JONES DAY TALKS®: UCC Proposed Amendments Address Crypto and Other Digital Assets
Jones Day partner Kim Desmarais discusses the Uniform Law Commission's and American Law Institute’s proposed amendments to the Uniform Commercial Code (UCC), and their potential impact on commercial transactions involving digital assets and other emerging technologies.
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A full transcript is below.
Dave Dalton:
One of the notable regulatory related events of 2022 occurred when the Uniform Law Commission and the American Law Institute approved amendments intended to modernize the US Uniform Commercial Code, or UCC, specifically with respect to transactions involving emerging technologies. There are potentially significant ramifications for participants in the digital asset space. Jones Day partner Kim Damaris, is here with an overview. I'm Dave Dalton. You're listening to JONES DAY TALKS®.
Kim Damaris has successfully acted as lead council on complex US and cross-border financings across a broad range of industries for more than two decades. She consults on lending arrangements involving crypto assets and companies in the digital assets industry, and is actively involved in Jones Day's global FinTech working group. Kim, thanks for being here today.
Kim Desmarais:
Hi, Dave. Thanks for having me. Happy to be here.
Dave Dalton:
Before we jump into today's discussion, you and I have talked a few times on the phone. I think you've done a couple of our videos. This is your first podcast. If you don't mind, can you tell us a little bit about your background, what your practice focuses on, and what you concentrate on at Jones Day?
Kim Desmarais:
Sure. I'm a banking and finance lawyer. I'm in the financial markets practice at Jones Day, and I've been practicing for about 20 years now. I would say that what I like the most about my practice is its diversity of clients, industries and transactions.
Dave Dalton:
Mmhmm.
Kim Desmarais:
I started off my career doing basically large cap LBOs, both domestic and cross border. And then over time, as I became more interested in the UCC and commercial law in general, I began to also advise on more complex secured transactions, more esoteric assets involved in those transactions across really a broad range of industries. And most recently that has involved transactions in the digital assets industry.
Dave Dalton:
Right. To say the least, a very interesting time in terms of the type of law you practice. You're in New York office, right? New York?
Kim Desmarais:
I am. Correct. Yes.
Dave Dalton:
Is that home? Did you come from the New York area originally, or where are you from?
Kim Desmarais:
No, not originally, although I've been here now longer than I've lived anywhere else, so I guess technically it's home. I'm originally from the Northeast, but Massachusetts.
Dave Dalton:
Okay. In New Hampshire. And then I did high school and college out in Southern California. I came back to the East coast for law school.
Kim Desmarais:
Your experience has spanned the continent, that's for sure. Anyway. Well, Kim, we're glad you're here and thanks so much for being with us today. Let's dive into this. We're going to talk about the Uniform Commercial Code and some recent developments there. I did a little research. I had heard of the Uniform Commercial Code, but didn't realize how really important it is. It's something I knew was there but didn't understand it. Maybe for people who don't or aren't as well-read about it as they should be, give us a little background on the UCC, what it is, what does, and why it's important.
Sure. As you said, the UCC stands for the Uniform Commercial Code. It is a comprehensive collection of legal rules that govern commercial transactions. Important business transactions in the United States. It was first published in 1952, so it's been around for quite some time.
Dave Dalton:
70 years.
Kim Desmarais:
Yes.
Dave Dalton:
See, I can do that math in my head.
Kim Desmarais:
It's been working hard for 70 years. It is a uniformly adopted state law. It's not a federal law. And what makes it important and relevant is the fact that it creates a uniform law, which is important because as you know, parties transact business across state lines on a regular basis. They enter into contracts that are governed by the laws of different states. And what the UCC does is it creates consistency in terms of how those contracts and the terms in those contracts will be enforced by courts across different states. It's extremely important. It's one of the reasons why it's easy from a legal perspective to enter into business transactions with multiple parties involving different assets again, that are across state lines.
Dave Dalton:
Interesting. Now we're about to talk about some amendments or changes to amendments in the UCC, but generally speaking, and we establish it's been around for 70 years. Does UCC change a lot? Is it common that adjustments or amendments are made, or is it set in stone or does it change often?
Kim Desmarais:
I guess you can think of it as the constitution, the US Constitution in the sense of as times change, even though it is a set of rules that were established in a way that were meant to grow and be able to be used, the legal constructs change within the United States. While it is, again, largely static, times do affect certain industries, certain legal principles. And there have been amendments to the UCC, again to address changes in the law, changes in the types of transactions from those that existed in 1952 through the years. And there have been amendments, but again, the amendments are rare.
Dave Dalton:
Mm-hmm.
Kim Desmarais:
The last set of amendments that we had were in 2010.
Dave Dalton:
Okay.
Kim Desmarais:
And then before that, it was in 1998, was I would say the largest set of comprehensive amendments that were made to the UCC. And again, to make the laws under the UCC more commercially available and usable among parties.
Dave Dalton:
Sure. Well, this is a beautiful segue into what we're really here to talk about today in terms of times changing, commerce changing the needs of a industrial economy changing and so forth. Let's get at it. This last summer, the Uniform Law Commission and the American Law Institute approved amendments intended to modernize the UCC, especially with respect to transactions involving emerging tech. Give us an overview of this new article 12, if you could, Kim.
Kim Desmarais:
Yeah, absolutely. I think this is the bread and butter if you wish, of the amendments to the UCC. A new Article 12 was added, and that new Article 12 does quite a few important things, most notably of which is the creation of new digital asset related terms and rules to address existing and emerging technologies. I would say that the highlight of Article 12 is the new term controllable electronic record and rules relating to transactions involving controllable electronic records.
As you mentioned, the amendments modernize the UCC. And one of the things that started occurring in the market when these types of digital assets started entering the market and started entering business transactions was, "Okay, how do these commercial law rules, how does the UCC apply to these new types of assets that were not contemplated when the UCC was originally drafted and any amendments that were made to the UCC.
There was a significant lack of clarity in the market in terms of how do these rules apply to both sales of Bitcoin, ether, NFTs, other virtual currencies or other digital assets, and how do these rules apply to use of these assets as collateral and secure transactions. The market has been patiently waiting for amendments such as this, in particular the new Article 12.
Dave Dalton:
Certain digital assets are classified under the new term controllable electronic records, and as you mentioned, that includes Bitcoin, NFTs, et cetera. All this is covered there?
Kim Desmarais:
Right. The thing to keep in mind about a controllable electronic record is that the drafters of the amendments to the UCC wanted to make sure that it was a term that would grow as the technologies in the digital asset market continue to expand and grow. The term applies to anything that is a record which is defined under the UCC that is in an electronic format, and then also, which is a record that is controllable. The important thing to note is that the electronic record has to be subject to control in order for it to be a controllable electronic record. And the amendments have clear rules on how you establish control of an electronic record or determine if an electronic record is controllable.
And again, that's important because one of the issues that we had encountered with assets like Bitcoin and NFTs is how do you determine who actually owns the Bitcoin? How do you determine who actually has the power to transfer the Bitcoin to another party, whether using it as collateral or just in a transaction where you're purchasing and buying Bitcoin and other virtual currencies. The term and the rules around the term give clarity, again, as I said, where that clarity was lacking under the existing rules for these types of assets.
In addition to creating this new type of asset under the UCC, the amendments also have other new rules that are equally important, and again, help to provide clarity in transactions that involve digital assets. One of the ones that I just wanted to touch on, we already talked about the control rules, but there is this take free rule, and as I said, one of the concerns that parties to a transaction had was, "Okay, well if I'm taking a lien in this Bitcoin or if I'm purchasing this Bitcoin, how do I know that the interest that I'm taking is not subject to a competing property claim? How do I know that there's no other party out there that is claiming an interest in that Bitcoin or in that NFT."
There are these take free rules that are established under Article 12, and basically if you're a qualifying purchaser, as defined, and that means essentially you're a good faith purchaser for value that meets the control rules, the UCC is now clear that that qualifying purchaser, that transferee, will take an interest in that digital asset so that Bitcoin or that NFT, brie of competing property claims that other parties could have in that Bitcoin or that NFT. Again, welcome clarity, welcome goals that the market has certainly been wanting to have within the commercial law.
Dave Dalton:
As we've been recording these JONES DAY TALKS® podcasts last several years, we run into that all the time where technology is way in front of the regulations, right? And people are looking for some clarity. What are the guardrails, what are we supposed to be doing, what can't we do? And so forth. This has got to be a relief, I would think, to clients and other interested parties out there that the UCC is starting to define these things, at least it's a very, very good start. Right?
Kim Desmarais:
Right. Absolutely. It definitely is appreciated among practitioners. Again, we have still been doing transactions, right, that involve these types of digital assets. It's not as if the transactions have not been occurring, but they've been occurring based on current rules where legal practitioners were not necessarily sure if the way that we were putting together those transactions would be held up in a court of law, because again, it was more of interpreting the rules in a way where we thought, "Okay, well this is what the drafters of the UCC must have meant, and so then this is how we're going to fit these new technologies into these roles."
We figured out a mechanism under the existing rules may not be perfect, but it was definitely working currently. But certainly, as you said, it's a welcome relief to have these rules that clarify certainly what we had been doing in terms of certain workaround rules under the existing UCC, but also clarify and fill gaps that currently existed in the UCC and will certainly make people more comfortable transacting in these types of assets, and especially as they evolve over the years. Oftentimes we do have to give legal opinions on these types of transactions. And for legal practitioners who do have to give those legal opinions more so are these rules definitely appreciated and welcome because then there's more clarity in the legal opinions that we're giving.
Dave Dalton:
Sure. Kim, I want to talk about Article nine a little bit and we swerve into that, but I think this is a good place to mention the law can be difficult and complicated enough, and then you throw in this emerging new dynamic technology, it's so important a client be able to reach out to people that A, certainly understand the law, but B, have deep knowledge of the tech and understand what's going on. I think that's pretty rare now. All this has happened so fast. And if you can find lawyers that understand and appreciate and get the nuances of the tech and also know the law, those are pretty good people to have in your corner.
Kim Desmarais:
A hundred percent agree with that. This is an area of the law that has been moving pretty quickly. As you said, the nuances of the types of digital assets and the technology relating to those digital assets is not intuitive. If you haven't been keeping up and keeping track, it's hard then to understand these new rules that are applying to those types of assets and technologies that you're not fully aware of or comfortable with. And as you said, Jones Day has been really at the forefront of this. We have a very large working group of attorneys that not only understand the tech, but that understand the rules and the regulations, and that definitely is a value add for our clients.
Dave Dalton:
Sure, sure. And you throw in global coverage and so forth, and it's an interesting dynamic, that's for sure. Let's jump into Article nine, and maybe you swerved into this a little bit already, Kim, but I want to make sure people hear what they need to hear. With the UCC this summer the amendments, there were also amendments to Article nine, which involved security interest and we talked about controllable electronic records as well as money, and that's in quotation marks, and introduce a new term electronic money. Give us an overview of the changes in Article nine and why they're important.
Kim Desmarais:
Yeah, sure. As we talked about, controllable electronic records are also addressed in Article nine. And there's a distinction between Article 12 and Article nine in the fact that Article nine deals with secured transactions. Article nine was under the amendment revised to provide clear rules on how you perfect a security interest in controllable electronic records. And there's priority rules as well that determine whether or not you have a lien on the controllable electronic record that is perfected ahead of other creditors that could also have a lien on the same controllable electronic record.
The rules are clear that if you perfect your lien in the Bitcoin or whatever digital asset is the controllable electronic record by control, then your lien takes priority over any other creditor or secured party that has not perfected their lien by control. You can still perfect your lien by filing a financing statement against the controllable electronic record, but you'll be trumped by anyone who has perfected their lien by control.
And as you mentioned, one of the things that we wanted to touch on today were the changes relating to money and electronic money. Many people who are listening to this might be aware of a bit of a conundrum that we had under the UCC when El Salvador and the Central Africa Republic had made Bitcoin legal tender in their countries, and the act of making Bitcoin legal tender then in their countries raised a question in terms of, "Okay, well, is Bitcoin now money as defined under the UCC? And if it is it subject to the perfection by possession rules of Article nine?" Under current Article nine, money, the only way in which you can perfect your lien in it is by actual physical possession. And the conundrum was that you can't actually physically possess an intangible asset like Bitcoin.
Dave Dalton:
Right?
Kim Desmarais:
A bit of uncertainty in the markets. There have been some workarounds to address it, but what the amendments did was clarify that money as defined under the UCC does not include any electronic medium of exchange. Any digital currency that existed before the government actually adopted that preexisting electronic digital currency as legal tender in that country. What the amendments have done is clarified that any existing digital currency that exists today, including Bitcoin, can never constitute money or electronic money under the UCC, and instead they could constitute a controllable electronic record. That conundrum in that question that the market was struggling with is addressed in the amendments.
And as you said, the other thing that the amendments did was address electronic money. Electronic money as defined in Article nine, is money, which we just talked about, the definition of money, which we know does not include any existing digital currency.
It's money in an electronic form. And what that is getting at is more of a fiat currency that's in digital form. If you have a government that does create a digital currency and adopts that digital currency as legal tender in its country, then that could be electronic money under Article nine of the UCC. And then you have clearer rules in terms of how you perfect your lien in that electronic money. And the rules tell you that you can only perfect your lien in electronic money by control, which is the same rules as determining control for a controllable electronic record.
Dave Dalton:
A lot to unpack, Kim.
Kim Desmarais:
Yes.
Dave Dalton:
I don't know how you guys keep up.
Kim Desmarais:
Only scratching the surface of the a.
Dave Dalton:
I can only imagine. Oh, I've seen some of the publications you're practice puts out. It's great stuff. We're talking to Kim Damaris, we're talking about uniform commercial code and digital assets. Kim, what happens next? Is this now left to the individual state legislatures to approve or modify, or now that the UCC has come together on this, what happens now?
Kim Desmarais:
Yeah, that's a great question. Even though it's a uniform set of commercial laws, they are adopted on a state by state basis. Now that both the Uniform Law Commission and the American Law Institute have approved the proposed amendment, they are now cleared to be adopted by each of the states. The process is state specific as a result of the adoption. And one thing that we do want to impress upon people in the market is that going forward, if you're involved in transactions that do involve digital assets, to monitor the adoption of the amendments across the states because the adoption of the amendments could impact and have an effect on the financial transactions that you have already entered into or are entering into in that state.
Dave Dalton:
I see. Well, this is not low profile stuff. I got to think there's some sense of urgency. And I know these amendments are rare, we talked about that earlier. This doesn't happen all the time, but if you had to guess in terms of a timeline, will most states get on this fairly quickly?
Kim Desmarais:
I think so. Certainly states that are states where there's more commercial transactions in that state, will want to adopt these amendments as soon as possible. The amendments themselves do recommend that states adopt the amendments either on January 1 of 2025, or July 1 of 2025, and they've done that to maximize the number of states that will have the opportunity to enact the amendments. Just going through the enactment or the adoption process in each state does take time. You first have to get it on the agenda and then both houses need to approve. And all of that does take time. And then there's also just education, right? Educating people on the amendments in each of the states that need to approve them. The drafters of the amendments recognize that. And that's why they're suggesting 2025 as the year in which these are adopted.
There are some states that have already proceeded with adopting parts of the amendments, in particular Article 12. And that's because some states had already included certain types of modifications to their UCC to address digital currencies, that was due in large part because those are states where a lot of digital currency exchanges or digital currency custodians were being set up. And they did amend their UCC in those states, but again, it was limited amendments, not these broad-based amendments that we see as part of the proposed 2022 amendments.
Dave Dalton:
Sure. And I would've guessed, and this is a layup, but there are certain states, big financial centers, the New York, the Illinois, the Floridas, the Georgias, the North Carolinas that have these... California, big financial centers, lots of banking. I would imagine they'll lead the charge on this if they haven't already. It seems like that's the way it would go.
Kim Desmarais:
Yeah, it seems like it.
Dave Dalton:
It's just like, "Well, not really Dave." You'd think so, but...
Kim Desmarais:
But exactly to your point. New York is obviously a big commercial financial center, and historically in New York, adoption of these types of changes to the commercial law do take a little bit longer, and that's more so to make sure that we get it right in New York. And because of the importance of New York and wanting to ensure that people continue to transact business in New York, from the legislature's perspective, it's more of, "Okay, well we want to do this, but let's make sure that we do this in the way that works for the state and for the business that we want to continue to be conducted in this state."
Dave Dalton:
Absolutely and fair enough. But what happens in the meantime before states approve or take on some form of what the UCC is doing. What do people do now?
Kim Desmarais:
Again, a very good question. We definitely recommend that people monitor the enactment process across the states to the extent that you are currently entering into or have transactions that involve digital assets, you are under the rules of the state that is the governing law for the contract. If it's New York, you're under the rules of New York. Pretty much business will continue as is in New York until the amendments are approved.
But the point is is that there are also certain choice of law rules that are under the amendments, and under those choice of law rules, it could point you to another state. An example is perfection by filing where the choice of law rules point you to the state where the debtor, the owner of the digital asset is located. Even if your contract is governed by New York law, you'd have to look to the state where the debtor is located for purposes of determining things like perfection by filing, and then look and see, okay, well under the choice of law rules, what states do they point me to and have those states enacted the amendments? And then how does that impact my transaction and how does that impact the drafting of my contracts?
Dave Dalton:
Sure, sure. A lot of plates spinning, a lot of balls in the air, as they say, to keep an eye on. Kim, this has been great. I wanted to finish up with a couple of quick questions. First of all, who's ultimately affected by these changes? And I have a feeling I know what the answer is, but individuals, financial institutions, banks, funds, investors, lenders, who's impacted by these UCC changes?
Kim Desmarais:
Everyone.
Dave Dalton:
I knew it.
Kim Desmarais:
Yes, you did. Anyone who does a transaction that involves either the purchase and sale of a digital asset, or the granting of a lien, or the taking of a lien in a digital asset would be impacted by this, and that would be people on both sides. The seller of the asset, the purchaser of the asset, and then in a secured transaction, it would be both the secured party and the debtor to that transaction.
Dave Dalton:
Got it. Last question, Kim. Anything else you'd like our listeners to know about digital assets and the actions of the UCC?
Kim Desmarais:
Yes. One thing that would be helpful for people to know is that the amendments to the UCC to address digital assets in other emerging technologies is dense. Even the drafters of the amendments acknowledge the fact that the amendments are dense, but there's comments to the amendments that do help you understand the new provisions, the new rules. And Jones Day, we ourselves will also be having seminars and CLEs for our clients and for people in the industry to help them to process and understand the amendments. I would just recommend that people take advantage of those seminars and CLEs that will be coming out. It is dense, it will take time, but we will all get there.
Dave Dalton:
A lot of good information coming, I'm sure. That was Jones Day partner, Kim Damaris. Kim, thanks so much for being here.
Kim Desmarais:
Thanks, Dave. This was great.
Dave Dalton:
For a complete biography and contact information for Kim Damaris, visit jonesday.com. While you're there, check out our insights page for more podcasts, publications, videos, newsletters. You'll also find an entire page devoted to FinTech topics and content. Subscribe to JONES DAY TALKS® wherever podcasts are found. JONES DAY TALKS® is produced by Tom Conolis. As always, we thank you for listening. I'm Dave Dalton. We'll talk to you next time.
Sedrick Craig:
Thank you for listening to JONES DAY TALKS®. Comments heard on JONES DAY TALKS® should not be construed as legal advice regarding any specific facts or circumstances. The opinions expressed on JONES DAY TALKS® are those of lawyers appearing on the program and do not necessarily reflect those of the firm. For more information, please visit jonesday.com.
