United States: Chattel Paper In The Electronic Age

The world is going digital and equipment lease transactions are no exception.  Today, business is increasingly conducted online, and the necessity to do so has only been amplified with the COVID-19 health crisis.  Luckily, because the movement of transactions into the digital space was already well underway prior to COVID-19, the law and the market have had time to adapt to provide relatively clear guidance as to best practices to ensure transactions, including equipment lease transactions, can be completed seamlessly online.

There are two main areas of concern regarding 'virtual' transactions:  (i) the validity of signatures; and (ii) the creation of an original, authoritative copy of the relevant lease documents.  This article tackles both to provide lessors guidelines to ensure any electronic lease transaction is properly executed and the lessor is provided with the original paper.

E-signatures

Technically, the term 'electronic signature' or 'e-signature' encompasses a variety of digital sounds, symbols, or processes.  At its broadest, this term refers to any electronic process that indicates acceptance of an agreement or record, including digitised images of handwritten paper signatures, typed notations such as "/s/ John Smith" at the end of a digital document or email, or even just an email signature block.  A 'digital signature' is a type of electronic signature that uses secure cryptographic technology to certify authentication of sender identity, data integrity, and non-repudiation.  The term 'e-signature' is commonly understood to subsume all forms of non-ink assent, including digital signatures.

At present, a patchwork of federal and state laws dictate when and how the validity of electronic signatures can and must be established:

1. Federal law: Signed into law on 30 June 2000, the Electronic Signatures in Global and National Commerce Act of 2000 (E-SIGN) became effective on 1 October 2000.
2. Uniform law: The Uniform Electronic Transactions Act (UETA) preceded E-SIGN. The UETA, or a modified version of UETA, has been codified in 47 states, the District of Columbia, and the U.S. Virgin Islands.
3. Outlier laws: Three states – Illinois, New York, and Washington – have forged their own paths, with New York's and Washington's efforts predating E-SIGN's passage.

In general, to comply with these acts, four requirements must be met:

1. Intent to sign: Electronic signatures, like traditional 'wet ink' signatures, are only valid to the extent that each party actually intended to assent to the relevant agreement.
2. Consent to do business electronically: Participants in a transaction must agree to use electronic records and signatures in lieu of paper documents and traditional 'wet' signatures. This consent may be expressly stated by the parties, whether as part of the substantive contract or an addendum, or implied from the circumstances.  Express consent is required in only some consumer situations.
3. Association of signature with record: Verification of an electronic signature involves proving that the electronic signature was made by the intended signee. This can usually be accomplished by establishing the date, location and time the signature was made and that there was no tampering with the document.
4. Record retention: Electronic signature records must be capable of retention and accurate reproduction so as to be used for reference by all parties or persons entitled to retain the contract or record.

Importantly, these laws are similarly limited in scope.  Not one requires a person to use or accept electronic records or electronic signatures, though all limit governmental agencies' authority to deny such records' validity to some extent.  In addition, each nullifies any legal requirement that contracts or other records be written, signed, or in non-electronic form, but not one purports to affect any other statutory or regulatory rights or obligations.  For the most part, those rights remain within the province of state substantive law.

E-documents

As with paper documents, the Uniform Commercial Code (UCC) governs the perfection of a security interest in electronic chattel paper.

While filing an effective financing statement in the appropriate place may perfect a security interest in chattel paper under section 9-310 of the UCC, a possessor of tangible chattel paper can obtain superior rights in the chattel paper under section 9-330.  To obtain those superior rights, the possessor must possess the copy of the tangible chattel paper marked "original".  With respect to electronic documents, 'control' is the operative word and corollary to 'possession' with respect to traditional 'paper' chattel paper.

Section 9-105 of the UCC sets forth the relevant standard for 'control'.  Section 9-105(a) provides that, generally, "[a] secured party has control of electronic chattel paper if a system employed for evidencing the transfer of interests in the chattel paper reliably establishes the secured party as the person to which the chattel paper was assigned."  Section 9-105(b) lists the six essential features of such a system:

1. Authoritative copy: Electronic chattel paper must consist of a single authoritative copy of the chattel paper record or records which is unique, identifiable, and generally unalterable.
2. Identity of secured party: The authoritative copy must identify the secured party as the secured party or as the assignee of the electronic chattel paper.
3. Maintenance of authoritative copy: The authoritative copy must be communicated to and maintained by the secured party or its designated custodian.
4. Participation by secured party: The secured party must be a necessary participant whenever changes that affect the ownership of the electronic chattel paper are made to any authoritative copy.
5. Distinguishable copies: Any copy of the authoritative copy, and even any copy of such a copy, must be readily distinguishable from the authoritative copy itself.
6. Capacity of business information system: the secure business information system within which electronic chattel paper is maintained must be able to distinguish between authorised revisions and unauthorised revisions.

Control/possession of chattel paper is the preferred method for perfecting a security interest in the chattel paper.  In the 'paper world', a lessor's practice is likely to require delivery of an original equipment schedule along with a copy of the master lease.  Together, these two documents constitute the original chattel paper for purposes of perfecting the lessor's interest in the transaction.

As explained above, control of electronic chattel paper replicates functionally in an electronic medium the possession of tangible chattel paper by providing a standard for the establishment of control.  The definition then provides a 'safe harbour' test that, if met, proves as much.  By design, per section 9-105 of the UCC, this definition "leaves to the marketplace the development of systems and procedures, through a combination of suitable technologies and business practices, for dealing with control of electronic chattel paper in a commercial context."  As the comment to this section explains, "[s]ystems that evolve for control of electronic chattel paper may or may not involve a third party custodian of the relevant records."  Accordingly, under the safe harbour, the authoritative copy "is communicated to and maintained by the secured party or its designated custodian".  Because the UCC does not mandate or otherwise provide for public access to the information lodged in a system for control of electronic chattel paper, it would be a 'private registry' under the taxonomy adopted here (e.g. eOriginal, File Hold, Templafy).

Insurers and ratings agencies recognise electronic vaulting platforms as meeting the requirements for securitisation of electronic chattel paper in the secondary market.

Conclusion

The still-evolving law of electronic chattel paper promises peril and opportunity.  Recent statutes and case law offer some direction as to what a party must do to stymie challenges to a transaction predicated solely on the parties' use of e-signatures.  The UCC, in turn, specifies how perfection of an interest in chattel paper can be attained.  In this electronic age, the discrete requirements imposed by these varied – and endlessly variable – sources will determine whether any business dealing with electronic chattel paper has an enforceable security interest.

Originally published May 12, 2020.

This article is presented for informational purposes only and is not intended to constitute legal advice.