The Uniform Commerce Code and Digital Assets: What You Need to Know | Orrick, Herrington & Sutcliffe LLP

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Digital assets have grown in popularity, with waves of innovation outpacing legislation and regulation. In an attempt to close the gap, the Uniform Law Commission has urged US states to change the commercial law governing the transfer of these digital assets. Here is an overview of the proposed changes:

What happened?

The Uniform Law Commission (Commission) recommended changes in 2022 to the Uniform Commercial Code (UCC) to govern the transfer of digital assets, including cryptocurrency, digital tokens, and non-fungible tokens (NFTs). The proposal contemplates adding a Chapter 12 to the UCC and other changes.

How did we come here?

Virtual currency and other blockchain-based digital assets have spread rapidly. In 2019, the Commission and the American Law Institute began considering recommending changes to the UCC to accommodate emerging technologies, including artificial intelligence, distributed ledger technology, and virtual currency.

The changes recommended by the Commission address issues such as whether cryptocurrency is “money”, how digital assets can be transferred to lenders and buyers, and how people or companies who buy digital assets can protect against adverse claims.

Who will the changes affect the most?

Despite the market upheavals affecting crypto, the NFT market is not a passing fad or limited to the crypto market. NFTs allow anything digital to be “tokenized” – represented in a digital record stored on the blockchain, including files containing images, videos and music. NFTs will encompass a range of assets such as virtual games, virtual real estate and virtual claims. The proposed changes aim to facilitate transactions involving virtual currency, NFTs and other digital assets, including:

  • Virtual currency and other digital tokens exchanged for goods and services.
  • Tokens evidencing membership interests in a limited liability company.
  • Sale of digital art and other collectibles, and digital images of athletes, artists, performers and others.
  • Sale of virtual currency.
  • Secured lending transactions, including digital assets pledged as collateral for funding.
  • Securities issued by startups, crypto companies, fintech companies and others in which payment is derived from virtual currency or other digital assets.

What happens next?

All 50 states, Washington, DC and US territories will review the recommendations. Several states have already adopted the amendments; others plan to do so soon. The effective date of the proposed changes will vary by state.

The Commission has proposed a grace period to allow lenders who hold security over digital assets to renegotiate terms. This period is called the “adjustment date”. Each state will choose an adjustment date of January 1 or July 1, 2025 or, whichever is later, the first anniversary of the effective date of a law.

What is an auditable electronic record?

Article 12 introduces some new terms. Here are four terms you are likely to hear:

  • Controllable Electronic Record (CER): A record of electronically stored information that is susceptible to control and that a person has the power to use.
  • Controllable account: An account materialized by a CER, and the agreement of the debtor of the account (debtor) obligated on the account to pay the person who controls the CER.
  • Controllable payment immaterial: An intangible payment evidenced by a CER, and the agreement of the account debtor (debtor) obliged on the intangible payment to pay the person who controls the CER.
  • Electronic money: Means of exchange authorized or adopted by a government or an intergovernmental organization in electronic form.

What types of digital assets would be subject to the proposed changes?

Examples include bitcoin, stablecoin, and other cryptocurrencies as well as digital art and music, digital coupons, hybrid tokens, and security tokens.

Is cryptocurrency “money”?

Cryptocurrencies are not considered “currency”, primarily because private parties – not governments – create them. Cryptocurrency is not considered “currency” even if a country allows or adopts it as a medium of exchange, as El Salvador did in 2021.

What should businesses (especially secured lenders) do with the proposed changes?

  • Know your warranty/portfolio: Does your borrower currently own any digital assets? What happens if your borrower acquires digital assets? Does your security agreement cover subsequently acquired digital assets? What is the lender’s lien priority? Does the lender control the digital assets? What are the lender’s rights if the borrower sells the pledged digital assets?
  • Obtain lien releases/verify your lien position: Are a borrower’s digital assets subject to pre-existing (adverse) privileges? Do you have any claims against the borrower or others for breach of representations, warranties or covenants of pre-existing liens?
  • Take control/File a financing statement: Update documents with borrowers to put you in control of digital assets.
  • Upgrade your systems: Do your systems or documents guarantee you control over digital assets? How will you verify/maintain control?
  • Monitor adoption of amendments: Changing lien priority will depend on each state’s applicable “adjustment date”. For each transaction, know the applicable law and the adjustment date.
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