Smart Contracts and the UCC #2: Secured Transactions

Article 9 of the Uniform Commercial Code describes the rules for transactions where collateral is pledged as security for a debt. Article 9 covers any kind of property that may be given as collateral other than real property. This is relevant for the cryptolegal community as it creates new fintech models.

If cryptocurrencies or colored coins associated with property are used as collateral, it is important to understand the rules for making sure the creditor’s interest is protected, not only from a programming perspective, but from a traditional legal one as well. Article 9 raises some interesting issues that will need to be addressed in order for cryptocurrencies to be a robust, multi-level part of commerce.

Article 9 provides the rules by which a creditor, having accepted an interest in property to secure an obligation, may put other parties on notice of its interest and foreclose that interest in the event of debtor default. Article 9 is a broad statute that works like a complex computer program, with if/then logic leading to the rule in a particular case.

The unifying concepts of Article 9 are the creation and attachment of a security interest in property, the perfection of the security interest and the rules of default. Within this framework, the statute branches based on fact-specific conditions and gives a slightly but materially different set of rules. For example, the default rules for consumer debtors are different than for commercial debtors.

A security interest is usually created, or “attaches” by a security agreement that grants the creditor a security interest. The security agreement may or may not contain the full agreement between the parties. It might be one of a set of contracts working together to make a complete deal.

Once a security interest attaches, it is up to the creditor to perfect its interest. Perfecting a security interest means taking action to put others on notice of one’s interest. Perfecting a security interest gives a creditor priority over any other creditors in the event of default or bankruptcy. The notice provision serves another purpose: before creating a security interest in property, it is the creditor’s obligation to check the record to see if a prior interest exists. In general, if a perfected security interest exists, the debtor cannot convey clear title without the creditor’s consent.

The rules for perfecting a security interest are necessarily varied and complex because they try to reflect the commercial reality of dealing in a given type of property. For example, automobile security interests are generally recorded as a lien on the title at the centralized motor vehicle registry where the debtor lives, but machinery and equipment UCC filings are usually maintained in another location. The UCC has evolved to more centralized filing system to avoid the problem of creditors having to search in multiple jurisdictions in order to determine if property was previously given as collateral – analogous to the Bitcoin “double spend.” The blockchain has the potential to moot the issue.

Because cryptocurrency tokens may represent items of value (e.g., colored coins) as well as hold value (e.g., Bitcoin) they create interesting challenges for secured transactions. Bitcoins fit into the property category “general intangibles.” Section 9-315(a)(1) provides that a creditor’s interest continues in general intangibles even after a debtor sells them to a third party. The security interest continues in the Bitcoins, even through subsequent transfers. This rule does not apply if Bitcoin is held to be money under section 9-322. Scholars have noted it’s possible for Bitcoins to be considered “investment instruments” under Article 8. The European Union and the IRS have issued conflicting statements about the nature of Bitcoin as property, so this issue remains open.

Issues presented by colored coins and default are addressed in Part 2 of this article: Smart Contracts & Secured Transactions Case Study: The Automobile Finance Contract. This nuts-and-bolts look will show programmers how the law affects smart contracts while providing ideas for smart contract programmers looking to create fintech solutions.

**Nothing in this article is intended as legal advice. If you have legal questions, contact a lawyer in your jurisdiction.

2 thoughts on “Smart Contracts and the UCC #2: Secured Transactions

  1. Great article. Interesting that the blockchain is a natural to record security interests. It seems this could be an easy change as it it can just replicate the existing system. Please keep the legal lessons coming.
    Thanks

Leave a Reply

Your email address will not be published.