Many individuals and entities now own digital assets such as cryptocurrency or nonfungible tokens (NFTs). And if those individuals or entities want to borrow money, they may want to use their digital assets as collateral for the loan. Although lenders are increasingly willing to accept digital assets as collateral, they have run into a problem — namely, how to perfect their security interest in the digital assets.
However, as this article points out, amendments to the Uniform Commercial Code approved by the UCC’s sponsoring organizations in 2022 mean that clarification may soon be coming.
Perfecting an interest in personal property
Digital assets are personal property. And the perfection of a security interest in personal property is, in general, governed by Article 9 of the Uniform Commercial Code (UCC).
Perfection under Article 9 can be accomplished by filing a UCC-1 financing statement, by controlling the property, or by possessing the property. Which method to use depends upon how the property is characterized in Article 9. Although Article 9 lists a number of different property types, until the 2022 UCC amendments, digital assets were not included, which is not surprising considering that the ownership of digital assets was not nearly as common in 2010 — the last time Article 9 was revised until 2022.
Perfecting an interest in digital assets under the pre-2022 amendments to Article 9
Because Article 9 did not include digital assets, lenders have analogized them to the types of property that are included in Article 9. And because with only a few exceptions, the states have not amended their UCC laws to address the perfection of digital assets, lenders are still using these analogies.
Some lenders treated digital assets as “general intangibles” — which are perfected by filing a UCC-1 financing statement. Others as “investment property” — which can be perfected by filing a UCC-1 or, preferably, by control.
Some analogize them to “money”, which is perfected by possession. But because digital assets are intangible, there is uncertainty as to whether they could be controlled or possessed.
Clarity is coming with Article 9 amendments and a new Article 12
Clarification as to how to perfect a security interest in digital assets is on the way. A few states have already amended their versions of Article 9 to address the issue.
In addition, the Uniform Law Commission and American Law Institute, the organizations that sponsor the UCC, have approved amendments to the UCC, which they have offered to the states for enactment. The UCC amendments include changes to most of the existing articles of the UCC, as well as adding a new Article 12, which governs transfers of interests involving a subset of digital assets referred to as “controllable electronic records” or “CERs”. There are also amendments to Article 9 addressing the perfection of a security interest in CERs.
In general, the states that have already amended their laws, as well as the 2022 UCC amendments, provide that a security interest in digital assets or CERs can be accomplished by filing a UCC-1 and/or by controlling the asset. They also provide that a lender that has perfected by control takes priority over a lender that has perfected by filing a UCC-1 but not by control.
The laws also define control. Under the UCC amendments, for example, control occurs when a person has (1) the power to enjoy substantially all of the benefits of the CER, (2) the exclusive power to prevent others from enjoying substantially all of the benefits of the CER, and (3) the exclusive power to transfer control of the CER.
Recent developments indicate that clarification as to how lenders can perfect their security interests in cryptocurrency, NFTs, and certain other kinds of digital assets is on the way. A few states have already amended their versions of UCC Article 9 to address this issue. More significantly, the UCC itself was just amended by its sponsoring organizations. Those amendments, among many other things, amend Article 9 to provide rules for perfecting security interests in digital assets.
Although it is too early to say if every state will adopt these amendments, the fact that every state adopted the last major amendments to Article 9, in 2010, may be an indicator of a willingness to adopt the 2022 amendments to Article 9 as well. If they do, it should provide a level of comfort for lenders and borrowers interested in using digital assets as collateral. However, it is important to keep track of the state legislative developments to see if and when the states amend their versions of Article 9 to address the perfection of security interests in this increasingly popular asset class.
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