I’m a Cadwalader UCC lawyer focused on digital assets, so I scan the news every day looking for interesting blockchain items. There are many announcements of tokenized real world asset finance projects. Some experiment with novel legal approaches. Others are cautious, retaining familiar legal structures and adding tokenization only incrementally. Sometimes those structures look identical to traditional finance deals, except with a token bolted onto the side.

Nonetheless, whether innovative or cautious most of the projects share a common trait: the tokenization features only apply to the instrument sold into the capital markets. The underlying collateral assets are typically not tokenized. Instead, those base-level assets usually retain the time-honored, paper-bound forms that old-school TradFi lawyers like me know and love.

That’s not universally the case, of course. Some projects do tokenize the underlying collateral as well as the issued security. Figure Markets and Centrifuge are two long-standing examples. Intain and FIS more recently rolled out their tokenized loan platform for community banks. There are certainly others. But projects that tokenize assets at the underlying collateral level, rather than only at the issued security level, still seem the exception rather than the rule.

As a result, I’m always on the lookout for new entrants to the tokenized-collateral club. So it is that my eye was caught a few days ago by a press release from Forum Markets, in which they announced a new loan warehouse facility for tokenized auto loans.

The arrangement described in release involves the automation of loan applications at the dealer level, and the use of AI to deliver credit decisions within minutes. But in addition to those features, the release describes the project’s integration of blockchain infrastructure at the point of origination and dealer funding. The release says that Forum uses the blockchain-based rails of Liquidity.io’s alternative trading system to enable 24/7/365 settlement for a “real-time blockchain-native issuance framework.”

Now, from the public details in the press release I can’t really be sure that these auto loans are tokenized from inception—although it sure sounds like it. (I’d be eager to understand the Forum structure better.)

But in my UCC lawyer’s brain, the very concept of tokenizing underlying receivables collateral triggers one big, flashing idea.

Tokenized receivables are simply better collateral.

The reason hearkens to the recent 2022 amendments to the UCC. One of the most important—and, I think, least appreciated—aspects of those recent amendments is how they give certain tokenized receivables superpowers.

Everyone’s familiar with the usual way to perfect a pledge against traditional receivables: you run a UCC search and file a financing statement. For certain receivables, if your structure involves buying rather than merely pledging, you might get automatic perfection without filing. And in either case your perfection is solid—so long as you’re first to file or perfect. Under the pre-amendment UCC you couldn’t perfect your security interest in garden-variety receivables (i.e., accounts or payment intangibles) by taking control of them—there was no such concept.

Under the amended UCC, though, things can be different. If an account or payment intangible is evidenced by a crypto token—or in UCC parlance, a “controllable electronic record” (CER)[1]—and the obligor on the receivable agrees to pay the person who controls the token, that receivable might be something new: a “controllable account” or a “controllable payment intangible.” And security interests in controllable accounts and controllable payment intangibles can be perfected by control.

If a secured party takes control of the token evidencing such a receivable, that secured party’s interest can not only be perfected through such control, but it can be prior to other, non-control-perfected security interests—even ones that were perfected by financing statements filed earlier in time.

Not only that, if a secured party or other purchaser takes its interest in such controllable accounts and controllable payment intangibles for value, in good faith, and without notice of a claim of a property right, the amended UCC lets that secured party or purchaser take the receivable free of other competing property interests. Those other property interests are actually cut off. That’s true even if the person granting the interest didn’t actually have a good property interest in the collateral to begin with—as might be the case if (to take a totally random and not-at-all-timely example) a debtor were to double-pledge its receivables. A secured party that takes control of receivables that are properly tokenized so that they constitute controllable accounts or controllable payment intangibles should win in a contest with other security interests and property claims, as long as the controlling secured party is pure of heart.[2]

The UCC-astute among you will no doubt point out that auto loans, like those in the Forum warehouse facility, are presumptively chattel paper under the UCC, not accounts or payment intangibles. They would therefore fall outside the scope of “controllable accounts” and “controllable payment intangibles” under the amended UCC. True enough. But changes under those same UCC amendments can also render tokenized chattel paper better collateral than non-tokenized chattel paper.

The pre-amendment UCC encompassed electronic, as well as tangible, chattel paper. For this discussion we can leave aside the tangible type. The pre-amendment UCC did permit perfection of a security interest in electronic chattel paper to be achieved by control. But under the pre-amendment statute’s safe harbor, such control generally required that the chattel paper be locked into a system that permitted only a single authoritative copy of the chattel paper. Further, the pre-amendment statute specified certain technological details required of an acceptable system, like requirements that copies of the authoritative record be noted as copies, or that amendments to the record be identifiable as such.

Those legacy systems are perfectly workable, as far as they go, and still work under the amended UCC. But those systems often take the form of electronic vaulting platforms that immobilize the chattel paper onto a centralized server. Transacting with such controlled chattel paper is therefore a function of that centralized server: if the guy who needs to push a button on the server hasn’t made it into the office yet, your transaction isn’t going through until he does.

The UCC amendments, however, expanded the concept of control for electronic chattel paper to include tokenization-friendly concepts. First, multiple authoritative copies are now permitted—as would be the case in a blockchain ledger distributed over many nodes. Second, a purchaser may identify itself by any means, including by cryptographic key. Third, the amended UCC language ports in many of the same phrasings used in the control provisions relating to CERs. Those terms focus less on details of a particular technological system and more on the powers of the control person to control modifications and transfers.

In addition, the UCC amendments also imported certain other CER-related language into the chattel paper provisions: terms about when control is “exclusive” or not, and how control can be shared. As a result, wallets that are set up for control of crypto could potentially also work to give UCC control of tokenized chattel paper.

While the amendments to the UCC don’t extend new take-free rights to tokenized chattel paper, like for controllable accounts and controllable payment intangibles, they do make control perfection and enhanced priority available. No longer does electronic chattel paper have to be tied down to a single, immobilized authoritative copy. Now tokenized chattel paper—with all its open-ended features of programmability, composability, efficiency and always-on transactability—can also benefit from that control perfection and non-temporal priority.

In a word, tokenized chattel paper is also now better collateral.

I’ll stop there, although the UCC analysis can go much deeper. Even these few points give some important things to think about. And, of course, there are many reasons besides the UCC why it might make sense to tokenize a deal’s underlying collateral, and not just the top-level security.

It will be interesting to see whether innovations like the Forum, Figure and Intain projects that tokenize underlying assets continue to be the exception—or whether they herald a coming wave of more complete, top-to-bottom tokenization structures.

[1] Actually, a CER isn’t necessarily identical with a “token.” Whether any particular digital token in fact constitutes a CER under the UCC requires a somewhat complicated inquiry into how its tech stacks up against the Article 12 definition of “control.” But, since in general most typical crypto tokens should fall under the rubric of CER, we can leave that complexity aside.

[2] As for whether the secured party can be “empty of head” as well as “pure of heart,” note that New York’s enactment of the UCC amendments retains its non-uniform subjective standard for “good faith.” See https://www.cadwalader.com/fin-news/index.php?eid=1005&nid=142#:~:text=New%20York's%20definition%20of%20QP%20would%20pull,dealing%E2%80%9D%20included%20in%20the%20uniform%20UCC%20text.

I’m a Cadwalader UCC lawyer focused on digital assets, so I scan the news every day looking for interesting blockchain items. There are many announcements of tokenized real world asset finance projects. Some experiment with novel legal approaches. Others are cautious, retaining familiar legal structures and adding tokenization only incrementally. Sometimes those structures look identical to traditional finance deals, except with a token bolted onto the side.

Nonetheless, whether innovative or cautious most of the projects share a common trait: the tokenization features only apply to the instrument sold into the capital markets. The underlying collateral assets are typically not tokenized. Instead, those base-level assets usually retain the time-honored, paper-bound forms that old-school TradFi lawyers like me know and love.

That’s not universally the case, of course. Some projects do tokenize the underlying collateral as well as the issued security. Figure Markets and Centrifuge are two long-standing examples. Intain and FIS more recently rolled out their tokenized loan platform for community banks. There are certainly others. But projects that tokenize assets at the underlying collateral level, rather than only at the issued security level, still seem the exception rather than the rule.

As a result, I’m always on the lookout for new entrants to the tokenized-collateral club. So it is that my eye was caught a few days ago by a press release from Forum Markets, in which they announced a new loan warehouse facility for tokenized auto loans.

The arrangement described in release involves the automation of loan applications at the dealer level, and the use of AI to deliver credit decisions within minutes. But in addition to those features, the release describes the project’s integration of blockchain infrastructure at the point of origination and dealer funding. The release says that Forum uses the blockchain-based rails of Liquidity.io’s alternative trading system to enable 24/7/365 settlement for a “real-time blockchain-native issuance framework.”

Now, from the public details in the press release I can’t really be sure that these auto loans are tokenized from inception—although it sure sounds like it. (I’d be eager to understand the Forum structure better.)

But in my UCC lawyer’s brain, the very concept of tokenizing underlying receivables collateral triggers one big, flashing idea.

Tokenized receivables are simply better collateral.

The reason hearkens to the recent 2022 amendments to the UCC. One of the most important—and, I think, least appreciated—aspects of those recent amendments is how they give certain tokenized receivables superpowers.

Everyone’s familiar with the usual way to perfect a pledge against traditional receivables: you run a UCC search and file a financing statement. For certain receivables, if your structure involves buying rather than merely pledging, you might get automatic perfection without filing. And in either case your perfection is solid—so long as you’re first to file or perfect. Under the pre-amendment UCC you couldn’t perfect your security interest in garden-variety receivables (i.e., accounts or payment intangibles) by taking control of them—there was no such concept.

Under the amended UCC, though, things can be different. If an account or payment intangible is evidenced by a crypto token—or in UCC parlance, a “controllable electronic record” (CER)[1]—and the obligor on the receivable agrees to pay the person who controls the token, that receivable might be something new: a “controllable account” or a “controllable payment intangible.” And security interests in controllable accounts and controllable payment intangibles can be perfected by control.

If a secured party takes control of the token evidencing such a receivable, that secured party’s interest can not only be perfected through such control, but it can be prior to other, non-control-perfected security interests—even ones that were perfected by financing statements filed earlier in time.

Not only that, if a secured party or other purchaser takes its interest in such controllable accounts and controllable payment intangibles for value, in good faith, and without notice of a claim of a property right, the amended UCC lets that secured party or purchaser take the receivable free of other competing property interests. Those other property interests are actually cut off. That’s true even if the person granting the interest didn’t actually have a good property interest in the collateral to begin with—as might be the case if (to take a totally random and not-at-all-timely example) a debtor were to double-pledge its receivables. A secured party that takes control of receivables that are properly tokenized so that they constitute controllable accounts or controllable payment intangibles should win in a contest with other security interests and property claims, as long as the controlling secured party is pure of heart.[2]

The UCC-astute among you will no doubt point out that auto loans, like those in the Forum warehouse facility, are presumptively chattel paper under the UCC, not accounts or payment intangibles. They would therefore fall outside the scope of “controllable accounts” and “controllable payment intangibles” under the amended UCC. True enough. But changes under those same UCC amendments can also render tokenized chattel paper better collateral than non-tokenized chattel paper.

The pre-amendment UCC encompassed electronic, as well as tangible, chattel paper. For this discussion we can leave aside the tangible type. The pre-amendment UCC did permit perfection of a security interest in electronic chattel paper to be achieved by control. But under the pre-amendment statute’s safe harbor, such control generally required that the chattel paper be locked into a system that permitted only a single authoritative copy of the chattel paper. Further, the pre-amendment statute specified certain technological details required of an acceptable system, like requirements that copies of the authoritative record be noted as copies, or that amendments to the record be identifiable as such.

Those legacy systems are perfectly workable, as far as they go, and still work under the amended UCC. But those systems often take the form of electronic vaulting platforms that immobilize the chattel paper onto a centralized server. Transacting with such controlled chattel paper is therefore a function of that centralized server: if the guy who needs to push a button on the server hasn’t made it into the office yet, your transaction isn’t going through until he does.

The UCC amendments, however, expanded the concept of control for electronic chattel paper to include tokenization-friendly concepts. First, multiple authoritative copies are now permitted—as would be the case in a blockchain ledger distributed over many nodes. Second, a purchaser may identify itself by any means, including by cryptographic key. Third, the amended UCC language ports in many of the same phrasings used in the control provisions relating to CERs. Those terms focus less on details of a particular technological system and more on the powers of the control person to control modifications and transfers.

In addition, the UCC amendments also imported certain other CER-related language into the chattel paper provisions: terms about when control is “exclusive” or not, and how control can be shared. As a result, wallets that are set up for control of crypto could potentially also work to give UCC control of tokenized chattel paper.

While the amendments to the UCC don’t extend new take-free rights to tokenized chattel paper, like for controllable accounts and controllable payment intangibles, they do make control perfection and enhanced priority available. No longer does electronic chattel paper have to be tied down to a single, immobilized authoritative copy. Now tokenized chattel paper—with all its open-ended features of programmability, composability, efficiency and always-on transactability—can also benefit from that control perfection and non-temporal priority.

In a word, tokenized chattel paper is also now better collateral.

I’ll stop there, although the UCC analysis can go much deeper. Even these few points give some important things to think about. And, of course, there are many reasons besides the UCC why it might make sense to tokenize a deal’s underlying collateral, and not just the top-level security.

It will be interesting to see whether innovations like the Forum, Figure and Intain projects that tokenize underlying assets continue to be the exception—or whether they herald a coming wave of more complete, top-to-bottom tokenization structures.

[1] Actually, a CER isn’t necessarily identical with a “token.” Whether any particular digital token in fact constitutes a CER under the UCC requires a somewhat complicated inquiry into how its tech stacks up against the Article 12 definition of “control.” But, since in general most typical crypto tokens should fall under the rubric of CER, we can leave that complexity aside.

[2] As for whether the secured party can be “empty of head” as well as “pure of heart,” note that New York’s enactment of the UCC amendments retains its non-uniform subjective standard for “good faith.” See https://www.cadwalader.com/fin-news/index.php?eid=1005&nid=142#:~:text=New%20York's%20definition%20of%20QP%20would%20pull,dealing%E2%80%9D%20included%20in%20the%20uniform%20UCC%20text.