US Commercial Laws Get Ready for Digital Assets

In July 2022, the Uniform Law Commission approved proposed amendments to the Uniform Commercial Code (Proposed UCC) addressing transactions involving emerging technologies such as virtual currencies and distributed ledger technologies. When adopted by the states, these new rules will provide much-needed clarity in the treatment of digital assets lacking under most states' commercial laws. A notable exception to the general absence of digital assets-related rules is Wyoming's UCC,  which was amended in 2019 (Wyoming UCC) to address digital assets. In this article¹ we highlight and compare the salient features of the Proposed UCC and the Wyoming UCC, with the former offering more comprehensive and future-proof changes to accommodate new technologies. Until the Wyoming UCC is conformed to the Proposed UCC, parties will need to be aware of the differences and plan for a potential transition.

General Approach

The Uniform Commercial Code divides assets into different categories and prescribes different rules regarding transfer and creation, perfection and priority of security interests. The Wyoming UCC takes a somewhat surgical approach by treating, for purposes of the provisions relating to security interest, digital assets as existing categories of assets – even if inconsistent with the definition of existing categories. It addresses digital assets and technologies that are currently in the market, defining "digital assets" as a representation of rights that are stored in computer readable format.²

Sponsored by the Uniform Law Commission and the American Law Institute, the Proposed UCC seeks to address digital assets, both in their current form and with potential future evolution, by focusing instead on the effect of the technology – control – and sets forth a more comprehensive set of commercial law rules for transactions involving digital assets.

Digital Asset Categories

The Wyoming UCC defines three mutually-exclusive types of digital assets, and categorizes them using the existing categories, but only for purposes of Article 9 (Secured Transactions) and Article 8 (Investment Securities):

• "Digital security" is a digital asset that meets the definition of security under the Wyoming UCC,³  and considered securities (under Article 8) and investment property (under Article 9).⁴
• "Virtual currency" is a digital asset that is used as a medium of exchange, unit of account or store of value,⁵ and not recognized as legal tender by the U.S. government, and considered money.⁶
• "Digital consumer assets" are digital assets that do not fall into the other two categories,⁷  and considered general intangibles.⁸

The Proposed UCC creates a new UCC asset category for most digital assets (subject to exclusions), and some subsets of existing categories specific to other digital assets:

• "Controllable electronic record" is a new category under the UCC, and means a record stored in an electronic medium that can be subjected to control as defined under Section 12-105⁹  (and discussed below).
• "Controllable account" means an account evidenced by a controllable electronic record that provides that the account debtor undertakes to pay the person that has control of the controllable electronic record.¹⁰
• "Controllable payment intangible" means a payment intangible evidenced by a controllable electronic record that provides that the account debtor undertakes to pay the person that has control of the controllable electronic record.¹¹
• "Electronic money" means money, i.e., a medium of exchange authorized or adopted by a government,¹²  in electronic form.¹³

Under the two sets of rules, digital assets may fall under different categories – for example, some virtual currencies may be treated as money under the Wyoming UCC and controllable electronic record under the Proposed UCC.

Definition of Control

Both the Wyoming UCC and the Proposed UCC define a key term, "control", with respect to digital assets specifically.

Under the Wyoming UCC, "control" focuses on the exclusive authority to transact, and means:

1.  A secured party (or an agent) has the exclusive legal authority to conduct a transaction relating to a digital asset;
2.  A smart contract created by such a secured party.¹⁴

Under the Proposed UCC, "control" focuses on property rights. A person has "control" of a controllable electronic record if the electronic record or system:

1. gives the person the power to avail itself of substantially all the benefit from the electronic record;
2. gives the person exclusive power to prevent others from availing themselves of the benefits and to transfer the control to another person; and
3. enables the person readily to identify itself as having the power specified above.

Take-Free Rule and Negotiability

The Wyoming UCC provides a limited take-free rule: a transferee takes a digital asset free of any security interest (perfected other than by control) two years after the transferee takes the asset for value and does not have actual notice of an adverse claim.¹⁵

The Proposed UCC provides a much broader take-free rule and creates the functional equivalent of a negotiable instrument. A qualifying purchaser, or a purchaser that obtains control of the controllable electronic record for value, in good faith, and without notice of a claim of a property right in the controllable electronic record, controllable account or controllable payment intangible,¹⁶  takes free of a claim of a property right.¹⁷  This rule is analogous to the take-free rules in existing UCC provisions applicable to securities under Article 8 and negotiable instruments under Article 3.

Further, if the terms of a controllable account or controllable payment intangible provide that the account debtor will not assert claims or defenses against the transferee of the controllable electronic record, then the asset could essentially be the electronic equivalent of a negotiable instrument.¹⁸

Methods of Perfection of Security Interest

The Wyoming UCC provides for perfection either by filing a UCC-1 financing statement or by control with respect to security interests in all digital assets, regardless of the category.¹⁹   A corollary of the limited take-free rule discussed above is that where a security interest is perfected by filing only, if the collateral is transferred and the transferee does not have actual notice of the security interest during a two-year period, such security interest will lapse.²⁰   This rule may be another incentive for secured parties to perfect their security interest by control.

The Proposed UCC similarly provides for perfection by either filing a UCC-1 financing statement or control with respect to security interests in controllable electronic records.²¹   Security interests in other digital assets, such as controllable accounts, controllable payment intangibles and electronic money, must be perfected using the existing methods provided in the UCC.

Governing Law

The Wyoming UCC does not include digital asset-specific governing law provisions. To the extent that general choice of law rules turn on the location of the digital asset, the Wyoming UCC provides that the asset is located in Wyoming if it is held by a Wyoming custodian, or the debtor or secured party is physically located or organized in Wyoming.²²

The Proposed UCC provides that the local law of the jurisdiction where the controllable electronic record is located governs the transfer rules, and the perfection, effect of perfection or non-perfection, and priority of a security interest in a controllable electronic record perfected by control. The Proposed UCC determines the jurisdiction where the controllable electronic record is located using the following "waterfall":

•  the jurisdiction of location provided under the record or the rules of the system; if not, then
•  the jurisdiction of governing law provided under the record or the rules of the system; if not, then
•  Washington, DC.

Conclusion

While the Wyoming UCC and the Proposed UCC both seek to address the lack of definitive commercial law rules for transactions involving digital assets, the Proposed UCC goes much further and is more future-proof, offering comprehensive changes that better capture the nuances of new technologies. Of particular importance is the Proposed UCC's broad take-free rule and formulation of essentially an electronic negotiable instrument framework, giving more certainty to the rights of a transferee. Parties should carefully analyze the nuanced differences between the rules in structuring their transactions. If (or when) states such as Wyoming decide to bring their existing laws in line with the Proposed UCC, secured parties should further consider taking action to ensure that the laws of their choice apply, and that their security interest is perfected, with priority preserved, under both the existing UCC and the Proposed UCC, regardless of how their digital asset collateral is categorized.

Authors: Julia Lu, Partner; Nathan Huynh, Senior Associate

<sup>1. We are not licensed to practice law in the State of Wyoming. This article is solely based on our review of Wyoming Statute 34-29-101 through 34-29-105, as available here.
2. W.S. 34-29-101(a)(i).
3. W.S. 34-29-101(a)(iii).
4. W.S. 34-29-102(a)(ii).
5. W.S. 34-29-101(a)(iv).
6. W.S. 34-29-102(a)(iii).
7. W.S. 34-29-101(a)(ii).
8. W.S. 34-29-102(a)(i).
9. Proposed UCC Section 12-102(a)(1).
10. Proposed UCC Section 9-102(a)(27A). "Account" is an existing UCC asset category.
11. Proposed UCC Section 9-102(a)(27B). "Payment intangible" is an existing UCC asset category.
12. Proposed UCC Section 1-201(b)(24).
13. Proposed UCC Section 9-102(a)(31A). "Money" is an existing UCC asset category.
14. W.S. 34-29-103(e). The statute does not specify a conjunction between the two prongs.
15. W.S. 34-29-103(d).
16. Proposed UCC Section 12-102(a).
17. Proposed UCC Section 12-104(e).
18. UCC Section 9-403.
19. W.S.34-29-103.
20. W.S. 34-29-103(d).
21. Proposed UCC Section 12-104(a).
22. W.S. 34-29-103(f).</sup>