Commercial Code (2022), which are now recommended for enactment by the states.

The Amendments, if adopted by the states, would both create a new Article 12 of the UCC (UCC Article 12) and revise other, related provisions of the UCC – especially in Article 9.  The Amendments are wide ranging and cover a variety of topics and issues.  We will be examining the impact of the Amendments over the coming months.

Today, we will focus on certain provisions of the Amendments, and particularly UCC Article 12, that address gaps in the law governing the transfer of property rights (including both ownership rights and security interests) in certain assets that consist of, or are evidenced by, electronic records, where the law has lagged behind both technological developments and commercial practice. 

Examples include:

• Virtual currencies
• Non-fungible tokens (NFTs) and
• Payment intangibles and accounts evidenced by an electronic record.

In particular, the current structure and terms of Article 9 of the Uniform Commercial Code has impaired efficient transfer of interests in these categories of property in at least two respects:

• The proper classification of the Covered Property under UCC Article 9 is not always clear and
• Even when it is clear, the classification often makes it difficult for a transferee or pledgee to be certain that the transferred interest is taken free of third-party claims, absent detailed examination of state UCC filing records and/or negotiation of intercreditor agreements or claim releases.

At a high level, UCC Article 12 would extend the concept of “control” currently used with respect to certain other types of electronic records, such as a “transferable record” under Section 201 of the federal ESIGN Act (ESIGN) and Section 16 of the Uniform Electronic Transactions Act (UETA), to “Controllable Electronic Records.”  A Controllable Electronic Record will include some (but probably not all) NFTs and virtual currencies, as well as accounts and payment intangibles evidenced by an electronic record that includes an undertaking by the obligor to pay the person that has control (respectively, a Controllable Account or Controllable Payment Intangible).  

A Controllable Electronic Record does not include electronic chattel paper, electronic documents of title, electronic money (“money” is limited to fiat currency under the UCC), investment property, or transferable records (as those terms are defined in the Amendments).  Those categories of property will continue to be governed by their own stand-alone rules (which, in some cases, are affected by other part of the Amendments).  In addition, the commentary to Amendments cautions that in some instances having control of the electronic record doesn’t necessarily extend to rights in related property that is “tethered” to the electronic record (such as real estate, intellectual property, etc. that may be associated with an NFT).

As a general matter, UCC Article 12 gives a party in control of a Controllable Electronic Record the same type of super-priority currently granted to a party in control of a transferable record under ESIGN and the UETA – that is, the right to take an interest in the record free of most competing claims, even if that competing claim has otherwise been perfected under the UCC.   However, UCC Article 12 establishes more liberal standards for creating control than apply to transferable records, without creating a “safe harbor” that depends on the existence of an “authoritative copy,” as provided for in ESIGN and UETA. 

Under UCC Article 12, person has control of a Controllable Electronic Record if:

• The Controllable Electronic Record, a record attached to or logically associated with the Controllable Electronic Record, or the system in which it is recorded, if any, gives the person:
  • The power to avail itself of substantially all the benefit from the Controllable Electronic Record
  • The exclusive power to prevent others from availing themselves of substantially all the benefit from the Controllable Electronic Record and
  • The exclusive power to transfer control of the Controllable Electronic Record to another person or cause another person to obtain control of a Controllable Electronic Record; and
  • The Controllable Electronic Record, a record attached to or logically associated with the Controllable Electronic Record, or the system in which the Controllable Electronic Record is recorded, if any, enables the person to readily Identify itself as having the powers set forth above.

Note that a power is “exclusive” under UCC Article 12 even if:

• The Controllable Electronic Record, a record attached to or logically associated with the Controllable Electronic Record, or the system on which it is recorded, if any, limits the use to which the Controllable Electronic Record may be put or has a protocol programmed to cause a change, including a transfer or loss of Control or a modification of benefits afforded by the electronic record or
• The person has agreed to share the Power with another person.

The potential impact of UCC Article 12 on the assignment of rights in an electronically executed non-negotiable promissory note or other non-negotiable credit agreement is significant.  Many such obligations, evidenced by an electronic record, will qualify as Controllable Payment Intangibles. In particular, an assignment of a Controllable Payment Intangible using a transfer of control could serve to establish the priority rights of the assignee and, in many cases, eliminate the current need to conduct a UCC-1 search or file a UCC-1 financing statement with respect to the assigned obligation.

While the transferable record provisions in ESIGN and UETA remain intact, UCC Article 12 could be used as an alternative, with respect to debt obligations evidenced by electronic records that could also qualify as transferable records.  However, the choice to use UCC Article 12 will involve evaluating the relative benefits to a lender or investor of UCC Article 12 as compared to having the rights equivalent to a holder in due course under ESIGN and UETA.

Bear in mind that the choice of law provisions associated with UCC Article 12 can be complex, and that to date preliminary versions of UCC Article 12 have been adopted in Nebraska and Iowa (with adoption in progress in New Hampshire).  Until such time as it has been widely adopted, the utility of the UCC Article 12 provisions will likely be limited and will have to be evaluated on a case-by-case basis.