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Steven O. Weise

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Steve Weise is a partner in the corporate department, practicing in its Los Angeles office. He practices in a wide range of commercial law. He spends much of his time on matters arising under the Uniform Commercial Code, especially under Article 9 – Secured Transactions.  He is a nationally-recognized expert in these matters. Steve is also authoritative on third-party opinion letters and contract law matters, especially online contracting, plain English drafting, contract drafting, and boilerplate.

Steve is a member of the Permanent Editorial Board for the Uniform Commercial Code and of the Council of the American Law Institute. For thirty years, Steve has been on many Uniform Commercial Code drafting committees, including the comprehensive revision of UCC Article 9 in 1999 and the 2022 UCC Amendments addressing digital assets as collateral.  Steve is a Lecturer in Law at UCLA Law School, where he teaches Uniform Commercial Code – Secured Transactions.

Steve was instrumental as an Adviser in the preparation of the recently-completed American Law Institute Restatement of the Law, Consumer Contracts and is active in many other Restatement projects. Steve is the former chair of the American Bar Association’s Section of Business Law and its Legal Opinions Committee. He has been the Reporter for many TriBar Opinions Committee reports on opinions under the UCC and has long been a member of the board of the Working Group on Legal Opinions.

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As discussed in Part I of this series, NFT-based lending is pioneering a new avenue of investment and activity on the blockchain that will enable new and innovative use cases. In this Part II, we will discuss the implications for Lenders.

I. Issues for Lenders:

These on-chain loans secured by digital assets present a question for lenders: how do lenders get comfortable extending secured financing to borrowers where the secured asset is digital, like an NFT? In traditional financing, lenders and borrowers negotiate a security agreement, which governs the rights a lender will have in a transaction. Per the Uniform Commercial Code (the “UCC”), which regulates interests in personal property as collateral for debt, a security interest in tangible collateral can be perfected against third parties by possession of the collateral or by filing a financing statement. At the same time, a security interest in many kinds of intangible collateral can be perfected against third parties only by filing a financing statement. Sometimes, best practice calls for possession and filing (when both types of perfection are permitted under the UCC).

Mechanically, when the lender and borrower agree to terms on a peer-to-peer marketplace like Blur (as discussed in Part I of this series), the NFT is placed into a vault – a smart contract with specific storage and security features – with a lien on it; at this point, the principal is transferred to the borrower. As discussed below, the UCC, as currently adopted in most states, does not account for perfection of a security interest in digital assets by any method other than the filing of a financing statement, so a vault & lien combination is insufficient to perfect a security interest in the NFT collateral against third parties; however, the 2022 UCC Amendments provide certain clarity for perfecting a security interest in digital assets against third parties.

In general, the UCC is periodically updated to incorporate emerging technologies and trends. Among other updates, the 2022 UCC Amendments address digital assets and distributed ledger technologies, affording transactors in goods and services updated default rules under the UCC. As such, lenders should be aware of the varying new measures to ensure their loans are adequately secured and perfected against the borrower and any third party, including customers and other creditors of the borrower. Hence, the lender would be first in line to realize on the collateral in a fight with other creditors of the borrower.

On July 5, 2022, cryptocurrency brokerage Voyager Digital filed for chapter 11 in the Southern District of New York Bankruptcy Court, citing a short-term “run on the bank” due to the “crypto winter” in the cryptocurrency industry generally and the default of a significant loan made to a third party as the reasons for its filing.  At Voyager’s first day hearing on July 8, 2022, the Bankruptcy Court asked the critical question of whether the crypto assets on Voyager’s platform were property of the estate or its customers.  Voyager asserted the crypto assets were assets of the estate pursuant to the terms of its customer agreements, but the question of ownership was more problematic in the context of a liquidation.  In that context, Voyager’s plan of reorganization proposes to resolve any mystery of ownership by delivering the reorganized company to its customers.

On July 13, 2022, cryptocurrency lender Celsius Network filed for chapter 11 in the Southern District of New York Bankruptcy Court.  Celsius had frozen customer withdrawals on June 12, 2022 and, at the time of its chapter 11 filing, indicated that it would not be requesting court authority to allow customer withdrawals.  Celsius noted in a press release that customer claims would be addressed through the chapter 11 process.

Voyager’s and Celsius’ chapter 11 bankruptcy filings highlight the question of whether crypto assets held by an exchange, or similar platform, may be considered property of a bankruptcy estate and, therefore, not recoverable by the customer, who would then likely be an unsecured claimholder of the debtor.

While some commentators have suggested that crypto assets might be considered property of the exchange’s bankruptcy estate, existing common law, existing provisions of Uniform Commercial Code (UCC) Article 8, and proposed amendments to the UCC recognize that if the arrangement and relationship between the exchange and its customers is one that is characterized as “custodial,” the crypto assets held by the exchange should remain property of the customer and, hence, not subject to dilution by general unsecured claimholders.

Last July, the Uniform Law Commission completed a uniform model state law, known as the Uniform Regulation of Virtual-Currency Businesses Act (“URVCBA” or the “Act”) (Steve Weise participated in the preparation of the Act).  Currently, state regulation in the virtual currency space is carried out under a patchwork of laws that typically do not directly contemplate virtual currency and blockchain technology. Attempting to bring clarity as to which types of entities require state licensure and also to encourage responsible innovation in this emerging area, the URVCBA provides a statutory framework for the regulation of companies engaging in “virtual-currency business activity.”  After carefully defining which activities fall under the Act’s purview, the uniform law requires covered entities to make the typical financial and business disclosures in its application, and also contains numerous user and consumer protections, including certain enforcement powers by the relevant state authority.

The mission of the Uniform Law Commission is to draft state laws on topics where standardized regulation across state lines is practical (e.g., the Uniform Commercial Code (the “UCC”)). Gaining final approval in 2017, the Act has so far been introduced in Connecticut, Hawaii, and Nebraska.