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Published Articles by David Balovich

Title: REVISED ARTICLE 7 of the Uniform Commercial Code
Published in: Creditworthy News
Date: 9/15/11

This is a continuation of a series of articles on the revised articles of the Uniform Commercial Code.

            The original Article 7 of the Uniform Commercial Code, “Warehouse Receipts, Bills of Lading and Other Documents of Title,” included two earlier uniform acts, the Uniform Warehouse Receipts Act (1906) and the Uniform Bills of Lading Act (1909), with some provisions from the Uniform Sales Act, which later became Article 2 of the UCC.  Before 2003 Article 7 had not been revised since the original Uniform Commercial Code, a period of 52 years.  The longevity of the principles of warehouse receipts and bills of lading illustrates the successful law and law-making as it pertains to the commercial storage and shipment of goods.  The basic principles do not change in the 2003 revision.  But there were reasons to readdress this area of the commercial law in 2003, which will be discussed later.  First, let's discuss some of the basics of Article 7.

The storage and shipment of tangible goods for commercial purposes has been going on for centuries.  The physical side of the business is carried on by entities that provide warehouses (warehousemen) and entities that transport goods from place of origin to destination (common carriers).  Article 7 provides for the transfer of rights in the goods while they are stored and/or shipped.  The common law provided the rules of bailment and the terminology of bailor and bailee is still incorporated in the Uniform Act.  As the law developed, the transfer of rights came to depend upon the transfer of specific documents of title.  The transfer of the documents from one person to another became known as the transfer of the rights.  Title documents were known as warehouseman’s receipts on the storage/warehouse side, and known as the bill of lading on the carrier side.  The original Article 7 and the 2003 revision all incorporate these basics.

One of the important elements carried forward into the 2003 revision is that of negotiability.  Free transfer of interests is an important policy norm throughout the UCC.  In Article 7, documents of title may be negotiable.  Whether a document is negotiable or non-negotiable depends upon how it identifies the transferee and the way transfer occurs.  A negotiable document may be one of two kinds of paper documents, bearer paper or order paper.  A document made out to the bearer may be transferred from one person to another by simple delivery of possession.  The delivery transfers the rights to the goods aka the title to the transferee.  Order paper is made out to a specific individual or person.  After initial delivery to the person named on the document, it may be negotiated to another person by the indorsement of the named person and delivery of possession to that other person.  The rights to the goods and title pass with the negotiation to the transferee.

Documents of title can also be made non-negotiable.  This is primarily done by a statement on the face of the instrument.  Non-negotiable documents of title may also be assigned or transferred.  The difference between negotiable and non-negotiable documents is the rights that they may transfer.  A non-negotiable document of title transfers only the actual interests of the transferor.  A negotiable document of title may transfer more than the actual interests of the transferor.  For example, it can transfer free of any claims against the issuer of the document.  A non-negotiable document is not free of such claims.

Negotiation as a concept exists to make commerce in goods possible.  Goods would not be transferred if the purchaser always has to look behind the transaction to see who may come after the goods after the transfer is complete.  Negotiation removes this peril.  The principle detailed in Article 7 is consistent with Article 3 of the UCC governing notes, drafts, and checks.

Article 7 governs other important aspects of the transfer of rights in goods when stored or shipped, such as the liens of warehousemen and carriers and the enforcement and allocation of risk of loss of the goods either in storage or transit. However, the issue of negotiation has been its single most important aspect, until the revisions in 2003.  That is when something very important occurred that changed the way we looked at the principle of negotiation.  That "something" was computers, electronic communications and the ability to create electronic documents of title.             Computers have been deranged and applauded for their impact on commerce and business.  Their impact on storage and shipment of goods has been profound.  Federal law has actually recognized electronic documents for some time, but electronic documents of title cannot be substituted one to one with tangible documents of title.  Their characteristics in electronic form are not the same as their characteristics in tangible form.

The tangible form is a written document on paper with signatures of issuers and subsequent transferors.  The individual document is a unique token of the rights and interests it represents.  Even when there is a copy, there is always the original.  This is not so with electronic documents.  Originals and copies are indistinguishable from each other in electronic form.  Signatures in the sense of an individual’s unique scrawl on a piece of paper cannot be equally duplicated in an electronic document.  Transferors and transferees, who are remote from each other when tangible documents are transferred, are not remote from each other in electronic media.  Electronic communications can occur between any two persons anywhere in the world.  Yet, it is difficult for each participant in an electronic communication to verify or authenticate the identity of the other party.   To have the effective electronic documents that commerce demands, new concepts had to be introduced into the law.  The concept of negotiation as we have known it in American law does not apply in electronic media.  Thus, the biggest addition to Revised Article 7 was the new rules for electronic documents of title.

These rules dealt with distinct issues:  recognition of electronic documents of title; statute of fraud extensions; establishment of the unique original in electronic form aka authentication; and interchangeability between electronic and tangible documents of title.  In addition, the rules for electronic documents of title had to work as seamlessly as possible into the existing system governing tangible documents of title.  The law had to avoid skewing the choice between tangible and electronic documents of title in the favor of either form.  Only the actual marketplace could determine users’ choices.  Revised Article 7 deals with these issues and meets the test of seamless insertion into the existing law.

Recognition of electronic documents of title begins in the definition of “Document of Title:” “An electronic document of title is evidence by a record consisting of information stored in an electronic medium.”  Other definitions have been modified to agree with this core definition.  For example, “Holder” is defined to include: “a person in control of a negotiable electronic document of title.”  Thus, electronic documents of title become the equal to tangible documents of title.

Revised Article 7 also extends the statute of fraud requirements to include electronic records and signatures.  Any writing requirement that relates to enforceability of a document is a statute of frauds requirement.  Article 7 treats electronic records and signatures as the equivalent of paper documents and written, manual signatures.  This initially occurs in new definitions of “record” and “sign.”  A record is “information that is inscribed on a tangible medium or that is stored in an electronic or other medium and is retrievable in perceivable form.”  The term “sign” is defined to “execute or adopt a tangible symbol” and “to attach or logically associate with the record an electronic sound, symbol or process.”  Within Revised Article 7, wherever the term “writing” or an equivalent may have been used before revision, the term “record” is uniformly used.  When a document is required to be signed anywhere in Revised Article 7, electronic signing meets the test.

Revised Article 7 also provides language stating expressly that it modifies, limits and supersedes the federal Electronic Signatures in Global and National Commerce Act.  This express language, permitted in the federal act, avoids any issue of federal preemption.  The federal statute allows specific tailoring for the purposes of incorporating electronic records and signatures into state law.

It is not possible to transfer an electronic document of title in the same manner as a tangible document of title, particularly in terms of negotiating it.  It cannot be guaranteed that a transfer directly from one person to the next by delivery and/or signature will transfer the authentic original document of title.  An electronic alternative to the tangible system was necessary.  To accomplish the equivalent system for electronic documents of title, Revised Article 7 adapts the concept of “control” to the purpose.  It is not a new concept. It originally was developed in Article 8 of the Uniform Commercial Code for investment securities in the indirect holding system.  In the 1999 revisions to Article 9 the concept was adapted further for secured transactions.  The concept also can be found in Section 16 of the Uniform Electronic Transactions Act for promissory notes.  This latter occurrence is most important for Revised Article 7, because the issues of negotiation for promissory notes is very similar to those for documents of title.

A person has control of a document of title for Revised Article 7 purposes “if a system employed for evidencing the transfer of interests in the electronic document reliably establishes that person as the person to which the electronic document was issued or transferred.”  Such a system exists when it establishes a “single authoritative copy ...which is unique, identifiable and ... unalterable.”  The authoritative copy must identify the person in control or the next person to whom the document has transferred.  The person in control determines to whom the document is next transferred.  Further, the standard requires that copies that are not authoritative, including copies of the authoritative copy, must be readily identifiable as not being the authoritative copy.

There are many ways to meet this set of standards, unlike negotiation of a paper document, which occurs in one way only.  One way to establish the single authoritative document is to have a single custodian of the electronic record, who enters all transfers of the document and identifies the person in control on its records. In such a system, the person in control notifies the custodian of any transfer or authorized change in the document, who then notates its records appropriately and notifies the person in control and other relevant parties of the action.  A transfer would obviously shift control from transferor to transferee.  The transferee would become the new person in control.

Encryption technology can provide other methods for meeting these standards.  Some kind of hybrid system of encryption and custodian may arise.  UCC Revised Article 7 does not indorse any one system and more than one system may develop over time.  It is not possible to predict what technology will ultimately bring to electronic transfer systems.  Revised Article 7 allows the technology to develop without need to amend it later when a new kind of technology comes along.

UCC Article 7 provides for an electronic system of transfer for electronic documents of title and for the traditional paper system of documents of title which includes negotiable documents of title.  Control is the operative term with electronic documents and negotiation is the operative term for tangible documents of title.  With respect to the transfer of rights in a particular group of goods, can electronic documents be converted to tangible documents and vice versa?  UCC Revised Article 7 provides for such conversions.  An electronic document may be converted when the person with control surrenders that control to the issuer, who then issues a tangible document of title containing a statement that it substitutes for the electronic document.  The same kind of process will convert a tangible document to an electronic one.  The person entitled to enforce a tangible document surrenders possession to the issuer.  The electronic document must also state that it is a substitute for the tangible document. Without the ability to convert from tangible to electronic documents, this system would not work.

The revisions to UCC Article 7, beyond making way for electronic documents of title, primarily update or clarify existing rules of law.  There are references to tariffs and regulations in original UCC Article 7 that no longer exist with deregulation and these have been eliminated in the revised Article 7.  There is nothing more significant today as the rules for electronic documents of title.  These rules alone make it imperative for the states to enact the revision to UCC Article 7 as soon as practicable but to date only 31 states have enacted Revised Article 7 since it was given to the states in 2003. Documents of title are fundamental to the transfer of goods in interstate commerce.  The Revised Article 7 of the UCC is commerce friendly and not only does every state need to revise its' current Article 7, every credit professional needs to understand them as well.  

I wish you well.

The information provided above is for educational purposes only and not provided as legal advice. Legal advice should be obtained from a licensed attorney in good standing with the Bar Association and preferably Board Certified in either Creditor Rights or Bankruptcy.  

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