Green Grass and High Tides for Crypto: Article 12 of the UCC Explained
In 2022, the National Conference of Commissioners on Uniform State Laws and the American Law Institute published the first substantive amendments to the Uniform Commercial Code (UCC) since 2010 (the “2022 Amendments”). For clarity, whenever this post refers to the UCC, it will be referring to the UCC as amended by the 2022 Amendments. The 2022 Amendments have been adopted by 25 States and adopting legislation has been proposed in 9 additional states. The purpose of the 2022 Amendments was to pave the way for governing rights vested in “Controllable Electronic Records” or “CERs” including existing technologies like Bitcoin and also to anticipate technologies that will be developed in the future. As a part of an ongoing series of posts unpacking the 2022 Amendments, this blog summarizes the new Article 12, which was created by these recent amendments and principally governs ownership and transfer of CERs.
Article 12, in its drafters’ comments, makes clear the intention to allow CERs to operate as a “functional equivalent” of negotiable instruments. Negotiable Instruments, such as treasury bonds, promissory notes, and checks, are a unique asset class governed by Article 3 of the UCC and subject to special rules under Article 9 for Lenders seeking to perfect security interests in them as Collateral. Likewise, CERs governed under the new Article 12 are subject to special rules of perfection stated in Article 9 as amended in the 2022 Amendments. To analyze the amended Article 9, one must break down the definition of a Controllable Electronic Record and assess the rules for the ownership and transfer of CERs contained in Article 12.
“Controllable Electronic Record” is defined by Section 12-102(1) of the UCC; it means a record stored in an electronic medium that can be subjected to control under Section 12-105. However, the definition of CER excludes the following: controllable accounts; controllable payment intangibles; deposit accounts; electronic copies of records evidencing chattel paper; electronic documents of title; electronic money; investment property; or transferable records. That laundry list of exclusions is complicated most by the term “electronic money”. Twenty-five states have implemented the 2022 Amendments, but many of them have altered or excluded the proposed definition of electronic money, and by extension have altered the definition of a CER. This means that, in the future, the determination of whether a particular category of crypto-based asset is a CER or Electronic Money will be highly sensitive to the choice of law provisions contained in the parties’ documents or in the CER’s code, which will affect the perfection analysis under Article 9 as well.
“Control” of a CER is defined by Section 12-105. To paraphrase: control in this context means that the record or the system in which the record is recorded gives the controller:
(a) the power to avail themselves of substantially all of the benefit of the record;
(b) the exclusive power to prevent others from availing themselves of substantially all of the benefit of the record; and
(c) the exclusive power to transfer control of the record to another person.
Section 12-105 goes on to clarify that the powers in subsection (b) and (c) above remain exclusive even if the record itself has limitations on its use or if the power in question is shared with another person. Power is not shared and not exclusive (which means control has not been achieved) if the person claiming control cannot exercise the power without the consent of the person with whom they claim to share the power but the person with whom they claim to share can exercise the power without their consent. What reasonably follows, in effect, is that in order to effectively share control of a CER, the contract or protocol within the CER effecting that sharing must afford equal rights to both parties sharing control. They must either both be able to act without the other’s consent or they must both be able to act only with the consent of the other.
This leads to the next question: what is the “benefit” of a CER under section 12-105? The answer depends on the CER in question. Some CER’s can evidence a right to future payments. In those cases, receipt of those payments is the benefit. Others, such as Bitcoin, benefit their controller by serving as a store of value. That is to say that you benefit from a Bitcoin when you can spend it for goods or liquidate it for money. Accordingly, in the case of Bitcoin and other cryptocurrencies, having control means simply having the exclusive ability to spend or sell your Bitcoin or cryptocurrency.
Control in this context is not the same as having a property interest (such as ownership or a security interest) in the CER. This distinction is important. Control is critical because it contributes to the definition of a “Qualifying Purchaser” under section 12-102(2). A Qualifying Purchaser is a purchaser of a CER or an interest in a CER that obtains Control of the CER for value, in good faith, and without notice of a claim of a property right in the CER. Under Section 12-104(e) a Qualifying Purchaser acquires its rights in a CER free of any claim of a property right in the CER. Accordingly, good faith purchasers for value who acquire control of a CER will take ownership free and clear of any security interest in the CER held by any creditor. This deliberately parallels the rules governing the purchase of negotiable instruments and forms the foundation for Article 9’s provisions on perfection in CERs by control in addition to or instead of filing.
A deeper analysis of the revisions to Article 9 and a 50-state survey of the 2022 Amendments’ Implementation is needed for the practical use of the 2022 Amendments and CERs. Please stay tuned for further updated blogs on these and other Article 12 subjects.
For more information on the 2022 Amendments to the UCC, click here.
