1. The Impact of Technology on Real Estate Finance
1.1 Current Status of eDocuments Authorized By E-SIGN Act, UETA & UCC
1.11. E-SIGN Act
The federal Electronic Signatures in Global and National Commerce Act (“E-SIGN Act”), enacted in 2000, authorized a new type of electronic document, called a “transferable record.” Pursuant to the E-SIGN Act, a “transferable record” must meet the following conditions: (1) it must be an electronic equivalent to a “note” under Article 3 of the UCC, (2) the “issuer of the electronic record expressly has agreed [it] is a transferable record” pursuant to the E-SIGN Act, and (3) the transferable record must relate “to a loan secured by real property.”
1.1.2. UETA
The Uniform Electronic Transactions Act (“UETA”) contains similar rules regarding “transferable records.” UETA was introduced in 1999, and has been adopted by all states except New York.
1.1.3. UCC
The 1999 version of the Uniform Commercial Code (“UCC”) defined “record” to include “information . . . which is stored in an electronic or other medium and is retrievable in perceivable form.” The 2010 amendments to the Uniform Commercial Code (“UCC”) (1) authorized electronic signatures, (2) enabled secured parties to have “control” of “electronic chattel paper” if a “system” was used to store the related electronic “records,” (3) protected buyers of intangible collateral who gave value and were unaware of claims by secured parties, and (4) authorized electronic notices of UCC sales.
1.1.4. Control of e-Notes by Holder in Due Course
The E-SIGN Act provides that a person (including a lender) has “control” of an electronic note (“eNote”) if “a system employed for evidencing the transfer of interests in the [eNote] reliably establishes that person as the person to which the [eNote] was issued or transferred.” The person with “control” of such eNote is generally deemed to be the “holder” of it. Such person will also qualify as a “holder in due course” or “purchaser,” as applicable, if the relevant requirements are satisfied under the UCC, except that delivery, possession and endorsement are not required. Similar rules apply under the Uniform Electronic Transactions Act (“UETA”).
1.1.5. Current Fannie Mae Rules for Its Purchases of eNotes and eMortgages
Registration of eNotes & eMortgages: The Federal National Mortgage Association (“Fannie Mae”) has issued detailed rules for its purchases of eNotes and eMortgages. For example, Fannie Mae’s rules provide that “Lenders must . . . ensure eNotes are registered in the MERS eRegistry as soon as possible after the tamper-evident seal has been applied [to the eNote], but no later than one (1) business day of signing. All eMortgages delivered to Fannie Mae must also be registered on the MERS Residential System prior to delivery to Fannie Mae.” This registry is intended to comply with the requirements under UETA and the E-SIGN Act for a central registration system.
Transmitting eNotes to Fannie Mae through MERS eDelivery: A lender that is selling an eNote to Fannie Mae must actually deliver it to Fannie Mae through MERS eDelivery, and then must transmit a request to the MERS eRegistry to begin the process of transferring “Control” and “Location” of the eNote to Fannie Mae.
1.1.6. Recording of Paper Mortgages & Other Documents May Still Be Required
Even if an originating lender or a loan purchaser would prefer to accept only electronic documents, however, in some jurisdictions only paper mortgages (and other related recordable paper loan documents) are accepted for recording.
1.2. Impact of Cryptocurrencies & Other Digital Assets on Finance
Cryptocurrencies and other digital assets are held by many investors, and may be required by lenders as additional collateral, even if the primary collateral is real estate or another traditional form of security. As of January 1, 2023, several U.S. states have enacted various types of laws governing security interests in, as well as purchase or sale of, cryptocurrencies and other digital assets. However, there are also many bills, under consideration by various U.S. state legislatures, that, if enacted, would provide ground rules, and a regulatory structure, for such assets.
1.2.1. Current Practices for Loans Secured by Digital Collateral.
The following practices are customary in jurisdictions in which the proposed 2022 UCC amendments (or similar provisions) have not yet been enacted. In such jurisdictions, secured parties that are relying on digital assets, at least in part, will generally follow at least one of the following procedures:
(1) (a) the transfer of such digital assets to a securities intermediary, (b) the securities intermediary consents to hold the digital assets as financial assets, which are credited to the debtor’s securities account, creating a security entitlement and (c) control by the secured party of the security entitlement pursuant to Article 8 of the UCC, perfecting the secured party’s security interest in the securities account; or
(2) (a) delivery by the debtor to the secured party of a private key for a blockchain asset, (b) the secured party transfers such asset to the secured party’s crypto wallet, and (c) perfection of the secured party’s security interest by filing the applicable financing statements.
However, in each case specified in (1) and (2) above, there is no guarantee that the debtor actually owns the digital asset, or that the securities intermediary will get title to the digital asset free from other property claims.
1.2.2. Proposed 2022 UCC Amendments for Cryptocurrencies & Other Digital Assets.
The American Law Institute and the Uniform Law Commission approved in 2022, and recommended for adoption by all U.S. states, various proposed amendments to the UCC covering cryptocurrencies and other digital assets (the “2022 UCC Amendments”). These proposed amendments include changes to the existing Articles 1-9 of the UCC, as well as a new Article 12 of the UCC. However, as of January 1, 2023, according to the “Enactment Map” appearing on the website of the Uniform Law Commission, no state has adopted these amendments.
The following are new or revised types of assets that are covered in the 2022 UCC Amendments:
Controllable Electronic Records (CERs): The proposed 2022 UCC Amendments define various new types of digital assets that are covered by such 2022 UCC amendments. Probably the most important new type of digital assets are “controllable electronic records (‘CERs’).” According to the 2022 UCC Amendments, a CER “is a record that is stored in an electronic medium [such as the blockchain] and that can be subjected to control.” The comments in the 2022 UCC Amendments say, “think of bitcoin and other virtual currencies as prototypical controllable electronic records.” Another example is that J.P. Morgan has proposed “adapting decentralized finance (DeFi) protocols in the finance industry using tokenized real-world assets. DeFi protocols are self-executing applications on a blockchain that can automate financial services such as lending and borrowing, trading, and asset management while reducing manual involvement from intermediaries.”
Controllable Assets: CERs “also provide a mechanism for evidencing certain rights to payment—controllable accounts and controllable payment intangibles. An account debtor (obligor) on such a right to payment agrees to make payments to the person that has control of the [CER] that evidences the right to payment.”
Payment Intangible: “Payment intangibles” were defined in the 1999 UCC as “a general intangible under which the account debtor’s principal obligation is a monetary obligation.” The 2022 UCC Amendments add the following to such definition: “The term includes a controllable payment intangible.” Courts have ruled, for example, that payment intangibles include (1) payment streams that are stripped from equipment leases, and (2) settled tort claims.
Account: “Account” is a traditional UCC category that similarly has been broadened by inclusion of “controllable account” under the 2022 UCC Amendments. “Account” includes, for example, “a right to payment of a monetary obligation, whether or not earned by performance, (i) for property that has been or is to be sold, leased, licensed, assigned, or otherwise disposed of, (ii) for services rendered or to be rendered,” and certain other rights of payment, subject to various exclusions.
Controllable Account and Controllable Payment Intangible: A “controllable account” or “controllable payment intangible” means, respectively, an account (in the case of a controllable account), or a payment intangible (in the case of a controllable payment intangible) “evidenced by a controllable electronic record that provides that the account debtor undertakes to pay the person that has control under Section 12-105 of the controllable electronic record.”
Advantages of Control: If a party (1) acquires a CER by purchase, for value, in good faith and without notice of a competing claim of a property right in the CER, and (2) has control of the CER, then such party will be a “qualifying purchaser” of the CER. “Article 12 confers an attribute of negotiability on controllable electronic records because a qualifying purchaser takes its interest free of conflicting property claims to the record.”
Recommendations for Lenders Secured by Digital Assets: A lender that intends to be secured, in whole or in part, by digital assets, pursuant to the proposed 2022 UCC Amendments, should (1) design closing procedures, with the borrower’s acknowledgment and consent, in order to enable the lender to have “control” over such assets from the closing date (or such other date that is designated by the lender) until the lender is repaid, (2) require the borrower not only to pay the lender (or the person designated by the lender), but also to acknowledge that the lender is the person in “control” (as defined in the proposed 2022 UCC Amendments) of the digital asset, (3) include a ”choice of law” provision in each CER, and (4) obtain the consents of trading parties, and the borrower, to provide further assurances to the lender confirming that the lender is a first priority perfected secured party with control over the digital assets and other related collateral.
1.2.3 Regulatory & Other Legal Issues Relating to Cryptocurrencies & Other Digital Assets.
Bank Secrecy Act/Anti-Money Laundering (BSA/AML) & Combating the Financing of Terrorism (CFT). Because money laundering has been facilitated, and other crimes and terrorism have been funded, by cryptocurrencies and other digital assets, therefore the U.S. Treasury Department is devoting substantial resources to preventing this in the future. Accordingly, parties should expect a high level of regulatory scrutiny, if they are involved in transactions involving significant amounts of cryptocurrencies and other digital assets.
U.S. SEC & CFTC. The U.S. Securities and Exchange Commission (“SEC”) and the U.S. Commodity Futures Trading Commission (“CFTC”) have aggressively asserted their jurisdiction over cryptocurrencies. For example, the SEC charged that BlockFi Lending LLC both (1) failed to register, with the SEC, BlockFi’s offers and sales of its interest accounts under the Securities Act of 1933, and (2) failed to register as an investment company under the Investment Company Act of 1940. BlockFi then paid a $50 million penalty to the SEC. Also, the CFTC charged BitMEX with (1) illegally operating a cryptocurrency derivatives trading platform and (2) anti-money laundering (AML) violations. BitMEX then entered into a consent order, pursuant to which it paid a $100 million penalty to the CFTC and a $50 million penalty to FinCEN.
U.S. IRS & Other State Tax Agencies. The U.S. Internal Revenue Service (“IRS”) states that, in the case of the typical owner of virtual currency such as bitcoin (who purchases the virtual currency as a long-term investment and is not a dealer), the sale by such owner of such virtual currency results in long or short term capital gain. Therefore, spending bitcoin is not like spending U.S. currency, which is tax-free. Similarly, if you receive bitcoin for services rendered, that must be reported to the IRS as income.
Money Transmitter Licenses. The District of Columbia now requires a money transmitter license to be obtained by any person who engages in any money transmission involving bitcoin or other virtual currency “used as a medium of exchange, method of payment or store of value in the District.”