Texas Uniform Commercial Code Updated to Recognize Cryptocurrency
September 9, 2021
With the signing of Texas House Bill 4474 (“H.B. 4474”),1 Texas becomes the latest state—joining Wyoming and Rhode Island—to recognize cryptocurrency and other blockchain-based virtual currencies (“Virtual Currencies”) in its Uniform Commercial Code (“UCC”).2 As Virtual Currencies become more common on corporate balance sheets, such statutory updates will ensure both borrowers and secured lenders have a clear understanding of the requirements for pledging Virtual Currencies as security for loans and perfecting against such Virtual Currencies to establish priority and facilitate orderly foreclosure if necessary.
Definition
A primary issue in the use of Virtual Currencies as collateral is definitional. Without legislation such as H.B. 4474, Virtual Currencies are not otherwise expressly categorized under most state versions of the UCC in place today. Therefore, it falls to the lender to determine which existing Article 9 category would be the best fit, and the categorization will determine the necessary steps for perfection. A discussion of the pitfalls involved in that process can be found here.
H.B. 4474 settles this issue under Texas law by clearly defining Virtual Currencies as “a digital representation of value” that (1) “is used as a medium of exchange, unit of account, or store of value” and (2) “is not legal tender”. The bill also distinguishes Virtual Currencies from merchants’ rewards programs as well as gaming tokens, requiring that virtual currencies must be able to be “taken from or exchanged with the merchant for legal tender, bank credit, or virtual currency”.3
Perfection
H.B. 4474 also addresses perfection of a security interest in Virtual Currencies under Texas law.4 The updated law clarifies that perfection of a security interest in a Virtual Currency under the Texas UCC can be accomplished by filing a financing statement (similar to a security interest in certain investment property, chattel paper, and negotiable instruments). Furthermore, a security interest in a Virtual Currency can also be perfected by “control” (similar to certain investment property or deposit accounts).5
As with instruments and certain investment property such as certificated equity interests, it appears to be the case that perfection by control (or possession, as applicable to some of these other forms of collateral) is preferable to perfection only by filing.6 While the UCC is generally clear that a secured party perfecting a security interest in instruments and certain investment property by control or possession, as applicable, has priority over secured parties perfecting security interests in those assets by filing, H.B. 4474 does not contain an equivalent provision with respect to Virtual Currencies. But notably, the filing of a financing statement listing a Virtual Currency is not sufficient “notice” to prospective purchasers of an “adverse claim” to such Virtual Currency such that purchasers may take priority over prior secured parties.7 Therefore, for all practical purposes, a secured lender may need to perfect by control to attempt to guard against competing claims.
Control
While the concept of control may be familiar to lenders in the context of deposit accounts, the elements required to satisfy control vary for Virtual Currency. H.B. 4474 establishes that “control” of a Virtual Currency occurs when the person or entity has:
- “power to derive substantially all the benefit from the virtual currency” and “the exclusive power to prevent others from deriving substantially all the benefit from the virtual currency”; (emphasis added)
- “the exclusive power to transfer control of the virtual currency to another person”; and (emphasis added)
- the person is readily identifiable (via the virtual currency itself, a record attached thereto or “logically associated” therewith, or a virtual currency recording system).
Exclusivity is established even if the Virtual Currency (or its recording system) limits the use of the Virtual Currency or has protocols that would result in a transfer of control. The powers described above can also be considered exclusive even if the person has agreed to share the power(s) with another person.8
Exactly how a secured lender will practicably be able to obtain control pursuant to H.B. 4474 will be more complicated. Typically, transfer of Virtual Currencies can only be accomplished by possession of a private key associated with the particular Virtual Currency. Initially, it might appear that a secured lender would want to take possession of that private key upfront. However, that option may not be ideal to either the borrower—who may want or need to retain the ability to use the Virtual Currency (similar to a borrower needing to use its cash)—or to a lender—who does not want to take on the custodial risk of holding the private key.
A practical alternative could perhaps look somewhat like a deposit account control agreement or a source code escrow, whereby a crypto exchange or other custodian either holds a copy of the private key in escrow for the creditor or simply agrees in advance to comply with the creditor’s instructions upon notice. Indeed, Texas has also recently affirmed the ability of Texas state-chartered banks to provide clients with custodial services with respect to Virtual Currencies, and it is likely that as demand for such services grows, banks will begin developing form control agreements for Virtual Currencies.9
Conclusion
The passage of Texas’ Virtual Currency Bill is a significant step forward in the Virtual Currency space, as Texas is the second-largest economy in the US and has the most state-chartered banks of any state. The legislation provides greater certainty for both lenders and borrowers and allows industry participants to tap into an additional asset class as collateral. Texas now serves as a bellwether for the continued uptick in adoption of virtual currency legislation, of which the most significant may be the probable amendments to the model Uniform Commercial Code expected to be proposed by the Uniform Law Commission in 2022.
1 H.B. 4474 is referred to as the “Virtual Currency Bill” and is codified in Texas’ Business and Commerce Code, Chapter 12.
2 Most other states have some form of proposed legislation pending relating to virtual currencies. See: Cryptocurrency 2021 Legislation (ncsl.org)
3 Tex. Bus. & Comm. Code § 12.001.
4 Tex. Bus. & Comm. Code § 9.312.
5 Tex. Bus. & Comm. Code §§ 9.312 and 9.1071.
6 Tex. Bus. & Comm. Code §§ 9.330 and 9331.
7 Tex. Bus. & Comm. Code §§ 9331 and 12.003(h).
8 Tex. Bus. & Comm. Code § 12.004.
9 See: https://www.dob.texas.gov/sites/default/files/files/news/Industrynotices/in2021-03.pdf
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