February 05, 2025

Choice-of-Law Issues as the UCC 2022 Amendments Come Into Effect

Authors:

Source: National Law Journal (subscription required)

The authors write: In August 2021 and April 2022, this column discussed the, at the time, proposed substantial revisions to the Uniform Commercial Code (UCC) under consideration by the Uniform Law Commission (ULC) and American Law Institute (ALI) intended primarily to address the growing presence of an entirely new class of assets often referred to as “digital assets."

Introduction

In August 2021 and April 2022, this column discussed the, at the time, proposed substantial revisions to the Uniform Commercial Code (UCC) under consideration by the Uniform Law Commission (ULC) and American Law Institute (ALI) intended primarily to address the growing presence of an entirely new class of assets often referred to as “digital assets.” See Virtual Currencies (and Other Digital Assets) Under the UCC, 266 N.Y.L.J. No. 25 (Aug. 4, 2021) and

The UCC Emerging Technologies Committee: Part II (Chattel Paper) 267 N.Y.L.J. No. 66 (Apr. 7, 2022). In July 2022, the ULC and the ALI adopted the so-called UCC 2022 Amendments as a model law, which included a new Article 12 that provides a framework for transactions in negotiable digital records (called Controllable Electronic Records (CERs)) and controllable accounts and controllable payment intangibles, and then rolled that out for adoption by state legislatures in the United States.

Fast forward to today, and approximately 25 states have now adopted these amendments. Not surprisingly, this has given rise to some interesting choice-of-law issues when transactions involve, as they often do, multiple jurisdictions, some of which have and some of which have not adopted these amendments.

In July 2022, the ULC and the ALI adopted the so-called UCC 2022 Amendments as a model law, which included a new Article 12 that provides a framework for transactions in negotiable digital records (called Controllable Electronic Records (CERs)) and controllable accounts and controllable payment intangibles, and then rolled that out for adoption by state legislatures in the United States.

New Article 12 governs the transfer of property rights in a CER, that being a “record stored in an electronic medium that can be subjected to control.” (UCC §12-102(a)(1)). CERs would include such intangible digital assets as nonfungible tokens. Article 12 provides a framework for control of CERs, which is most analogous to “possession,” and for the negotiability of CERs in a way that cuts off competing property claims, such as security interests.

It also provides that perfection of a CER by control will have non-temporal priority over a security interest in the same CER perfected through the filing of a financing statement. This is a significant departure from the current UCC under which digital assets are usually considered general intangibles, security interests in which can be perfected only by the filing of a financing statement.

As of Feb. 4, 2025, according to the ULC website the UCC Amendments have been enacted in 25 jurisdictions, consisting of Alabama, California, Colorado, Delaware, the District of Columbia, Georgia, Hawaii, Illinois, Indiana, Iowa, Kentucky, Louisiana, Maine, Minnesota, Nebraska, Nevada, New Hampshire, New Mexico, North Dakota, Oklahoma, Pennsylvania, Rhode Island, South Dakota, Virginia and Washington.

Also according to the ULC website, as of Feb. 4, 2025 the UCC Amendments have been introduced but not yet adopted in Massachusetts, New York, Oregon and South Carolina. Thus, the amendments are effective in approximately half of the US states.

CERs and Potential Choice-of-Law Issues

Under Sections 9-306B and 12-107 of the UCC Amendments, the “local law of a controllable electronic record’s jurisdiction” will generally govern matters relating to Article 12, including perfection, the effect of perfection or non-perfection, and priority of a security interest.

Section 12-107(c) of the UCC Amendments provides a waterfall to determine a CER’s jurisdiction under that Article. If a CER “or a record attached to or logically associated with” the CER specifies a jurisdiction for purposes of Article 12, that is the CER’s jurisdiction. If the CER doesn’t so provide, but its system does so for the CER for purposes of Article 12, that is the CER’s jurisdiction.

If neither the CER nor its system provides a specific jurisdiction for purposes of Article 12, but the CER “expressly provide[s] that the controllable electronic record is governed by the law of a particular jurisdiction” then that is the CER’s jurisdiction. Failing that, if a CER’s system “expressly provide[s] that the controllable electronic record or the system is governed by the law of a particular jurisdiction,” that is the CER’s jurisdiction.

Finally, if none of the above apply, then the CER’s jurisdiction is the District of Columbia. This “waterfall” applies to perfection by control and the priority of a security interest in a CER. However, the perfection (but not priority) of a security interest in a CER by the filing of a financing statement is still governed by the debtor’s location (in the below examples, Delaware).

Despite Article 12’s proposed jurisdictional structure for CERs, choice-of-law issues pertaining to assets that could be characterized as CERs and that are pledged as collateral could still occur.

This is especially the case because approximately half of US jurisdictions, including New York, have not yet enacted the UCC Amendments and, under the current UCC in those states, a CER would likely be classified as a general intangible, and perfection by control (which would give non-temporal priority) as contemplated by Article 12 would not be available. The following examples illustrate several potential scenarios involving such conflicts.

Example 1: Consider a litigation surrounding whether a security interest has been perfected in a valuable nonfungible token, an asset that would likely be classified as a general intangible under the pre-amendments UCC, and as a CER under the UCC Amendments. In this example, the security interest is granted by a Delaware corporation debtor (D) to a secured party (SP) under a New York law-governed security agreement.

The security agreement grants a security interest in the described nonfungible token and SP perfects its security interest through the filing against D with the Office of the Delaware Secretary of State of a financing statement describing the token. Next, D tries to finance the nonfungible token with a third party lender (3P). 3P obtains control of the nonfungible token in accordance with Article 12, but 3P does not file a financing statement.

Imagine next that D encounters financial difficulties, and SP brings suit against D in California, the jurisdiction of D’s principal place of business, in order to foreclose on its perfected security interest in the nonfungible token. What ensues is a battle between the creditors, SP and 3P, with 3P claiming priority over SP’s filing because of its control, per Article 12, of the nonfungible token. California and Delaware have adopted the UCC Amendments; New York has not.

The California court, being the forum court, would first have to determine what underlying law applied to this litigation (i.e., whether this was a transaction governed by the UCC or some other legal system). Assuming it determined this was a UCC transaction, the court would then apply the choice-of-law rules applicable under the California UCC. Under UCC Section 1-301(a), parties may choose the governing law for their transaction as long as that jurisdiction bears a “reasonable” relation to the chosen jurisdiction or, if not, an “appropriate” relationship.

Given virtually all courts in the US will give effect to New York as the governing law for a UCC security agreement, it is safe to assume the California court in this example would do the same, in which case the California court will apply New York law in determining whether a security interest has been effectively created in respect of the nonfungible token.

However, UCC Section 1-301 does not apply to questions of perfection and priority. See UCC Section 1-301(c)(8). So the California court and would then also apply California UCC choice-of-law rules for determining the jurisdiction governing perfection on the nonfungible token and the priority of that security interest. California UCC Sections 9-301-9-307.

Since California has adopted the UCC Amendments, the California court would apply California’s characterization of the nonfungible token as a “CER”. Then, assuming that the CER’s jurisdiction is the District of Columbia (see the waterfall above) the court in California would look to the law of the District of Columbia to determine how to perfect a security interest in a CER by control.

The California court would likely determine under District of Columbia law that the nonfungible token constitutes a “CER”. Accordingly, perfection by control with non-temporal priority (such as for a CER in a jurisdiction that adopted the UCC Amendments) would be available under District of Columbia law. 3P would, therefore, have non-temporal priority in its perfection of its security interest in the nonfungible token on the basis of its having taken control of it per Article 12.

Example 2: If, in the above circumstance, all facts were the same, except that the CER provides that the CER’s jurisdiction is New York, which has not adopted the UCC Amendments, the outcome would be different.

In that case, the California court would proceed through the same steps, but as the UCC Amendments are not effective in the CER’s jurisdiction of the nonfungible token (New York), the California court, applying NY law, would determine that New York would not recognize the asset to be a CER and, in turn, would not permit perfection by control. SP would, therefore, have priority in its perfection of its security interest in the nonfungible token on the basis of its having filed a financing statement.

Example 3: Consider another example with identical base facts to Example 1 (a litigation surrounding perfection of a security interest in a nonfungible token pledged by a Delaware corporation debtor (D) to a secured party (SP) under a New York law-governed security agreement with the same ensuing battle of the creditors). As above, SP perfected its security interest through the filing of a financing statement in Delaware. This time, however, SP sues D in a jurisdiction that has not adopted the UCC Amendments.

If SP brings suit against D in, for example, Texas, which has not adopted the UCC Amendments, the Texas court would proceed through the same steps of determining what underlying law applied, and assuming the court determined the transaction was a UCC transaction, apply the applicable Texas UCC choice-of-law rules, which would send the court back to the New York-law governed security agreement for creation purposes.

But, for perfection and priority purposes, the Texas court would apply Texas UCC sections 9-301 – 9-307 and hold that Delaware law governs perfection. Per the above, that would likely result in the nonfungible token being characterized as a CER under the law of Delaware, which has adopted the Amendments, so 3P’s perfection by control would take priority over SP’s perfection by filing a financing statement.

Conclusion

The introduction of CERs and Article 12 in the UCC Amendments attempts to address the increasing prevalence of digital technologies and provide a framework by which parties to a financing arrangement could perfect liens on this new class of assets. As approximately half of US states—including New York—have not adopted the UCC Amendments, however, choice-of-law issues, such as those discussed above, could emerge in this transitory period. The state of affairs will continue to evolve as more states enact the UCC Amendments.