Virtual Currencies (and Other Digital Assets) Under the UCC
Virtual currencies continue to gain acceptance in commercial transactions. As a result, financial institutions are beginning to accept such currencies as collateral for financings. However, Article 9 of the Uniform Commercial Code (UCC) falls short of providing adequate guidance on how to create or perfect a security interest in these currencies. This uncertainty, and the consequent risks to lenders, are further exacerbated by the lack of helpful case law and non-uniform state laws. Recognizing this problem, the Uniform Law Commission and the American Law Institute in 2019 organized the Uniform Commercial Code and Emerging Technologies Committee (the Committee) to consider changes to the UCC intended primarily to address "digital assets" (a term used but not defined by the Code drafters), such as some virtual currencies. This article examines the scope of UCC Article 9 with a focus on virtual currencies, taking into consideration issues of classification and perfection, but also how the Committee is attempting to tackle these unsettled issues by modifying existing provisions and, in some cases, adding new ones.
Broadly speaking, virtual currency is a currency available only in electronic form. Currencies can be a government-authorized medium of exchange (see the UCC definition of "money" in §1-201(a)(24)), or they can exist through a decentralized system, with no central administrator controlling the currency supply. Decentralized currencies, which include Bitcoin, are not generated or supported by any central bank or other government agency; instead transactions are recorded through ledger entries across decentralized computer networks known as blockchains. Once verified, the transaction information becomes part of a permanent and unchangeable "block." Owners of the virtual currencies are able to transfer units of these currencies through the ledger system that records ownership and transfers, serving as a financial transaction database, which creates transparency among the various parties.
As many creditors know, for a security interest to be effective against the debtor it must initially "attach" to collateral, meaning there must be evidence of an intent of the debtor to grant a lien on such collateral in favor of the creditor. This is typically done through a security agreement. Then, in order for such lien to be effective against other parties, such as trustees in bankruptcy, it must be "perfected."
Article 9 divides the personal property it covers into over 12 different buckets. Determining which category (or bucket) your collateral falls into is of critical importance to a creditor, as it can dictate the correct approach to both attaching and then perfecting a lien on its collateral. Per UCC §9-108(a), a collateral description in a security agreement is sufficient to attach a lien to collateral if it "reasonably identifies what is described." UCC §9-108(b)(3) provides a safe harbor for that collateral description, that being if the asset is described by its correct category type. The methods of perfecting a security interest also vary depending on the collateral classification. Thus, the uncertainty over what collateral category a virtual currency falls within sows confusion at this all important step. Not surprisingly, one of the biggest challenges facing creditors in perfecting liens on virtual currencies is determining the correct category of asset type.
The fact that virtual currency is intangible certainly narrows the possibilities, the most likely candidates being money, deposit accounts, investment property and general intangibles.
UCC §1-201(b)(24) defines "money," in part, as "a medium of exchange currently authorized or adopted by a domestic or foreign government." While one might first logically turn to "money" as the likely category for virtual currency, and while virtual currency undeniably functions as a payment mechanism similar to traditional tangible money, until recently there was no virtual currency that actually met this definition. That is to say, virtual currency (such as Bitcoin) was not fiat currency—i.e., it had not been authorized or adopted by a domestic or foreign government—until recently, when El Salvador approved Bitcoin as legal tender. More importantly, perfecting a lien on collateral that constitutes "money" requires possession, and that obviously is inconsistent with the intangible nature of virtual currencies.
UCC §9-102(a)(29) defines "deposit account" in part as a "demand, time, savings, pass-book, or similar account maintained with a bank." This part of the definition prevents virtual currency from being classified as a deposit account since such account must exist through an intermediary—i.e., a bank or similar financial institution, the functions of which are not provided by virtual currency exchanges.
UCC §9-102(a)(49) defines "investment property," in relevant part, as a "security, whether certificated or uncertificated, security entitlement, ... or securities account ... ." These terms, somewhat like Russian dolls, are in turn defined by various definitions under Article 8 of the UCC per UCC §9-102(b). As virtual currencies are intangible assets, they would constitute either an uncertificated security or a security entitlement. UCC §8¬102(a)(15) defines a security, in part, as an obligation of an issuer represented by a security certificate or the transfer of which may be registered on books maintained by or for the issuer, which is one of a class or series or divisible into such class or series, and is either (1) of a type dealt in or traded on securities exchanges or (2) a medium for investment and by its terms provides it is a security governed by Article 8. "Security entitlement" is defined in UCC §8-102(a)(17) as a "financial asset," which is itself defined in UCC §8-102(a)(15), in relevant part, as a "security," an obligation or interest of a type dealt in or traded on financial markets or recognized as a medium for investment, or any property held by a securities intermediary in a securities account if it has been agreed that the subject property is to be treated as a financial asset.
It would be difficult to see a virtual currency fitting within these investment property criteria. It reflects neither a particular entity's obligation nor an interest in any cognizable entity. Therefore virtual currency would likely fail the definitional requirements of "security," "financial asset," and "security entitlement," and ultimately the classification of "investment property."
The most obvious category for virtual currency would be the catchall category of "general intangibles." Per UCC §9-102(a)(42), a general intangible is essentially any personal property that does not fit within any other specific collateral classification. The term has been interpreted as including such personal property intangibles as intellectual property and software. For now, virtual currency would most likely be classified as a general intangible.
Clearly, the Committee has its work cut out. Putting aside the issues regarding Article 9, there are numerous other flashpoints where digital assets touch upon commercial law. The Committee issued its first draft legislation this past July. Its goal is to obtain American Law Institute approval of this important legislation at its May 2022 annual meeting, and then final approval by the Uniform Law Commission at its July 2022 annual meeting.
The proposed amendments to the UCC include amendments to Articles 1 and 9 intended to address the concept of "intangible money" and then provide for its perfection by control. The amendments also create a new Article 12 entitled "Controllable Electronic Records." Article 12 is intended to establish a "legal regime" for digital assets that governs the transfer, either fully or for security, of interests in some, but not all, electronic records. Alongside such proposed new article are revisions to Articles 1 and 9 that create the definitions of "controllable account" and "controllable payment intangible," and rules that address, among other things, the attachment, perfection, priority and enforcement of security interests in such assets, as well as in "controllable electronic records."
Intangible Money. The draft proposal includes amendments to Article 9 to accommodate intangible money that serves as collateral. The one exception that also deals with tangible money relates to the actual definition of "money" in Article 1. That term, which includes tangible as well as intangible currency, remains defined as a medium of exchange authorized by a government, but language also including a "monetary unit of accounts established by an intergovernmental organization or by agreement between two countries" would be eliminated.
So "intangible money" would in this case be intangible fiat currency (i.e., authorized by a government, as is the case in El Salvador, for example), as opposed to intangible non-fiat currency, which is virtual currency that has not been adopted or authorized by a governmental authority. "Intangible money" is not actually defined in Article 1 or 9, although it would be made clear that "intangible money" does not include "money" that is a deposit account.
Under a proposed new UCC §9-105A, a security interest in intangible money can be perfected by control (as is the case with tangible money), and only by control. Perfection by control requires, among other things, that the intangible money, or any system in which it is recorded, give the secured party the power to avail itself and to prevent others from availing themselves of substantially all the benefit from the intangible money; and to transfer control or enable another person to obtain control of the intangible money that is traceable to the intangible money; and the intangible money, or a record or system attached to or associated with it, if any, enables the person to readily identify itself as having these powers. The provision clarifies that a power is exclusive even if the intangible money or any related system limits the use to which the money may be put or has protocols programmed to result in a transfer of control, or the person has agreed to share the power with another person.
The report acknowledges that certain countries might authorize or adopt intangible money as a medium of exchange, while others might authorize or adopt accounts with a central bank. Significantly, the Committee notes that while they have acknowledged this possibility, they have not yet considered how such an action may affect future drafts of their proposals. Moreover the report acknowledges the development in El Salvador, but again reserves comment on how this action may affect future draft legislation.
Controllable Electronic Records. According to the Committee, "controllable electronic records" is a subset of "digital assets." Under new Article 12, a "controllable electronic record" is a record (i.e., per UCC §1¬201(b)(31), information that is retrievable in perceivable form) that is stored in an electronic or other intangible medium and can be subjected to control, as defined in proposed UCC §12-105.
Article 12 largely applies to transfers of interests in records. As per the reporter's note, law other than Article 12 would determine whether a person acquires any rights in a controllable electronic record and so would be eligible to be a purchaser (being an acquirer of an interest in property through a voluntary transaction, such as a sale). Accordingly, in the case of a purchaser that is a secured party, the draft first refers to Article 9 to determine what steps must be taken to acquire rights as a secured party (and the scope of the rights being acquired) with respect to such records.
Under the draft amendments to Article 9, UCC §9-203 would determine whether a secured party had an enforceable security interest against a controllable electronic record. The secured party would also need to comply with Article 9 to perfect its security interest in that controllable electronic record, either by obtaining control over that record under Article 12 (the rules being the same as those with respect to control of intangible money under Article 9 (discussed above)) or by filing a financing statement.
In addition, the amendments create two new concepts related to controllable electronic records: accounts and payment intangibles evidenced by a controllable electronic record. These rights to payments are defined in UCC §9-102(b) as "controllable accounts" and "controllable payment intangibles." The attachment and perfection of a security interest in a controllable electronic record would also confer attachment (per UCC §9¬203(j)) and perfection ((per UCC §9-310(h)) of a security interest in controllable accounts and controllable payment intangibles evidenced by the controllable electronic record. Under these amendments, perfection of a security interest in controllable accounts and controllable payment intangibles can be achieved by obtaining control of the related controllable electronic record. Perfection of a security interest in a controllable account or controllable payment intangible can also be achieved by filing a financing statement.
Under proposed UCC §9-326A, a security interest in a controllable electronic record, controllable account, or controllable payment intangible perfected by control would have priority over a conflicting security interest perfected by another method perfected by another method (e.g., filing a financing statement).
The growing use of virtual currencies as collateral for secured loans has highlighted the shortcomings of the UCC, in particular Article 9, in respect of these assets and the need for amendments to accommodate them. New Article 12 lays the groundwork for rights of transferees in these intangible assets ("controllable electronic records"), and the amendments to Article 9 largely deal with the security interests in those assets. While we are far from having definitive answers, and much may change in regard to the Committee's proposals, its efforts are a big step in the right direction, showcasing their willingness to modernize the UCC to reflect emerging technology.
Barbara M. Goodstein is a partner at Mayer Brown. David B. Kobray , an associate in the firm's finance practice, assisted in the preparation of this article.
