The Effect of Electronic Signatures on Chattel Paper: Zooming in on the Key Questions

by Kenneth P. Weinberg Vol. 48 No. 3 2021

Electronic documents are here to stay, so Kenneth P. Weinberg addresses some of the most pressing questions about electronically signed chattel paper, including how to best determine the original or authoritative copy and more.

Kenneth P. Weinberg,
Shareholder,
Rimon, P.C.

Electronic signatures have become increasingly common in equipment leasing and finance transactions, and the COVID-19 pandemic has only accelerated this trend.

Many questions surrounding the enforceability of these transactions against lessees and borrowers are similar to those raised in other industries, including whether electronically executed documents are as enforceable against lessees and borrowers, as admissible in court and as compliant with various laws (including document retention laws) as contracts signed in wet ink. These particular issues have been generally addressed by the use of “medium neutral” language in some laws, like Article 9 of the Uniform Commercial Code, or by various state and federal laws providing that contracts will not be rendered ineffective, invalid or unenforceable solely because they exist electronically as long as the electronic records are capable of being retained and accurately reproduced for later reference by all parties or persons who are entitled to retain the records. The main federal law is the Electronic Signatures in Global and National Commerce Act (ESIGN). The main state law is the Uniform Electronic Transactions Act (UETA), which has been adopted in all states except New York and Illinois (which have implemented their own statutes regarding electronic signatures).

This column will focus on a separate issue unique to industries like equipment finance that involve the assignment (outright or as collateral) of leases or financings of specific goods. Such leases or financings are classified as chattel paper under Article 9 and any such assignment needs to be perfected.1 For a variety of reasons, market practice is often to rely on the special priority rule in Article 9 that grants assignees a priority interest in assigned chattel paper so long as certain criteria are satisfied, including the obtainment of possession or control of the chattel paper by the assignee.2

The concept of possession has been around for many years but does not work for contracts existing in electronic form since there is technically no single “original” to possess. Rather, there are multiple exact copies in various places. For example, transferring an electronic document from one place to another (even on the same computer) results in the creation of a new copy rather than actual movement of an original version.

For this reason, Article 9 takes different approaches for two subclasses of collateral: tangible chattel paper and electronic chattel paper. The concept of possession is preserved for tangible chattel paper, but the concept of control is introduced for electronic chattel paper. The elements of control focus on having a single “authoritative copy” of the electronic chattel paper at any given time.3 There are multiple ways to satisfy this criteria, but the equipment finance industry has coalesced around document management systems called e-vaults that use security protocols, watermarks, data trails and other information to maintain a single authoritative copy and to ensure other copies (electronic or tangible) are clearly marked as duplicates.

There remain, however, situations where electronic signatures must be addressed outside an e-vault solution, such as when:

  • The parties desire to deal in electronic chattel paper even though the original contract has wet ink signatures
  • The contract is captured within an e-vault system but the assignee wants to possess tangible chattel paper
  • The contract is signed electronically by one party but in wet ink by another

When considering these issues, it may help to simplify the distinction between electronic and tangible chattel paper and focus more intensely on the control and possession elements of the super priority rule.

On its face, the statutory definition of tangible chattel paper appears to be satisfied whenever the chattel paper is inscribed on a tangible medium such as paper, other fibers or even stone,4 and the statutory definition of electronic chattel paper appears to be satisfied whenever the chattel paper is stored in an electronic medium.5 Using the simplest interpretation of these definitions, tangible chattel paper includes any chattel paper in paper form, including a paper printout of chattel paper originally signed electronically. Electronic chattel paper includes any version of the chattel paper residing on a computer or other electronic device, including a scanned copy of chattel paper originally signed in wet ink.

Against the backdrop of this simple understanding of what is electronic versus tangible chattel paper, the role of the e-vault can be more easily understood. A proper e-vault environment ensures that only a single authoritative copy exists and that all other versions, whether electronic or tangible (for example, copies printed from the e-vault), are clearly marked as duplicates. In such a situation, control of the authoritative copy of the electronic chattel paper can be transferred to anyone with a compatible e-vault, and possession of the tangible chattel paper would not be a factor because no tangible versions of the chattel paper would be an original (i.e., all would be labeled as duplicates).

If the parties instead desire to deal in tangible chattel paper, the e-vault can print out a copy of the chattel paper (which is by definition tangible chattel paper), with an audit trail identifying it as the sole original chattel paper, and simultaneously render all electronic versions within the system and any other printouts from the system as duplicates. As before, the chattel paper still exists in both forms (tangible and electronic), but one party has possession of the sole original tangible chattel paper and nobody has control of the electronic chattel paper because no authoritative copy exists (i.e., all electronic versions are marked as duplicates).

On the other side of the coin, a single wet ink signed version of tangible chattel paper can be uploaded into an e-vault environment that makes sure only one electronic version is treated as the authoritative copy and any future printed tangible chattel paper is marked as a duplicate. However, the original wet-ink version needs to be addressed. Otherwise problems may arise from someone claiming possession of the wet-ink version. Is there an authoritative copy of the electronic chattel paper while a wet-ink version, which is also a unique copy, still exists? Indeed, the official comments make it clear, “[w]hen tangible chattel paper is converted to electronic chattel paper, in order to establish that a copy of the electronic chattel paper is the authoritative copy, it may be necessary to show that the tangible chattel paper no longer exists or has been permanently marked to indicate that it is not the authoritative copy.”6

In a situation where one or more parties electronically sign the chattel paper but an e-vault is not involved, it is difficult to imagine there being a single authoritative copy of electronic chattel paper. There would simply be too many electronic versions floating around without a system identifying them as duplicates. However, if one of the printed (tangible) versions of this chattel paper were somehow identified as the sole original, someone could still possess that tangible chattel paper for purposes of the super priority afforded by UCC 9-330.

If the chattel paper itself specifically identifies a method to determine the sole original for possession purposes, such as the one signed in wet-ink by the lessor or lender, why should a court treat that approach any differently than when there are two wet-ink signed versions? After all, the official comments make it clear, “[t]he parties may in the terms of their agreement and by designation on the chattel paper identify only one counterpart as the original chattel paper for purposes of taking possession,” and “[w]hen there are multiple copies of chattel paper, a secured party may take ‘possession’ or obtain ‘control’ of the chattel paper if it acts with respect to the copy or copies that are reliably identified as the copy or copies that are relevant for purposes of possession or control [and t]his principle applies as well to chattel paper that has been converted from one form to another, even if the relevant copies are not the ‘original’ chattel paper.”7

At the end of the day, we all eventually need to wrap our arms around concepts surrounding the assignment of electronic chattel paper. While it may not be the best approach for everyone, this author has found it helpful to use the simplest and most plain definitions of tangible and electronic chattel paper, assume both types of chattel paper can exist simultaneously for the same transaction and focus on the crucial elements of control and possession in this context.

1 See UCC §9-102(a)(11); §9-109; UCC §9-102(71)(D); and 1-201(b)(29).

2 See UCC §9-330. Generally speaking, the assignee must (1) give new value in good faith and without knowledge that the transaction violates the rights of another party and (2) obtain possession or control of the chattel paper.

3 UCC §9-105.

4 Tangible chattel paper is defined to be “chattel paper evidenced by a record or records consisting of information that is inscribed on a tangible medium.” UCC §9-102(a)(11). See also UETA, §2, Official Comments. Note that the UETA was created by the same organization that created Article 9.

5 Electronic chattel paper is defined to be “chattel paper evidenced by a record or records consisting of information stored in an electronic medium.” UCC §9-102(a)(31). As the official comments to Article 9 note, “[t]he concept of an electronic medium should be construed liberally to include electrical, digital, magnetic, optical, electromagnetic, or any other current or similar emerging technologies.” UCC §9-102, Official Comment 5(b).

6 UCC §9-105, Official comment 4.

7 UCC §9-330, Official Comment 4.

Kenneth P. Weinberg is a shareholder at Rimon, P.C., and practices in the area of commercial finance, focusing on equipment leasing, equipment finance and renewable energy project finance. He has penned Dispatches from the Trenches since 2002.

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