Digital Asset Guarantee – Fin Tech
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Secured lenders who include moveable assets as collateral in lending transaction structures have long relied on the regularity and clarity of Uniform Commercial Code (“UCC”) provisions that provide a roadmap for the creation, perfection and enforcement of security interests in movable property. Revisions to the UCC since 2000 have recognized and incorporated concepts to address changes in market reality driven by advances in technology. The creation of cryptocurrencies, however, has posed challenges for entrepreneurial lenders and their boards who wish to achieve a level of comfort that a perfected security interest in a cryptocurrency can be achieved within the existing UCC framework. The mere fact that a new UCC Section 12, tentatively titled “Auditable Electronic Records,” is in the early stages of adoption in state legislatures is proof enough that current legislation is inadequate at best to address issues specific to digital asset classes, including cryptocurrencies. The Wyoming Legislature amended its version of Article 9 of the UCC effective July 1, 2019 with the intent of enabling perfection through the control of cryptocurrencies (by controlling the applicable private key, including through multi-signature agreements) without addressing important legal, practical and policy issues addressed in the proposed new Article 12 and its corresponding amendments to other UCC Articles. It is currently unclear whether Wyoming will follow other jurisdictions in adopting the Section 12 regime.
Lending secured against cryptocurrencies as collateral is just one of the topics addressed by the proposed UCC revisions. Lenders who currently take cryptocurrencies as collateral and their advisers have followed two basic approaches to achieve perfection of collateral to the extent possible under current law:
Approach 1: The cryptocurrency is transferred to a securities intermediary, the securities intermediary agrees to treat the cryptocurrency as a “financial asset” which is then credited to the “securities account” of the the borrower held with the “securities intermediary”, and the securities intermediary, the borrower and the lender enter into a control agreement over the “securities account” and the “securities interest”; Where
Approach 2: Lender files a UCC Funding Statement listing the cryptocurrency/general intangible as collateral, the borrower provides the lender with the private key, and the lender transfers the cryptocurrency to their own public address or “wallet” . Note that in the absence of the filing of the financing statement, the lender will be imperfect; having the cryptocurrency in the lender’s “wallet” alone does not perfect the security. Often, lenders have no choice under current law but to hone via Approach 1, as borrowers may fear transferring the cryptocurrency to the lender and having a public record by filing a financing statement binding the borrower to the ownership of the cryptocurrency, especially if the public address or the amount of the cryptocurrency is disclosed in the financing statement.
However, neither approach provides the securities intermediary or secured party with any legal or practical assurance that the borrower owns the cryptocurrency free of other claims, or that the securities intermediary will acquire the cryptocurrency. cryptocurrency free from other claims. In the current version of Article 9 of the UCC, there is also no way to ensure priority of security without obtaining a release or subordination of all other secured parties, even if disclosed. Although Wyoming’s Non-Uniform UCC Amendments provide some additional protections, these uncertainties cannot be fully resolved under the current state of the law.
Therefore, lenders may simply have to rely on the borrower’s representations and warranties as to their ownership of the cryptocurrency being free and clear of liens and other adverse encumbrances. Additionally, in order to reassure the lender until the law catches up with the market, the lender may need to engage in a factual due diligence process to protect themselves from other cryptocurrency claimants that may exist in the marketplace. time of transfer. to the securities intermediary or the filing of the financing statement, such as reviewing on-chain transactions and finding previous owners and public addresses of the cryptocurrency used as collateral. In practice, without fully addressing these issues, some lenders have required borrowers to incorporate a borrowing entity in Wyoming to use Wyoming’s changes to Section 9 to use the third-party-control rules. available in that jurisdiction.
The UCC revisions, when enacted, will create legally uniform rules for the perfection of “verifiable electronic records” (a new class of assets that includes broadly defined digital assets and most, but not all , cryptocurrencies) via “control” a regime aligned with the peculiarities of this new asset class and rules that will either remove senior claims or give the secured lender with control priority over other claims. These revisions are clearer and more robust than Wyoming’s non-uniform edits. Wyoming, for example, provides for severance of prior claims only after two years following perfection by filing, provided the secured party has no actual, as opposed to implied, notice of an adverse claim during the window of two years. Unlike the very familiar account control agreements for custodial accounts and securities accounts currently in use where parties may seek the magic language that gives “control” to the secured party, the new Article 12 paradigm will require a careful analysis to determine whether in fact the asset in question is a “verifiable electronic record” and whether it meets the new “control” criteria of a “verifiable electronic record” set out in the new Section 12. It is unlikely that a document “form” like an account check agreement will be the unique mechanics to gain perfection by “check” for this asset class.
The content of this article is intended to provide a general guide on the subject. Specialist advice should be sought regarding your particular situation.
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