Secured lending and the 2022 UCC amendments

7 minute read
20 October 2022

The increasing popularity and support for digital assets, the adoption and introduction of cryptocurrencies by various governments, and the widespread use of digital assets for donations, purchases, and the like have all helped to centre digital assets in the minds of investors.

Lenders and borrowers may be interested in using such assets to secure loans. Given the speed with which technologies have advanced, existing laws governing lending transactions have struggled to keep up. This article provides an overview of some key amendments to the United States Uniform Commercial Code (the "UCC") that account for emerging technologies. Changes to Canadian laws will no doubt follow.

The UCC has been critiqued for failing to provide clear and reliable rules for the creation, perfection, enforcement, and priority of security interests in digital assets. To address these criticisms, a committee appointed by the Uniform Law Commission ("ULC") and the American Law Institute drafted amendments to the UCC that provide a legal framework to govern transactions involving digital assets and emerging technologies (the "Amendments"). The Amendments seek to provide clarity by, inter alia, establishing rules relating to the transfer of rights in and perfecting a security interest in digital assets such as virtual currencies and non-fungible tokens. In July of this year, the Amendments received final approval from the ULC and have been recommended for enactment in each state.

Controllable electronic records

The Amendments include the addition of a new Article 12 that governs the transfer of property rights in digital assets, which are referred to therein as "controllable electronic records". A controllable electronic record ("CER") is a record in electronic form that is susceptible to control. This would include digital assets such as virtual (non-fiat) currencies and non-fungible tokens and specifically does not include electronic chattel paper, electronic documents, investment property, or deposit accounts as there are already legal rules that adequately govern these assets. Under the Personal Property Security Act (Ontario) (the "PPSA"), there are also existing rules that govern those types of assets.

The Amendments also introduce changes to Article 9 of the UCC to provide clarity with respect to perfection and priority of security interests in CERs. The goal of the drafters was to preserve as much as possible the existing means of creating a valid and enforceable security interest. There has been no change to the rules for attachment and CERs are classified as  "general intangibles" which means there is no need to amend collateral descriptions in security agreements or financing statements. A security interest in a CER may be perfected by filing a financing statement or by control. A security interest perfected by control (in accordance with the elements of control set out the new Article 12) will have priority over competing interests no matter the method or time of perfection of such interest.

Electronic money

The existing definition of money is broad enough to include intangible or electronic money, which includes token-based or account-based money. The Amendments revise the definition of money to exclude mediums of exchange that were not originally issued or distributed by a government.

For clarity, a medium of exchange that was not originally issued or distributed by a government, but that is subsequently adopted by a government (for example, Bitcoin, which was adopted as a form of currency in El Salvador), would fall within the previous definition of money, but not the new definition of money. Such electronic currency may still fall within the definition of a CER .

The only means of perfecting money under the UCC prior to the Amendments was by possession. Evidently, intangible mediums of exchange cannot be "possessed" in accordance with the UCC. The Amendments revise Article 9 to permit perfection of security interests in electronic money by control (similar to control of a CER). However, if electronic money is credited to a deposit account, the normal deposit account perfection rules shall apply.

Elements of control pursuant to the Amendments

A person will have control of a CER where they have:

  1. The power to enjoy substantially all the benefit of the CER or electronic money (exclusivity is not required);
  2. Exclusive power to prevent others from enjoying substantially all the benefit of the CER or electronic money;
  3. Exclusive power to transfer the electronic record or electronic money; and

Additionally, the person must be able to identify themselves to a third party as having the powers to enjoy the substantial benefit, exclude others and transfer. Such identification can be made by a cryptography key or account number.

Transferring CERs and qualifying purchasers

The Amendments provide that where a CER is purchased, the purchaser acquires all the rights held by the transferor in the CER. If the purchaser is a qualifying purchaser, they will take the CER free and clear of any competing interests in the CER. A purchaser is a qualifying purchaser if they obtain control of a CER for value, in good faith, and without notice of an existing claim.

Where payment rights such as accounts or payment intangibles are embedded in the CER and the account debtor has agreed to pay the person in control of the CER, the accounts and payment intangibles are considered "controllable accounts" or "controllable payment intangibles". If control of the CER is transferred, the controllable account or controllable payment intangible travels with the CER. Provided the transferee is a qualifying purchaser, the transferee will take the controllable account or controllable payment intangible free and clear of competing interests.

Importantly, laws outside the UCC and Article 12 will govern what rights (other than payment rights as described above) are embodied in a CER and whether the take-free rules applicable to the CER are extended to such rights. For example, real estate law or copyright law may govern real estate or intellectual property rights associated with an NFT.

In Ontario, the PPSA governs the creation, validity, and enforceability of security interests in personal property. It has been similarly critiqued for failing to provide adequate rules relating to security interests in digital assets. Historically, changes to the UCC have been largely mirrored in the PPSA, it is therefore very possible that Ontario will see similar amendments to the PPSA to account for digital assets and emerging technologies.

NOT LEGAL ADVICE. Information made available on this website in any form is for information purposes only. It is not, and should not be taken as, legal advice. You should not rely on, or take or fail to take any action based upon this information. Never disregard professional legal advice or delay in seeking legal advice because of something you have read on this website. Gowling WLG professionals will be pleased to discuss resolutions to specific legal concerns you may have.