Model Law on Electronic Transferable Records 2017

A. Purpose

11.14

In making the ML-ETR available, UNCITRAL intends to provide a platform for ensuring harmonisation, legal certainty, and commercial predictability for the increased participa­tion in electronic commerce.

11.15       This potential framework for regulation will also provide some comfort to commercial parties developing blockchain technology.^[1101] Blockchains can passively and faithfully store records and information or can be used actively as a mechanism for facilitating commer­cial transactions. An example of the latter use is the ‘smart contract’. In essence, a ‘smart contract' is an agreement or part of an agreement converted into code. A ‘smart contract’ permits the increased use of automation in the commercial world, computer systems are effectively trusted with greater autonomy through artificial-intelligence platforms and the expanding use of blockchain or distributed-ledger technology. To form a ‘smart con­tract’ using such technology,^[1102] parties encrypt a message or messages, forming a block of data, using precise and predetermined protocols, which then ‘inform’ all the nodes on the network of the new block. The nodes validate the transaction by rigorously verifying the parties’ identity and then record the acceptance of the block on the ledger. This process is shared (or ‘distributed’) amongst the nodes. In due course, an additional encrypted block of data is typically added to the ledger (after it has been verified with the same level of rigour) after the previously verified block, thereby forming a chain of blocks. All network nodes continue verification and authentication of each new submission of a block. The integrity of the ledger is said to be immutable.^[1103] The ‘smart contract’ can be self-executing, which belies the underlying complexity.

11.16       Any number of contracts can be put into ‘smart’ form. One example is an option agree­ment: where the requirements of the option are satisfied, the ‘smart contract’ is activated and the necessary consequential actions are automatically taken, including execution and payment. Each step is recorded on the blockchain. In the international trade context, pay­ment under the sale contract may be triggered when the vessel reaches a set GPS position, or a financial penalty might be automatically imposed should the vessel fail to reach that position by a specified time and date. Such technology can also facilitate the financing of international trade and can be used in connection with letters of credit, independent guar­antees, bills of exchange, promissory notes, and so forth. This trade finance innovation is facilitated by the advent of ETRs and the introduction of the ML-ETR.

B. Operation

11.17       The ML-ETR builds on the core principles of non-discrimination against the use of elec­tronic means of transacting, the functional equivalence of paper-based and electronic methods and technology neutrality underpinning all UNCITRAL texts on electronic commerce. In regard to the last issue, Working Group IV (Electronic Commerce) barely

discussed the underlying technology involved, since the delegates and observers were typ­ically lawyers. Indeed, there was an underlying, unspoken assumption that the technical experts regarded any issues concerning the originality or duplication of ETRs as resolved. Accordingly, the text of the ML-ETR remains largely neutral in its references to the under­lying technology, although the Explanatory Note to the ML-ETR does refer to ‘enabling the use of various models whether based on registry, token, distributed ledger or other tech- nology’.^[1104] The reference to a ‘registry’ could include a centralised, decentralised, or distrib­uted registry.

11.18

Chapter II of the ML-ETR contains provisions on the ‘functional equivalence’ of paper­based and electronic methods. More specifically, articles 8 and 9 provide for the functional equivalence of electronic writing and electronic signatures,^[1105] so that writing and signatures should be treated equally by the applicable law whether in electronic or paper-based form. Whilst many nations have already enacted electronic writing and signature provisions in conformity with the ML-EC, the Working Group recognised the potential for a jurisdiction to adopt the ML-ETR without previously having enacted the equivalent of the ML-EC or the Electronic Communications Convention. In relation to trade finance, most financial institutions are members of SWIFT,^[1106] which since 1975 has provided a secure electronic network for financial institutions to send, receive, and authenticate information about fi­nancial transactions. It could be regarded as financial institutions own secure private intranet, which existed prior to the Internet.

11.19

The key provision of the ML-ETR is article 10.^[1107] Where the law requires a transferable docu­ment or instrument, that requirement is met by an electronic record where two conditions are met. First, the electronic record must contain the information that would be required to be contained in the corresponding paper-based transferable document or instrument. Second, a ‘reliable method' must be used ‘to identify that electronic record as the electronic transferable record'; ‘to render that electronic record capable of being subject to control from its creation until it ceases to have any effect or validity'; and ‘to retain the integrity of that electronic record'.

face="Times New Roman">11.20        The first of those conditions recognises the necessity to comply with the applicable sub­stantive law for the relevant transferable document or instrument. The second condition imposes requirements concerning identity, control, and integrity upon the validity and ef­fectiveness of the ETR. These elements will be considered in turn.

1.            ReliableMethod

11.21        The ML-ETR uses the expression ‘reliable method' in several key provisions to establish the standard to be met by electronic forms for functional equivalence to operate.

Legal, technical and commercial factors that may be taken into account in determining whether the method used. .. is appropriate, include the following: (a) the sophistication of the equipment used by each of the parties; (b) the nature of their trade activity; (c) the frequency at which commercial transactions take place between the parties; (d) the kind and size of the transaction; (e) the function of signature requirements in a given statutory and regulatory environment; (f) the capability of communication systems; (g) compliance with authentication procedures set forth by intermediaries; (h) the range of authentica­tion procedures made available by any intermediary; (i) compliance with trade customs and practice; (j) the existence of insurance coverage mechanisms against unauthorized

communications; (k) the importance and the value of the information contained in the electronic communication; (l) the availability of alternative methods of identification and the cost of implementation; (m) the degree of acceptance or non-acceptance of the method of identification in the relevant industry or field both at the time the method was agreed upon and the time when the electronic communication was communicated; and (n) any other relevant factor.^[1110]

11.22

The difficulty of interpreting, implementing, and applying the notion of ‘reliability’ by ref­erence to the multi-factorial approach in these explanatory notes is, however, immediately apparent. Indeed, those drafting the notes immediately recognised the problem, describing it thus:

[T]he courts in some States might be inclined to consider, for instance, that only signature methods that employed high-level security devices are adequate to identify a party, despite an agreement of the parties to use simpler signature methods.... The requirement that an electronic signature needs to be ‘as reliable as appropriate’ should not lead a court or trier of fact to invalidate the entire contract on the ground that the electronic signature was not appropriately reliable if there is no dispute about the identity of the person signing or the fact of signing, that is, no question as to authenticity of the electronic signature. Such a result would be particularly unfortunate...^[1111]

11.23

The solution to this problem was to incorporate an additional and alternative control or test that operated to limit the potentially negative consequences of the more open-textured approach to the notion of ‘reliability’. Accordingly, in the context of electronic signatures, article 9 of the Electronic Communications Convention went on to provide that, where the technological method for inserting an electronic signature is ‘[p]roven in fact to have ful­filled the functions [required] by itself or together with further evidence’,^[1112] then it is to be regarded as functionally equivalent to a manual signature. This addition prevents electronic signatures becoming too susceptible to legal challenge on technological grounds.

11.24

The ML-ETR unsurprisingly duplicated this approach. Hence, article 12 of the ML-ETR establishes a ‘general reliability standard’ for determining whether the technological method used for an ETR is ‘as reliable as appropriate’^[1113] That provision commences with a non-comprehensive list of seven factors to guide the determination of whether a particular method is ‘as reliable as appropriate’:

[T]he method referred to shall be: (a) As reliable as appropriate for the fulfilment of the function for which the method is being used, in the light of all relevant circumstances, which may include: (i) Any operational rules relevant to the assessment of reliability; (ii) The assurance of data integrity; (iii) The ability to prevent unauthorized access to and use of the system; (iv) The security of hardware and software; (v) The regularity and extent of audit by an independent body; (vi) The existence of a declaration by a supervisory body, an accreditation body or a voluntary scheme regarding the reliability of the method; (vii) Any applicable industry standard...^[1114]

11.25       As in the Electronic Communications Convention, there is then an alternative approach to demonstrating the reliability of the technological method, namely if it can be ‘proven in fact to have fulfilled the function by itself or together with further evidence’.^[1115] Most likely, it will be the latter test that is invoked in future disputes and analysis, as it bolsters the extent to which commercial parties may rely upon ETRs.

2.             Identity

11.26       'The nature of electronic duplication is that digital copies can be made that are indistin­guishable from the original. The latest technologies available to commercial parties, how­ever, provide solutions in a modern commercial context to minimise the risk of duplication of the electronic record. Working Group IV (Electronic Commerce) recognised this dif­ficulty, and took expert advice, initially through the 2011 Colloquium, about what tech­nical and practical solutions were available. Both the Working Group and the Explanatory Note to the ML-ETR considered expressions such as ‘uniqueness’ and ‘singularity’ when addressing this issue.^[1116] Despite the fact that electronic commerce will arguably reduce, ra­ther than increase, the commercial and instrument risk that has been part of the use of paper-based documents, the Note explains, however, that ‘uniqueness is a relative notion that poses technical challenges in an electronic environment, as providing an absolute guarantee of non-replicability may not be technically feasible’.^[1117] Of course, in the paper­based world, such a guarantee is not required. Even when forgery and fraud remain an ever­present risk, the original paper-based document or instrument may still be described as being unique. Centuries of commercial practice have permitted sophisticated trade parties to weigh and balance the underlying risks of forgery and fraud and to take appropriate, if not full-proof, actions. Indeed, such practices have developed to the point where, in the paper-based world, some instruments no longer need to be ‘unique’ For example, bills of lading are commonly issued in triplicate. Each is valid and acceptable, but not necessarily ‘unique’^[1118] Accordingly, the Explanatory Note adopts the term ‘singularity’ in preference to the term ‘unique’ and explains that the former term ‘requires reliable identification of the electronic transferable record that entitles its holder to request performance of the obliga­tion indicated in it, so that multiple claims of the same obligation would be avoided’^[1119] The other effect of the notion of singularity is ‘the prevention of unauthorised replication of an electronic transferable record by the system’^[1120]

11.27       Linked to the issue of ‘singularity’ is how the ETR can be transferred without duplication of the record. Working Group IV (Electronic Commerce) discussed in particular how an ‘electronic record’ could become an ‘electronic transferable record’ without undermining that record’s ‘singularity’. For a short time, the Working Group used the expression the Thp- erative electronic transferable record’ to distinguish it from a non-operative copy of that record. Later, the expression ‘authorised electronic transferable record’ was debated. In the end, it was determined that no additional descriptor was necessary and that it sufficed for reference to be made simply to ‘the’ electronic transferable record, which was then defined and described as containing the features required by article 10. Indeed, the Explanatory Note to the ML-ETR makes clear that the ‘[i]nsertion of a further qualifier might create uncertainty’.^[1121] Using the definite article ‘the’ did, however, cause concern for those nations in the session whose language did not have a corresponding word, but this issue was left to the translating personnel (and not considered further by the Working Group per se).^[1122] On the basis of these discussions, ‘electronic record’ was defined as ‘information generated, communicated, received or stored by electronic means, including, where appropriate, all information logically associated with or otherwise linked together so as to become part of the record, whether generated contemporaneously or not’^[1123] An ‘electronic transferable record’ was in turn defined as ‘an electronic record that complies with the requirements of article 10’^[1124]

3.            Control, Exclusive Control, and Transfer of Control

11.28

In the paper-based world, possession, including constructive possession, of the transfer­able document or instrument typically confers specific rights, economic value, legal posses­sion, and/or ownership upon the holder. The concept of ‘control’ was intended by Working Group IV (Electronic Commerce) to be the electronic functional equivalent of the paper­based notion of possession. In essence, the notion of ‘control’ focuses upon ‘the use of a reli­able method to identify the person in control of the electronic transferable record’^[1125] Indeed, given the concerns over the uniqueness of the ETR, the requirement of control must neces­sarily involve the exercise of exclusive control.

11.29

This issue is dealt with in article 11 of the ML-ETR. Sub-article 11(1) provides that, ‘where the law requires or permits the possession of a transferable document or instrument, that requirement is met with respect to an electronic transferable record if a reliable method is used... [t]o establish exclusive control of that electronic transferable record by a person; and to identify that person as the person in control’^[1126] The Explanatory Note to the ML-ETR considers that the reference to ‘exclusive’ control in this provision is for reasons of ‘clarity’, although in a somewhat circular (and unclear) manner then states that ‘the notion of “con­trol”, similarly to that of “possession”, implies exclusivity in its exercise’^[1127] Furthermore, the Note explains that the ‘concept of “control” does not refer to “legitimate” control, since this is a matter of substantive law’^[1128] Furthermore, the Note provides that the notions of ‘control’ and ‘singularity’ (considered above) in the ML-ETR operate independently and should be distinguished from one another, since ‘it is possible to conceive of exclusive control over a multiple record, as well as ‘non-exclusive control over a single record’^[1129] Accordingly, in the absence of more concrete guidance in the Explanatory Note, the notion of exclusivity of control will essentially be a question of fact and depend to a large degree on the precise technology used.

11.30       Despite the lack of clarity over the determination of control over the ETR, this notion also underpins sub-article 11(2), which deals with the ‘transfer’ of control. This is the functional equivalent of transferring possession of a paper-based document or instrument. In the paper-based world, transferable documents and instruments are typically those that evi­dence or create some form of property right that is capable of transfer. In such cases, the transfer of possession typically occurs by the simple delivery, or the endorsement and de­livery, of the relevant document. In that regard, sub-article 11(2) provides that ‘[w]here the law requires or permits the transfer of possession of a transferable document or instrument, that requirement is met with respect to an electronic transferable record by the transfer of control over the electronic transferable record’.^{style='font-size:9.0pt; font-family:"Times New Roman",serif;color:black'>[1130]} How precisely this transfer occurs will de­pend upon the nature of the technology used; but, whatever the precise mechanism, it must simultaneously satisfy the ‘exclusive control’ and ‘identity’ requirements in article 11(1) with respect to the transferee.

4.             Integrity

11.31       As well as ensuring the ‘singularity’ of the ETR, the ML-ETR also addresses the need to maintain the integrity of the ETR in the sense of ensuring that it is not subject to any un­authorised alteration. According to the Explanatory Note to the ML-ETR, ‘[t]he notion of integrity is an absolute one, since ‘[i]t refers to a fact, and as such, is objective, i.e. either an electronic transferable record retains integrity or it does not’.^[1131] In this regard, sub-article 10(2) provides the ‘criterion for assessing integrity’ of an ETR, namely ‘whether informa­tion contained in the electronic transferable record, including any authorized change that arises from its creation until it ceases to have any effect or validity, has remained complete and unaltered apart from any change which arises in the normal course of communica­tion, storage and display’^[1132] Accordingly, the ETR’s integrity will usually depend upon the security features of the underlying technology.

C.    Implementation

11.32       Despite the obvious advantages of the ML-ETR for international trade generally, and trade finance in particular, implementation is likely to be slow and cautious. Typically, paper­based transferable documents or instruments were used to transfer significant value or property rights. Accordingly, traders will initially be circumspect with respect to their own property and that of their clients. Similarly, banks will be concerned that their rights of re­course and rights as pledgee under the trade documents are not diminished. Accordingly, for the ML-ETR to be a worthwhile venture, a few nations need to be ‘pioneers’^[1133] by embracing the new ML-ETR. In that regard, nations such as Singapore have already com­menced the process.

Broadly, there are three possible approaches to implementing the ML-ETR. First, the principles 11.33 of the ML-ETR could be enacted in new or existing generic legislation dealing with the issue of electronic transactions.^[1134] Second, industry- or sector-specific legislation could be amended to allow ETRs as a substitute for particular paper-based instruments. For example, legislation dealing with the carriage of goods by sea could be amended to permit ETRs in place of a bill of lading; and bills of exchange legislation could be amended to allow for a similar step in respect of those instruments. Third, a combination of these approaches could be used to ensure both the specific and general application of the ML-ETR. The disadvantage of the first approach, how­ever, is that it does not signal to any particular industry or sector the specific changes in prac­tice that the legislative amendment is intended to encourage. Traders, lawyers, financiers, and insurers will typically only make themselves aware of the specific legislation, regulations, and amendments that are applicable to that particular industry or sector. If the pertinent electronic standard appears in, for example, generic electronic transactions legislation, questions will re­main as to the legislature’s intention behind the changes. It may be cogently argued that, if it is Parliaments intention to alter established common law principles in a particular area, then such changes should be made directly in industry-, sector-, or instrument-specific legislation. These specific amendments are more likely to encourage the use of ETRs by ‘pioneers’ and ac­cordingly promote the diffusion of innovation. Accordingly, it is submitted that the principles of control, identity, and transfer in the ML-ETR, as well as the definitions of ‘electronic record’ and ‘electronic transferable record’, would be more appropriately incorporated into domestic legis­lation dealing specifically with, for example, bills of lading or bills of exchange.^[1135] That said, the third possible approach is to combine the first two suggestions. This is the view preferred in this chapter. This will have the advantage of both targeting particular industries or sectors and pro­viding a general platform for all electronic transactions and instruments across the board. The result would be to embrace functional equivalence fully, to promote electronic media and trade, and to align economic and trade concerns with commercial realty.

III.