In its current form, the Uniform Commercial Code (“UCC”) does little to accommodate emerging technologies such as cryptocurrencies and non-fungible tokens.  In efforts to modernize and adapt the Uniform Commercial Code to newer technologies, the Uniform Law Commission (the “ULC”) and the American Law Institute have jointly sponsored the drafting of proposed extensive amendments to the Uniform Commercial Code, particularly in respect of new Article 12 (the “UCC Amendments”).  In July 2022 the ULC adopted the UCC Amendments as a model law which is now recommended for enactment by state legislatures throughout the U.S. in its entirety or with non-uniform state-specific variations.  We note that presently preliminary versions of Article 12 have been adopted in Nebraska, New Hampshire and Iowa, and Wyoming has recently enacted the Stable Token Act.  North Dakota has adopted the UCC Amendments in their entirety.

 UCC Articles 3 and 9 govern the sale and pledge of negotiable instruments (i.e., drafts and bills of exchange).  The significance of the proposed UCC Amendments in respect of drafts and bills of exchange is that they eliminate the current UCC Article 3 requirement that such drafts/bills of exchange be in a traditional paper form and “signed” with wet ink signatures.  The is a significant and very positive change because under revised Article 3 and new Article 12, there may be no further need to produce and deliver a physical negotiable instrument.  Elimination of the requirement of a paper draft will solve long-standing problems that have significantly constrained the growth of draft/bill of exchange-based financing structures in trade finance transactions.  The current UCC requirements for paper transfer of drafts/bills of exchange signed by the seller, circulated to the buyer for signature/acceptance and then endorsed and vaulted for safe-keeping or delivered to the seller’s bank leads to cumbersome processes, delays and expense, limitations that negatively impact the financing, and purchase and sale of goods and services in the U.S. and beyond.  Replacement of physical drafts with electronic drafts has the potential to eliminate these problems and spur the rapid growth of digital drafts/bills of exchange transactions and high volume buyer-led digital drafts financing programs across the globe.  The existing Uniform Electronic Transactions Act (“UETA”) which has been implemented 49 states (excluding New York State) and the Federal ESIGN Act (“ESIGN”) and similar “electronic records-related” legislation in other countries have paved the way for the innovations reflected in revised Article 3 and new Article 12 by increasing efficiencies and stimulating the growth of commercial transactions generally.

Revised Article 3 facilitates the transformation of a physical negotiable instrument to an electronic record in tandem with new general definitions in UCC Section 1-201.  Among other changes, new Subsection 3-105(a)(2) permits an instrument to be issued by an electronic transmission of an image and information derived from the instrument by the maker and drawer, rather than by physical delivery.  As a general matter, terms that applied only to paper transactions in the UCC have been omitted entirely from the UCC Amendments or redefined to encompass electronic transactions.  For example, definitions set forth in Section 1-201 have been amended so that the defined term “sign” now encompasses electronic signatures, “record” has replaced “writing,” and “conspicuous” has been redefined to broadly encompass both paper and electronic agreements.  The first two amended terms are directly relevant to digital drafts/bills of exchange to the extent they gain traction in the marketplace as viable commercial assets.

The New Article 12 in the UCC Amendments creates a class of digital assets defined as “controllable electronic records” (“CERs”). A CER is a “record stored in an electronic medium that is susceptible to ‘control.’”  The UCC Amendments provide for a CER to be, in effect, negotiable, i.e., capable of being transferred in such a way as to cut off competing property claims (including security interests) to the CER.  The UCC Amendments also provide for a security interest in a CER to be perfected by “control” to have priority over a security interest in the CER perfected only by the filing of a financing statement.  The control test in Article 12 is intended to work with systems that satisfy the requirement of control under UETA, as well as new technologies. At a high level, 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 ESIGN and the UETA to the concept of “controllable electronic records” under the UCC Amendments. 

“Accounts” or “payment intangibles” (as those terms are defined in UCC Article 9) can be evidenced by a CER, creating a “controllable account” or “controllable payment intangible” if the party obligated on the account or payment intangible has agreed to pay the person in control of the CER. If control of a CER that evidences a controllable account or controllable payment intangible is transferred, the controllable account or controllable payment intangible travels with the CER, and the transferee, if a “qualifying purchaser,” benefits from the same “take-free” rule that applies to the CER. A “qualifying purchaser” is a purchaser that obtains control of a CER for value, in good faith, and without notice of a claim of a property right in the CER, analogous to the current UCC Article 3-302 definition of a “holder in due course” in respect of a purchaser of negotiable instruments.  The effect is to create what is functionally an electronic instrument even though the payment rights continue to be classified as a “controllable account” or “controllable payment intangible.”

If the terms of the account or payment intangible also provide that the account debtor will not assert claims or defenses against the transferee of the CER (as, and to the extent, permitted by UCC Section 9-403), the effect is to create the substantial electronic equivalent of a negotiable instrument.  However it is important to note that a negotiable instrument under Article 3 and a payment intangible under Article 12 that works in a functionally equivalent way, are not one and the same:  in order for an electronic form of a physical draft to meet the Article 12 requirements, the content of the traditional draft would need to be altered to replace “pay to the order of” with a buyer’s “promise to pay to the person in control of such draft” and additionally, such draft would need to state on its face that the buyer agrees not to assert claims or defenses against any transferee. 

These Article 12 CER “control” provisions are intended to address market concerns in the trade finance area that commercial law rules are currently insufficient to support widespread electronic drafts/bills of exchange programs.  In short, Article 12 gives a drafts/bills of exchange purchaser who is in control of the related CER the same type of holder-in-due-course priority achieved by such purchaser under the current version of Article 3 in respect to the possession of a physical draft/bill of exchange, that is, the right to take an interest in the record (e.g., a draft or bill of exchange) free of most competing claims, even if that competing claim has otherwise been perfected under the UCC.                  The UCC Amendments could, in theory, have a profound impact on trade finance. Nonetheless there are a number of obstacles to practical implementation.  While some banks or Fintechs may be able to gear up to meet the Article 12 control tests for CERs right away, such parties face significant practical hurdles to widespread adoption.  These technologies may go mainstream or they may not, and even if they do become the norm, the timing of when they might happen is uncertain, particularly in the wake of the recent string of scandals and bankruptcies involving crypto currencies.  Given these challenges, there is a great deal of uncertainty whether the transfer or pledge of digital assets will become routine.  Whether new Article 12 has any real practical application, at least in the short term, remains to be seen.  Moreover, new Article 12 will have limited utility as far as cross-border trade finance transactions are concerned.  If one of the parties to the transaction is outside of the U.S., it is a given that the entity is residing either in a jurisdiction that does not recognize the concept of digital assets or has a differing interpretation as to how those assets can be sold or pledged.  For example, the UNCITRAL Model Law on Electronic Transferable Records (2017) (“MLETR”) addresses many of the same issues as Articles 12 and 3 of the UCC Amendments but approaches those issues entirely differently.  If the jurisdiction of the non-U.S. counterparty has adopted MLETR, then there will likely be an inconsistency or conflicts of law in how the finance or sale of digital assets is addressed.  Also, it is not clear how quickly MLETR – or other similar laws in respect of digital assets or electronic records – will be prevalent across the globe.^[1]  If the jurisdiction does not recognize the concept of digital assets, then any proposed cross-border transaction involving that jurisdiction and digital assets may have significant enforceability issues.

[1] MLETR has to date been adopted in Singapore, Bahrain and Abu Dhabi.