June 09, 2019
by Katherine Cooper

Although distributed ledger technology offers significant potential to streamline financial transactions, it does not come without potential challenges to its use to record electronic warehouse receipts – a fundamental part of the financial plumbing supporting cash commodity and commodity derivatives transactions.

Background

In 2003, the Uniform Law Commission (“ULC”) adopted revisions to Article 7 of the Uniform Commercial Code (“UCC”) to create a statutory framework for the issuance, negotiation and enforcement of electronic documents of title such as warehouse receipts (the “2003 Revisions”).[1]  The 2003 Revisions have been adopted in all fifty states and the District of Columbia.[2]

The 2003 Revisions adopt nearly identical standards for electronic documents of title as the federal Global E-SIGN Act (“ESIGN Act”)[3] and the Uniform Electronic Transactions Act (“UETA”)[4] created for electronic negotiable instruments.[5] 

The 2003 Revisions added Section 7-106 “Control of Electronic Document of Title” to Article 7.  Section 7-106(a) provides:

A person has control of an electronic document of title if a system employed for evidencing the transfer of interests in the electronic document reliably establishes that person as the person to which the electronic document was issued or transferred.

The original Article 7 used the concepts of delivery and indorsement as the prerequisites for due negotiation of a tangible document of title.[6]  These concepts are based on the presumption that a person negotiating (selling) a tangible document of title would have physical possession of the document.  In the case of an intangible electronic document of title, the drafters of the 2003 Revisions needed a substitute for the concept of physical possession.  Hence, the drafters used the concept of “control” of an electronic document of title to substitute for possession of the document of title.[7]  The 2003 Revisions added Section 7-501(b)(2), which states:

If the document’s original terms run to the order of a named person and the named person has control of the document, the effect is the same as if the document had been negotiated.

The ULC’s Summary of the 2003 Revisions notes that using “control” to substitute for “possession” “is not a brand-new concept,” explaining that the concept of “control”

was developed in Article 8 of the Uniform Commercial Code for investment securities in the indirect holding system.  The 1999 revisions to Article 9 adapted the concept further for secured transactions.  Further adaptation of the concept occurred in Section 16 of the Uniform Electronic Transactions Act for promissory notes.  This latter adaptation is most important for Revised Article 7, because the issues of negotiation for promissory notes are very similar to those for documents of title.[8]

Thus, Section 16 of the UETA and Section 7021 of the ESIGN Act contain almost identical language to Section 7-106.[9]

One problem with the definition of “control” in Section 7-106 (as well as in the UETA and ESIGN Act), is that it is very broadly defined and lacking in specificity.  As such, the definition of “control” may be vulnerable to multiple conflicting interpretations.  Section 7-106(b) seeks to address this vulnerability by creating a safe harbor by setting forth specific characteristics of a system that “reliably establishes” that a document of title has been transferred to a particular person:

A system satisfies subsection (a), and a person is deemed to have control of an electronic document of title, if the document is created, stored, and assigned in such a manner that:

(1) a single authoritative copy of the document exists which is unique, identifiable, and, except as otherwise provided in paragraphs (4), (5), and (6), unalterable;

(2) the authoritative copy identifies the person asserting control as:

(A) the person to which the document was issued; or

(B) if the authoritative copy indicates that the document has been transferred, the person to which the document was most recently transferred;

(3) the authoritative copy is communicated to and maintained by the person asserting control or its designated custodian;

(4) copies or amendments that add or change an identified assignee of the authoritative copy can be made only with the consent of the person asserting control;

(5) each copy of the authoritative copy and any copy of a copy is readily identifiable as a copy that is not the authoritative copy; and

(6) any amendment of the authoritative copy is readily identifiable as authorized or unauthorized.

Section 16(c) of the UETA and Section 7021(c) provide for a safe harbor using nearly identical language.[10]

Issues with Using Distributed Ledger to Record Electronic Documents of Title

The safe harbor’s requirement for there to be “a single authoritative copy of the document [of title to] exist[] which is unique, [and] identifiable,” raises the question of whether a distributed ledger system can satisfy the requirements of the safe harbor.  The very basic concept of a distributed ledger is that it

is a database replicated on multiple computers at the same time.  This database is not managed by a central authority; instead, in the classical implementation of the technology, everyone in the network gets a copy of the same whole database and can add to it.  To enter the database, any new addition has to be confirmed by the other participants on the network.[11]

If each computer or node of a distributed ledger contains the same copy of the whole database, then how can there be one unique original authentic copy of an electronic document of title recorded on the ledger?  Although a basic blockchain network such as the Bitcoin network may easily satisfy the requirement that the owner of the document of title has control because only the owner’s private key can authorize a transfer of the document through the system, such a network may not be able to satisfy the single authoritative copy requirement.  More advanced distributed ledger solutions, however, may contain functionality that better creates a single, authoritative copy.  For instance, in Corda, a distributed ledger solution developed by R3, Inc.,  

the communication . . . is point to point, as opposed to broadcasting to the entire network [so that] only the parties involved in a transaction can see it.[12]

Lessons from the Caselaw

There appears to be no decisions interpreting or applying UCC Section 7-106’s language to an actual case or controversy.  A handful of decisions have been issued, however, interpreting and applying the nearly identical language in UETA Section 16 and Section 7021 of the ESIGN Act governing the recognition of electronic negotiable instruments.

Whether a person has control of an electronic negotiable instrument (“transferable record”) is important because it determines who can enforce the rights contained in the transferable record.  UCC § 3-301 defines a “Person Entitled to Enforce Instrument” to mean, among others, “the holder of the instrument.”  UCC § 1-201(21) states that

“Holder” means: (A) the person in possession of a negotiable instrument that is payable either to bearer or to an identified person that is the person in possession; or (B) the person in possession of a document of title if the goods are deliverable either to bearer or to the order of the person in possession.

 

ESIGN Section 7021(d) essentially states that “control” of a transferable record is the equivalent of “possession” of a written negotiable instrument:

 

a person having control of a transferable record is the holder, as defined in section 1-201(20) of the Uniform Commercial Code, of the transferable record and has the same rights and defenses as a holder of an equivalent record or writing under the Uniform Commercial Code, including . . . the rights and defenses of a holder in due course or a purchaser, respectively.[13]

Results in decisions interpreting and applying UETA Section 16 and ESIGN Section 7021 have been mixed.  In a series of mortgage foreclosure cases, the foreclosing plaintiff have been found to be in “control” and not in “control” of the mortgage e-notes in question.  In Good v. Wells Fargo Bank, N.A.,[14] the note in question by its own terms required that it be held in a note holder registry.  “Wells Fargo has not designated any evidence of a note holder registry, let alone evidence showing that Wells Fargo [the servicer] or even Fannie Mae [the owner of the note] is identified in the note holder registry.”[15]  The court reversed the lower court’s grant of partial summary judgment to the plaintiff because Wells Fargo “did not establish that it was the person entitled to enforce the Note as the holder for the purposes of the UCC.”[16]

 

In Rivera v. Wells Fargo Bank, N.A.,[17] the court found that Wells Fargo had proved that Fannie Mae (the owner of the note) had control of the e-note based on evidence about Wells Fargo’s systems and evidence from MERSCORP Holdings, Corp. (the operator of a nationwide mortgage e-note registry) that Wells Fargo, as agent of Fannie Mae, had control over the e-note that the Riveras had defaulted on.[18]

In Wells Fargo Bank, N.A. v. Benitez,[19] the trial court denied Wells Fargo’s motion for summary judgment because it concluded that an “eNote Certificate of Authentication” Wells Fargo had submitted was insufficient to establish that Wells Fargo maintained “the single authoritative copy of the note as described in 15 U.S.C. § 7021(c)(1).”[20]  Also, because Wells Fargo had not submitted the “eNote transfer registry with its motion,” the court ruled that Wells Fargo had not proven that it was the controller and thus the holder of the eNote with standing to enforce the eNote.[21]

In New York Community Bank v. McClendon, the appeals court found that the eNote transfer history established that the FDIC as receiver for the original lender had transferred the eNote to the plaintiff.  The transfer history, together with the eNote itself, proved that the plaintiff had control of the transferable record, and thus was the holder of the eNote with standing to sue the defendant for her default on the eNote.[22]

In Decisive Innovations, LLC v. Eel River Organics, LLC,[23] a federal district court held that the plaintiff had established that a .pdf copy of a note that the defendant had electronically signed was the single authoritative copy of the note.  In this case, the plaintiff submitted evidence of its receipt of the .pdf as an attachment to an email that the defendant sent to the plaintiff, and that the plaintiff had maintained the .pdf in its electronic systems since receipt of the defendant’s email.

The lessons from this caselaw are that, one, in enforcing one’s rights under an electronic document of title or e-note, it is crucial to submit sufficient evidence to establish that one is the controller of the single authoritative copy of the instrument.  This usually involves presenting a detailed transfer history, and extensive evidence regarding the systems used to store the single authoritative copy of the instrument.

Two, significant care must be used in drafting the terms of the instrument in the first place.  The courts’ decisions in Good, Rivera, and McClendon all analyzed in depth the language in the e-notes themselves as part of their reasoning whether bank plaintiffs had standing to enforce the e-notes.  Among other things, the instrument should reflect the parties’ understanding the instrument exists in electronic form and that the parties’ electronic signatures will bind them to the terms of the instrument with the same full force and effect as if they had manually signed a physical instrument.

 

Although promising many efficiencies, the application of distributed ledger technology to electronic warehouse receipts and electronic negotiable instruments must be made with close attention to the details of the technology to ensure that the records recorded on the distributed ledger will be recognized as providing the owner of the record enforceable rights in court.

 

[2] The revisions have not been adopted in Puerto Rico or the U.S. Virgin Islands.  See ULC’s UCC Article 7, Documents of Title Homepage available at: https://www.uniformlaws.org/committees/community-home?communitykey=9893636e-0046-498a-8ed9-3d57c192489a&tab=groupdetails

[3] 15 U.S.C. §§ 7001 et seq.

[5] The ESIGN Act provides that it does not preempt state law in states that have adopted the UETA.  The UETA has been adopted in all of the states, the District of Columbia and the U.S Virgin Islands, except Illinois, New York, Washington and Puerto Rico.  Thus, in those latter four jurisdictions, the ESIGN Act is the governing law regarding electronic transferable records of title.

[6] UCC § 7-501(a).

[7] Official Comment 2, UCC § 7-106 (ULC 2003).

[8] Revised Article 7 of the Uniform Commercial Code – A Summary 3-4 (ULC 2003) available at: https://www.uniformlaws.org/HigherLogic/System/DownloadDocumentFile.ashx?DocumentFileKey=0473346b-9027-56b3-d485-8042d75a7d37&forceDialog=0

[9] After defining the term “transferable record” to mean an instrument that would be a negotiable instrument under the UCC, Section 16(b) of the UETA goes on to define “control” as:

A person has control of a transferable record if a system employed for evidencing the transfer of interests in the transferable record reliably establishes that person as the person to which the transferable record was issued or transferred.

Section 7021(b) of the ESIGN Act contains identical language.  See 15 U.S.C. § 7021(b).

[10] UETA Section 16(c) provides:

A system satisfies subsection (b), and a person is deemed to have control of a transferable record, if the transferable record is created, stored, and assigned in such a manner that:

(1) a single authoritative copy of the transferable record exists which is unique, identifiable, and, except as otherwise provided in paragraphs (4), (5), and (6), unalterable;

(2) the authoritative copy identifies the person asserting control as:

(A) the person to which the transferable record was issued; or

(B) if the authoritative copy indicates that the transferable record has been transferred, the person to which the transferable record was most recently transferred;

(3) the authoritative copy is communicated to and maintained by the person asserting control or its designated custodian;

(4) copies or revisions that add or change an identified assignee of the authoritative copy can be made only with the consent of the person asserting control;

(5) each copy of the authoritative copy and any copy of a copy is readily identifiable as a copy that is not the authoritative copy; and

(6) any revision of the authoritative copy is readily identifiable as authorized or unauthorized.

Section 7021 of the ESIGN Act contains identical language.  See 15 U.S.C. § 7021(c).

[11] A. Doychev, Executive Guide to Distributed Ledger Technology: Introduction to the Corda platform — architecture, properties, and industry solutions (Medium Apr. 1, 2019), available at:  https://medium.com/industria-tech/executive-guide-to-distributed-ledger-technology-9e13c2316942

[12] Id.

[13] 15 U.S.C. § 7021(d).

[14] 18 N.E.3d 618 (Ind. Ct. App. 2014).

[15] Id. at 624.

[16] Id.

[17] 189 So.3d 323 (Fla. Ct. App. 2016).

[18] Id. at 329.

[19] 2016 WL 7647929 (Suffolk Cty. Sup. Ct. 2016).

[20] Id. at *5.

[21] Id.  In Wells Fargo Bank, N.A. v. Benitez, 2017 WL 6883783 (Suffolk Cty. Sup. Ct. 2017), the court found that in a subsequent filing Wells Fargo supplied such additional factual information to overcome the issues identified in the court’s earlier ruling denying Wells Fargo’s motion for summary judgment.

[22] 138 A.D.3d 805, 807 (2d Dep’t 2016).

[23] 2019 WL 229441 (M.D. Fla. Jan. 16, 2019).

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