MLETR vs. UCC Amendments: Highlighting the Key Differences
While both MLETR and the UCC Amendments provide means for facilitating digitalization of trade finance, key differences exist between these model laws. Marek Dubovec focuses on four main areas of difference.
Commercial law governing trade finance, including that in two major financial centers – London and New York – has been undergoing significant updates to facilitate digitalization. While the underlying aims of legislative initiatives in this area, including those in France, Singapore, the United Kingdom, and the United States, are equivalent, the approaches taken by the jurisdictions vary. The purpose of this comparative analysis is to highlight and explain some of the fundamental differences between the two leading models of the Model Law on Electronic Transferable Records (MLETR) and the US Uniform Commercial Code (UCC) Amendments, which include the new UCC Article 12 (Controllable Electronic Records).
MLETR was adopted by the United Nations Commission on International Trade Law (UNCITRAL) in 2017, and the UCC Amendments were approved by their co-sponsors, the Uniform Law Commission and the American Law Institute, in 2022. MLETR has been adopted by ten jurisdictions,[[1]] and UCC Amendments by 31 US states.[[2]] Both are model laws that may be incorporated by individual jurisdictions into their domestic legislation with adaptations. As a result, the differences between MLETR and UCC Art. 12 may not be identical to the differences between the UK Electronic Trade Documents Act and the UCC Art. 12 as enacted in New York (which has yet to enter into force). This note thus highlights the differences between MLETR and UCC Amendments as adopted or approved by their sponsoring entities. It focuses on the main areas of difference: 1) scope, 2) control, 3) rights of the holder, and 4) conflict of laws. Several authors have noted that UCC Art. 12 and MLETR serve distinct purposes, which is largely accurate; however, UCC Art. 12 has a significant impact on finance by recognizing a new type of asset – the controllable account.
1. Scope
Laws governing digital assets must be carefully calibrated to avoid interfering with the application of existing laws that govern different types of intangible rights and to exclude certain types of assets for which such a commercial regime would not be suitable (e.g., pure data). Establishing the scope by listing the types of assets or tying it to a particular technology risk that the law would quickly become uncertain or outdated. A classification of a digital asset as a controllable electronic record (CER) or electronic transferable record under UCC and MLETR would not dictate its classification under regulations governing other aspects of finance (e.g., Bitcoin may be a CER under UCC, but could be a commodity under other applicable US regulations).
UCC Art. 12 applies to a new type of asset – CERs, which are a record stored in an electronic medium that can be subjected to control. UCC Section 12-102 provides for a list of exclusions identifying digital records to which UCC Art. 12 would not apply, primarily because they are already covered by other UCC Articles, such as electronic documents of title in UCC Art. 7. Accordingly, UCC Art. 12 does not apply to the types of electronic transferable records that MLETR does.
UCC Art. 12 does not recognize digital equivalents of paper transferable documents. However, it recognizes two new types of assets – controllable accounts and controllable payment intangibles – that are defined in UCC Art. 9. They are functional equivalents of negotiable instruments. Other than these two types of assets, UCC Art. 12 applies only to records rather than rights evidenced by those records.
MLETR deals only with linked assets and does not create a new type of asset. Instead, it defers to other local law that already recognizes “paper” linked assets, such as negotiable instruments. MLETR does not empower parties to create new types of electronic transferable records. It ensures that the same law applies to paper and electronic transferable records.
Both UCC and MLETR carefully define their respective scopes. The MLETR approach is straightforward in that it does not create a new asset that would not already be recognized by other laws in a paper form. UCC creates two new types of assets. Neither model applies to many types of intangible assets, including investment securities and bank accounts. The respective scopes do not align, as UCC Art. 12 was primarily designed to apply to “cryptoassets” such as Bitcoin, whereas MLETR was designed for commercial instruments and documents. A more appropriate comparator to the MLETR would be UCC Art. 7.
2. Control
Control is intended as a proxy for the transfer of physical possession of goods. It is a factual concept, unlike the right to possession. It is technology-neutral, being designed to accommodate all types of technologies, systems, and practices. The rules that determine whether a person is in control of a digital record vary.
Under UCC, control is a key requirement for a person to become a qualifying purchaser, take free of third-party claims of a property interest, and achieve perfection of a security interest that also confers super-priority on the secured party. As explained above, it also determines whether a record is a CER and thus subject to UCC Art. 12. The meaning of control differs for various types of assets covered by the UCC. For instance, one achieves control differently over a bank account than over an electronic bill of lading. The parameters for control of CERs set out in UCC Section 12-106 require a person to have three powers. The powers may be shared, which is a new concept.
MLETR Article 11 provides that a legal requirement for possession is satisfied by control if a reliable method is used to establish exclusive control by a person and that method identifies the person in control. Even though it refers to “exclusive,” control, like possession, it may be exercised concurrently by multiple people. MLETR Article 12 outlines the standard of general reliability applicable to any management system for electronic transferable records.
While UCC provides for specific requirements that must be met to constitute control over a CER, MLETR does not define control. Rather, it identifies a functional equivalent to the fact of possession. Given that both approaches are rooted in replicating the function of possession, systems that meet the UCC requirements are likely to satisfy the MLETR test and vice versa.
3. Rights of the holder
In the history of commerce, a narrow set of documents has been recognized in law as “negotiable”. Unlike transferability in general, negotiability provides parties with a higher degree of protection against conflicting claims. The degree of negotiability varies among the various types of assets, ranging from very high for money to more limited, such as for warehouse receipts. The type of transfer method employed, whether assignment, negotiation, or novation, determines the nature of the rights of holders.
UCC Art. 12 accords a high level of negotiability to CERs, creating a new protected status of “qualifying purchaser”. UCC Art. 12 constructs a bundle of rights that a purchaser acquires from the specific rules, such as the shelter principle in UCC Section 12-104 and other laws. Other UCC Articles already provide that a purchaser may acquire greater rights than the transferor could convey. The conditions for a person to become a qualifying purchaser, including of controllable accounts, are derived from those governing holders of due course of negotiable instruments under UCC Art. 3. The rules governing transfers and rights of acquirers of documents of title, such as bills of lading continue to be governed by UCC Section 7-502.
MLETR focuses on the transferability of the record. Negotiability relates to the underlying rights, which are a matter of other substantive law. This is logical, as it does not recognize a new type of asset, as opposed to UCC.
To some extent, the UCC and MLETR approaches are equivalent. UCC Art. 7 provides for the same standard applicable to written and electronic documents of title, but recognizes a new qualifying purchaser status for holders of controllable accounts. MLETR extends the existing protections available to holders of written documents and instruments to their electronic equivalents. There are advantages and disadvantages to the two approaches. The law of negotiable instruments has evolved over centuries and has become overly complex, at times becoming disjointed from practical application.[[3]] Setting out the requirements specific to CERs, including controllable accounts, ensures a clean slate. In contrast, rules outside of commercial law, such as regulations that recognize negotiable instruments, could more easily accommodate their electronic equivalents.
4. Governing law
Also known as conflict of laws rules, they determine the law applicable to the rights and obligations of parties to a transaction, including their effect on third parties. Generally, the law of the location of an asset determines whether the transfer has a property effect or a security interest is perfected. Accordingly, written documents, such as negotiable instruments, are transferred in accordance with the law where the delivery of the instrument occurs. Obviously, this approach does not work for digital equivalents of those instruments.
UCC Art. 12 sets out a new approach clearly in UCC Section 12-107 under which the local law of a CER’s jurisdiction is the governing law. This Section is premised on party autonomy, enabling, for instance, the issuer of a CER to designate the applicable law in the CER itself. Third parties considering the acquisition of the CER may predictably and transparently identify the applicable law by looking to the CER or the system where it is recorded (Section 12-107 provides a list of connecting factors that will eventually yield an applicable law).
MLETR does not include a conflict of law rule. MLETR Article 19 is limited to the recognition of legal effect and validity of electronically transferable records issued in a foreign jurisdiction. Paragraph (2) contemplates the application of conflict of laws rules governing transferable documents and instruments. This was a deliberate choice to avoid creating a dual regime for electronic and paper transferable documents. However, these aspects are already being addressed by the Hague Conference on Private International Law (HCCH). Similarly, the UK Law Commission has been considering conflict of laws issues related to electronic trade documents within the broader context of digital assets.[[4]]
UCC Art. 12 enables parties to determine the law applicable to transfers of CERs, including controllable accounts. This is critical in cross-border transactions, including trade finance. The absence of a conflict of laws rule in MLETR specifically applicable to electronic transferable records creates uncertainty and increases the cost of applying traditional conflict of laws rules, designed for paper instruments and documents, to their electronic equivalents.
5. Final remarks
The US states that have enacted the UCC Amendments and those jurisdictions that have implemented MLETR have taken critical steps towards digitalizing and reducing the cost of commerce, including trade finance. This note highlighted some of the key differences. UCC created a new law, while MLETR’s function is more limited to recognizing electronic equivalents of paper documents. From the perspective of cross-border transactions, in the absence of a conflict of law rule in MLETR jurisdictions, UCC Article 12 provides a superior approach to the financing of payment rights represented by digital records.
Marek Dubovec is Director of Law Reform Programs at the International Law Institute and the American Law Institute delegate to the Study/Drafting Committee that produced the 2022 UCC Amendments.
