A NEW SYSTEM OF CONTROL OF ELECTRONIC CHATTEL PAPER: NOTIFICATION OF ASSIGNMENT
– Thomas E. Plank –
Since the beginning of the twenty-first century, contracts evidenced solely by electronic records instead of written agreements have proliferated as a result of technological developments, competitive pressures to reduce costs, and enabling legislation. An important subset of these electronic contracts consists of “electronic chattel paper.” Chattel paper evidences a loan secured by a specific good, such as an automobile loan. Before 2001, the only form of chattel paper was tangible chattel paper, that is, chattel paper evidenced by a writing. Tangible chattel paper has from the beginning been quasi-negotiable. The owner of the tangible chattel paper, such as an automobile dealer who received the chattel paper a part of the price of an automobile, could transfer to a purchaser perfected rights in the chattel paper superior to the rights of prior secured creditors or prior buyers simply by transferring possession of the writing.
The 2001 revision of Article 9 of the Uniform Commercial Code authorized debtors to enter into security agreements evidenced by an electronic record instead of a writing, including chattel paper, and created the new category of electronic chattel paper evidenced by an electronic record. To give electronic chattel paper the quasi-negotiability of tangible chattel paper, the 2001 revision further created the concept of “control” of the electronic chattel paper to correspond with the concept of possession of tangible chattel paper. The definition of control required the creation of a single, unique, authoritative copy of the electronic chattel paper that cannot be altered without consent of the party with control. The very specific definition of control was intended to mimic possession of tangible chattel paper.
Satisfying the definition of control, however, has been a challenge because of the differences in the physical characteristics between a written record and an electronic record. A tangible writing, such as tangible chattel paper, becomes a single unique object when signed by the obligor. Possession of the wet ink signed writing distinguishes this writing from any copies of the writing. An electronic record, however, can be perfectly replicated many times. Therefore, there is no single, easily distinguished electronic record from a copy, and a tangible writing, which becomes a single unique object when signed by the obligor. Commercial enterprises have met this challenge by developing an elaborate system that combines computer hardware and software technology with a set of control procedures essentially to isolate one electronic copy of the chattel paper in an electronic vault.
In 2010, the Uniform Law Commission and the American Law Institute revised the definition of control to add a more general rule for control, and by 2014 all states (other than New York) and the District of Columbia enacted this revision. Under the new general rule, a person will have control of electronic chattel paper if a system “reliably establishes” the person to which the record was assigned. This article proposes a simple system for the transfer of electronic chattel paper that does reliably establish the person to which the electronic record was assigned without attempting to mirror possession of a writing. This proposed system consists of notification to the obligor on the electronic chattel paper of the assignment of the chattel paper to an assignee with instructions to pay the assignee.
Under current law, notification of assignment with instructions to pay the assignee is already an essential element in the assignment of chattel paper, whether written or electronic, and other receivables. The obligor on chattel paper need not pay any person other than the original payee until the obligor receives notification of assignment with instructions to pay the assignee. Once the obligor receives such notification with payment instructions, the obligor can only discharge its obligation by paying the assignee. Therefore, notification with payment instructions is the surest way to ensure that the assignee will be paid. For this reason, notification with payment instructions is a system that reliably establishes the assignee of electronic chattel paper as the person to which the chattel paper has been transferred. Therefore, notification with instructions to pay the assignee gives the assignee “control” of electronic chattel paper. Notification will be less complicated and less costly than the current vaulting system used to establish control.
Reliance on notification to establish superior rights in the assignee is not a new idea. In many jurisdictions, before the enactment of Article 9 of the UCC and a variety of accounts receivable assignment statutes beginning in the late 1940s and the 1950s, notification perfected the interests of the assignee in rights to payments, including trade receivables, and gave the assignee priority over prior purchasers who had not given notification of assignment.