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Law

Commission

Reforming the law

Law Com No 405

Electronic trade documents:

Report and Bill

Presented to Parliament pursuant to section 3(2) of the Law Commissions Act 1965

Ordered by the House of Commons to be printed on 15 March 2022

HC 1188

© Crown copyright 2022

This publication is licensed under the terms of the Open Government Licence v3.0 except where otherwise stated. To view this licence, visit nationalarchives.gov.uk/doc/open-government-licence/version/3.

Where we have identified any third party copyright information you will need to obtain permission from the copyright holders concerned.

This publication is available at www.gov.uk/official-documents.

Any enquiries regarding this publication should be sent to us at [email protected].

978-1-5286-3219-5

E02724598 03/22

Printed on paper containing 75% recycled fibre content minimum

Printed in the UK by HH Associates Ltd. on behalf of the Controller of Her Majesty’s Stationery Office

The Law Commission

The Law Commission was set up by the Law Commissions Act 1965 for the purpose of promoting the reform of the law.

The Law Commissioners are:

The Right Honourable Lord Justice Green, Chairman

Professor Sarah Green

Professor Nicholas Hopkins

Professor Penney Lewis

Nicholas Paines QC

The Chief Executive of the Law Commission is Phil Golding.

The Law Commission is located at 1st Floor, Tower, 52 Queen Anne's Gate, London SW1H 9AG.

The terms of this report were agreed on 9 February 2022.

The text of this report is available on the Law Commission's website at

https://www.lawcom.gov.uk/project/electronic-trade-documents/.

Contents

GLOSSARY

LIST OF ABBREVIATIONS

• CHAPTER 1:    INTRODUCTION

International trade

About this project

Initiatives aimed at digitalising trade

This report

• CHAPTER 2:    THE CASE FOR REFORM

Why is this reform necessary?

Other reform initiatives

Consultees’ support for reform in England and Wales, and views as to impact

Reforming the law to allow for trade documents in electronic form

The least interventionist approach

Technology neutrality

International compatibility

• CHAPTER 3:    CURRENT LAW - TRADE DOCUMENTS

Documents to which possession is relevant: A brief introduction

Trade documents - negotiability and transferability

Types of trade documents and how the law works in relation to them

How trade documents are used in practice

Delivery and being a holder

Further consequences of paper trade documents being capable of possession

• CHAPTER 4:    RECOMMENDATIONS - THE TYPES OF DOCUMENTS

COVERED BY OUR RECOMMENDED REFORMS

Our provisional proposals in the consultation paper

Potential risk of accidentally creating documentary intangibles

Our recommendations

Power to add, remove or amend an entry in the list of documents

• CHAPTER 5:    CURRENT LAW - POSSESSION

Categories of property: the distinction between “things in action” and “things in possession”

Possession beyond tangibility

• CHAPTER 6:    RECOMMENDATIONS - THE “GATEWAY” CRITERIA

The “gateway” criteria

First criterion: the information contained in an electronic trade document, and the meaning of “document"

Second criterion: reliability of an electronic trade document system

Third criterion: integrity of an electronic trade document

Fourth criterion: capable of exclusive control

Fifth criterion: divestibility

Sixth criterion: identification of the document

Seventh criterion: identification of the persons who could exercise control of a document in electronic form

Any other criteria?

• CHAPTER 7:    RECOMMENDATIONS - POSSESSION OF ELECTRONIC

TRADE DOCUMENTS

An overview of our recommendations regarding possession of electronic trade documents

Our position in the consultation paper

Our recommended approach

Could there ever be a question about who possesses an electronic trade document?

What constitutes possession in the context of electronic trade documents? 146

Transfer of possession of an electronic document

• CHAPTER 8:    RECOMMENDATIONS - CONSEQUENCES OF AN

ELECTRONIC TRADE DOCUMENT BEING POSSESSABLE

Using electronic trade documents in the same way as paper trade documents

Application of possessory concepts to electronic trade documents

Issues relating to transfer

Discharge, surrender, accomplishment

Using electronic trade documents in cross-border trade

CHAPTER 9: RECOMMENDATIONS - OTHER ISSUES

Formalities

Indorsement

Accessibility of information

Sets of documents

Change of form or medium

Application of the Bill to existing trade documents

Electronic presentment under the Bills of Exchange Act 1882

Repeal of sections 1(5) and 1(6) of the Carriage of Goods by Sea Act 1992 210

• CHAPTER 10:    THE POTENTIAL IMPACT OF REFORM

Introduction

General questions

Potential benefits

Potential costs

• CHAPTER 11:    RECOMMENDATIONS

• APPENDIX 1:    TERMS OF REFERENCE

• APPENDIX 2:    ACKNOWLEDGEMENTS

• APPENDIX 3:    A SUMMARY OF DISTRIBUTED LEDGER TECHNOLOGY 238

• APPENDIX 4:    BILL

Glossary

List of abbreviations

Websites

All websites referenced in this document were last visited on 9 March 2022.

Electronic trade documents

To the Right Honourable Dominic Raab MP, Lord Chancellor and Secretary of State for Justice

• Chapter 1:    Introduction

INTERNATIONAL TRADE

• 1.1    International trade is worth around £1.266 trillion to the UK.¹ The process of moving goods across borders typically involves multiple actors, including those involved in transportation, insurance, finance and logistics.² One trade finance transaction typically involves 20 entities and between 10 and 20 paper documents, totalling over 100 pages.³ In a transaction covered by a bill of lading, for example, it is common to find 50 sheets of paper in a package of shipping documents that must be exchanged between as many as 30 different parties.⁴

• 1.2    Dr Burcu Yuksel Ripley gives a helpful overview of the parties and documentation involved in a “typical” trade transaction, and the involvement of paper documents:

Export-import transactions have several interconnected phases involving international sales (as the underlying deal between exporting seller and importing buyer of the goods), transportation, insurance, payment and finance, and customs. In each of these phases, a huge amount of international trade paperwork is often issued which typically involves sale of goods contracts, commercial invoices, packing lists, certificates of inspection, export and import licenses, bills of lading, insurance policies, letters of credit and customs declarations. In the way that international trade traditionally operates, this paperwork is required to be exchanged in a physical format among several parties from different countries involved in one or more phases of transactions, such as exporting seller, importing buyer, freight forwarder, carrier, insurer, bank and custom authority. It is crucial not only to get the

Department for International Trade, “UK Trade in Numbers” (January 2022), https://www.gov.uk/government/statistics/uk-trade-in-numbers/uk-trade-in-numbers-web-version.

E Ganne, World Trade Organisation (“WTO”), Can Blockchain revolutionize international trade? (2018) from p 17, https://www.wto.org/english/res_e/booksp_e/blockchainrev18_e.pdf.

paperwork right but also to get the right paperwork physically delivered on time to the right party or parties.¹

• 1.3    Despite the size and sophistication of this market, many of its processes, and the laws underlying them, are based on practices developed by merchants hundreds of years ago. In particular, international trade still relies to a large extent on a special category of document that entitles the holder to claim performance of the obligation recorded in the document, and to transfer the right to claim performance of that obligation by transferring (physical) possession of the document. The document is said to “embody” the obligation, which may be to deliver goods or to pay money. For example, simply handing over a bill of lading can be sufficient to give the new holder a right to the goods described in the bill.²

• 1.4    The legal rules governing these documents are premised on the idea that they are physical documents which can be physically held or “possessed”. The current law in England and Wales does not recognise the possibility of possessing electronic documents; possession is associated only with tangible assets. ³Industries using these documents are therefore prevented by law from moving to a fully paperless process. To give a sense of the enormous amount of paperwork global trade generates, consider that the world’s largest containerships can carry 24,000 twentyfoot containers at any one time on any one voyage.⁴ For each one of those cargoes, paper transport documentation has to be produced, and must be processed manually to go from the shipper of the goods to the ultimate buyer at destination, sometimes through numerous intermediaries. The effect of the current law is that much of the documentation needs to be in hard copy. The Digital Container Shipping Association (“DCSA”) has estimated that 16 million original bills of lading were issued by ocean carriers in 2020, and that more than 99% of these were in paper form.⁵

• 1.5    This is clearly archaic, inefficient, and wholly unsuited to a world in which processes and transactions are increasingly in digital form. Allowing for electronic versions of certain trade documents could lead to significant cost savings and efficiencies, together with improvements in information management and security.

• 1.6    The emergence over the past two decades of central registry systems and more recently of technologies such as distributed ledger technology (“DLT”) has made paperless trade increasingly feasible. The push for digitalisation became particularly acute in 2020 and 2021, with the introduction of global restrictions on movement and human-to-human contact in response to the COVID-19 pandemic. Stakeholders pointed to the risk of delays in receipt of paper documents disrupting supply chains for essential goods such as food and medical equipment.⁶ DCSA has recently observed that DLT could eliminate the risk of a single catastrophic failure or attack that would compromise the security of an electronic bill of lading.⁷

• 1.7    While the pandemic forced businesses to develop rapid technical solutions, the law continues to lag behind. In a survey undertaken by the World Trade Organisation (“WTO”) and Trade Finance Global (“TFG”) on the impact of COVID-19 on DLT and trade, ⁸it was noted that “legal challenges were rated as posing a more pressing challenge than any of the other challenges”. In particular, the “lack of legal clarity and enabling regulatory framework” was pointed out. ⁹The law of England and Wales currently enjoys a pre-eminent status as the law of choice in global commerce, but if it fails to evolve to reflect new technological possibilities, it risks losing this preeminence.

• 1.8    In this report, we make recommendations for law reform to allow trade documents in electronic form to have the same legal effect as their paper equivalents, provided that they meet certain requirements to enable their possession in a digital context. We include a Bill which would implement those recommendations, and provide commentary on that Bill.¹⁰

ABOUT THIS PROJECT

Background

• 1.9    The Law Commission first looked at areas of emerging legal technology, and smart contracts in particular, in 2018. ¹¹Our early research suggested that we would need to consider digital assets as part of this work. We identified the law’s treatment of electronic documents, such as the Bills of Exchange Act 1882 (“1882 Act”), as a blocker to digitalisation. ¹²A review of the 1882 Act and related laws was also suggested as a separate project by stakeholders.¹³

• 1.10    The Lawtech Delivery Panel’s UK Jurisdiction Taskforce (“UKJT”) published a legal statement on cryptoassets and smart contracts in November 2019 (“UKJT Legal Statement”). ¹⁴The UKJT Legal Statement concluded that, since cryptoassets are a purely “virtual” form of property, they are not capable of being “possessed” under the current law.¹⁵ While their focus was on cryptoassets, a sub-category of digital assets, their analysis and conclusions - with which we agree - are equally applicable to digital assets more generally, including trade documents in electronic form.

• 1.11    As well as our existing work on smart contracts,¹⁶ the UK Government subsequently asked the Law Commission to undertake two separate pieces of related work on digital assets.

• (1)    Electronic trade documents: to make recommendations to enable the legal recognition of certain trade documents in electronic form. This report contains our final recommendations in respect of this project.

• (2)    Digital assets: to review the law on cryptoassets and other digital assets more generally, and consider what reforms are needed to ensure that the law of England and Wales can accommodate such assets.¹⁷

• 1.12    The two phases of our work, while distinct, involve similar legal concepts. This report relates only to the electronic trade documents project.

Terms of reference

• 1.13    In September 2020, the Department for Digital, Culture, Media and Sport (“DCMS”) asked the Law Commission to make recommendations to solve the problems caused by the law’s approach to the “possession” and transfer of electronic documents.

DCMS also asked the Law Commission to prepare draft legislation to implement those recommendations.

• 1.14    Our full terms of reference are included at Appendix 1.

Consultation

• 1.15    We published a consultation paper in April 2021, seeking views on our provisional proposals. ¹⁸The consultation paper included a Bill which would implement those proposals. We received 55 responses to the consultation paper from various industry participants, including businesses, industry associations and groups, academics, law firms and individuals.

• 1.16    We have considered the responses in detail and have developed our thinking and the Bill to reflect many of the points raised. Throughout this report, we reference key points made by consultees which have confirmed our approach, or which have caused us to change direction, whether on matters of policy or drafting.

Acknowledgements and thanks

• 1.17    In Appendix 2 of this report, we provide a list of those who responded to the consultation paper, together with a list of stakeholders we met with during the course of this project. We are extremely grateful to all those who took the time to respond to our consultation, or who otherwise met with us or responded to other requests for assistance or information in support of this work.

Related current and upcoming Law Commission work

Digital assets

• 1.18    We began our work on cryptoassets and other digital assets in March 2021 and published a call for evidence in April 2021. We plan to publish a consultation paper with provisional proposals for reform in summer 2022. Our work on digital assets will expand upon the work undertaken in the particular context of electronic trade documents.

• 1.19    Our work on digital assets will, among other things, consider whether the concept of possession could be extended further - beyond the limited subset of electronic trade documents - to certain other digital assets. While the concept of possession justifiably can be extended to electronic trade documents,¹⁹ it may be that an alternative approach is preferable for other digital assets. These are questions that we will consider in our forthcoming consultation paper.

Conflict of laws

• 1.20    We have agreed with Government that we will undertake a project looking at the rules relating to conflict of laws as they apply to emerging technology, including smart legal contracts and digital assets, and consider whether reform is required. We expect that this future project will consider some of the problems identified in relation to private international law in the context of electronic trade documents. We hope to be in a position to begin this work in mid-2022.²⁰

INITIATIVES AIMED AT DIGITALISING TRADE

• 1.21    We note that significant progress is being made globally in the adoption of initiatives aimed at digitalising trade documents. As G7 President, the UK has been leading the work on legal and regulatory barriers in relation to electronic transferable records. In April 2021, the G7 and digital technology trade ministers agreed to collaborate on electronic transferable records. Together with Australia and the Republic of Korea, the UK has published a roadmap to reform, which lays out practical steps to facilitate the adoption of electronic transferrable records within the G7 and beyond.²¹

• 1.22    In response to the COVID-19 pandemic and its subsequent impact on trade finance, the International Chamber of Commerce (“ICC”) called on all governments to remove, as an emergency measure, any legal requirements for hard-copy trade documentation. ²²They further encouraged all governments to make longer-term changes to their legal frameworks to provide for electronic documents. In a paper published by the WTO and TFG, it was noted that digitalisation efforts could help improve service delivery for micro, small, and medium sized enterprises.²³

• 1.23    In terms of legal frameworks, we note the importance of the work done by the United Nations Commission on International Trade Law (“UNCITRAL”). UNCITRAL’s Model Law on Electronic Transferable Records (“MLETR”) is an international attempt to provide a legal framework for electronic trade documentation which can be adapted and adopted by individual jurisdictions. ²⁴The Bankers Association for Finance and Trade (“BAFT”) has stressed the importance of the role of the MLETR in its 2021 report on the progress of trade digitalisation.²⁵ Like the WTO, BAFT encouraged governments to remove legal blockers to digitalisation, and to harmonise domestic legal frameworks with the MLETR. The Digital Standards Initiative, which is a crossindustry effort aimed at enabling standardisation in digital trade, also advocates for the global adoption of the MLETR.²⁶

• 1.24    In April 2020, the International Trade and Forfaiting Association (“ITFA”) launched its Digital Negotiable Instrument initiative. ²⁷ITFA proposes specifications for electronic documents (which use e-signatures, DLT and cryptography) in order to create functionally equivalent electronic negotiable instruments that operate in the same way as paper bills of exchange or promissory notes. ²⁸Relatedly, a framework agreement (put together by the United Nations Economic and Social Commission for Asia and the Pacific on the facilitation of cross-border paperless trade) came into force in February 2021.²⁹ The objective of the agreement is to increase the digitalisation of trade processes by facilitating the exchange and mutual recognition of trade-related data and documents among paperless trade systems in the Asia-Pacific region.

• 1.25    In February 2022, DCSA, the International Federation of Freight Forwarders Associations, the Baltic and International Maritime Council, ICC and Swift formed the Future International Trade Alliance (“FIT Alliance”), which will focus on standardising digitalisation of international trade. ³⁰While three of these organisations have already devised standards for electronic bills of lading in respect of their own sectors of the industry, ³¹the FIT Alliance aims to reduce these three sets of standards to a single definitive set of rules for e-bills. In doing so, the FIT Alliance seeks to improve interoperability between all sectors of the trade and transport industries.

• 1.26    The work of LawtechUK on their Smarter Contracts project demonstrates how existing technologies can be used to modernise traditional documents. LawtechUK are currently actively exploring use-cases for the application of smart contract technology, ³²one of which includes a “smarter bill of lading”.³³ In that regard, LawtechUK notes that:

Use cases will help to show why smarter, technology-enabled ways of contracting can add value to business practices and provide a wide range of commercial and societal benefits.³⁴

International harmonisation

• 1.27    We are aware of calls for the international harmonisation of laws and of the need for global recognition of electronic documents. While our recommendations relate to domestic law and are designed to fit within the existing law of England and Wales, we do not make them in a vacuum: our work is informed by the activities and initiatives elsewhere and is intended to be compatible with them.

• 1.28    The jurisdiction of England and Wales is a global centre for finance, innovation, and international business. It has been suggested that “if the UK can fully digitise trade documentation, it sets an important precedent across all 54 Commonwealth countries and all contracts that use English law”.³⁵

THIS REPORT

• 1.29    In this report, we make recommendations for law reform to allow certain documents in electronic form to be recognised in law as possessable, so that they can have the same legal recognition and functionality as their paper counterparts. We call the documents “trade documents”, but in fact they are a subset of documents used in trade and trade finance which are dependent on possession for their operation. That is, the right to claim performance of the obligation recorded in the document (such as the right to claim payment of a sum of money, delivery of goods or an insurance payout) pertains to the person in possession of the document. The documents covered by our recommendations include all documents possession of which is required (as a matter of law or commercial practice) to claim performance of an obligation, such as bills of exchange, promissory notes and bills of lading. However, we recommend the exclusion of bearer bonds and uncertificated securities.

The criteria to qualify as an electronic trade document

• 1.30    We recognise that not every electronic document has the same functionality. What is important about a paper document is that it cannot be double spent, and once possession is passed to another party, the original possessor loses possession and control of the piece of paper. We recommend that only electronic documents which satisfy particular criteria, designed to replicate these salient features of paper documents, should be susceptible to possession. These criteria include that:

• (1)    in order to prevent double spending, it must not be possible for more than one person (or persons acting together) to exercise control of the document at any one time; and

• (2)    when the document is transferred, anyone who was able to exercise control of the document prior to the transfer loses the ability to do so.

• 1.31    “Double spending” occurs where an asset or thing is transferred to two (or more) different entities or places at the same time. For example, a MS Word document may be transferred from Alice to Bob, yet retained by Alice, who can then also transfer it to Caroline. This raises issues such as who received the document, and what it was that Alice lost in the transfer. ³⁶In contrast, tangible objects cannot be double spent. If Alice gives Bob an apple, Alice cannot then subsequently give the same apple to Caroline. So that they can function in the same way as paper trade documents, is important to ensure that any system that hosts trade documents in electronic form is designed to prevent double spending.

• 1.32    A trade document in electronic form that satisfies the relevant criteria qualifies as an “electronic trade document” for the purposes of the Bill. We recommend that an electronic trade document should be possessable as a matter of law. This will engage the existing common law of possession, to be adapted and applied to electronic trade documents. We recommend that an electronic trade document should be treated in law in the same way as those documents in paper form.

The structure of this report

• 1.33    This report comprises ten further chapters and four appendices.

• (1)    In Chapter 2, we explain the need for reform, including a short description of the developments in technology which have made trade documents in electronic form particularly viable. We explain the overarching considerations that have driven our approach, including why we think that possession should be the operative concept at the centre of the recommended reforms.

• (2)    In Chapter 3, we introduce the category of documents which we call “trade documents”. We explain the documents to which possession is relevant for their functionality, and give a summary of how these documents are used.

• (3)    In Chapter 4, we set out our recommendations as to the types of documents which we consider should fall within the recommended reforms and scope of the Bill.

• (4)    In Chapter 5, we discuss in more detail the “legal blocker” to the digitalisation of trade documents based on the current law’s concept of possession. We discuss the law of possession under the law of England and Wales more generally, and begin to consider how it could be expanded to trade documents in electronic form.

• (5)    In Chapter 6, we explain the concept of control, and set out the criteria which we think a trade document in electronic form must satisfy in order to be capable of possession. We explain the provisions of the Bill which contain these criteria.

• (6)    In Chapter 7, we discuss what it could mean to possess an electronic trade document.

• (7)    In Chapter 8, we consider the consequences of an electronic trade document being amenable to possession.

• (8)    In Chapter 9, we discuss other issues in relation to electronic trade documents, such as signing and indorsement, and changes of medium between electronic and paper trade documents.

• (9)    In Chapter 10, we consider the potential impact of our recommendations, to form the basis of an impact assessment if the recommendations are implemented.

• (10)    In Chapter 11, we include a full list of our recommendations.

• 1.34    Appendix 1 sets out our full terms of reference for both this work and our broader work on digital assets. Appendix 2 includes a list of those who responded to our consultation exercise, and the stakeholders we have met or corresponded with in the development of this report. We include an explanation of DLT in Appendix 3. The Bill is set out in Appendix 4.

Territorial extent

• 1.35    As the Law Commission for England and Wales, we can make recommendations only for that jurisdiction, and not for Scotland or Northern Ireland. There is a particular impetus to change the law of England and Wales given its widespread, international use. The vast majority of this report focuses on the law of England and Wales.

• 1.36    However, much of the relevant legislation, including the 1882 Act and the Carriage of Goods by Sea Act 1992, extends to the whole of the UK. The law of Northern Ireland similarly associates possession with physical objects. Scots law has recognised possession of certain intangible rights but has done so through deeming possession of certain physical objects to be possession of the intangible rights. ³⁷We have sought to engage with stakeholders in Scotland and Northern Ireland throughout this project and are grateful for the input received. We are also grateful to David Bartos of the Scottish Law Commission for his input in relation to Scots law.

• 1.37    It is beyond our remit and expertise to analyse how the Bill could or would apply in Scotland or Northern Ireland, and we do not attempt such analysis in this report. If the Bill is extended beyond England and Wales, appropriate legal advice will be required to consider whether any changes to the Bill are necessary to accommodate differences between the laws of the different jurisdictions.

• 1.38    We are pleased that the Government is engaging with the territorial offices and devolved administrations to explore the possibility of implementing our recommendations throughout the UK.³⁸

The team working on this report

• 1.39    The following members of the Commercial and Common Law team have contributed to this report: Laura Burgoyne (team manager), Daniella Lupini (team lawyer), Siobhan McKeering (team lawyer), William Vaudry (research assistant), James Taylor (research assistant) and Aparajita Arya (research assistant). Professor Miriam Goldby has been seconded to the Law Commission from Queen Mary University of London on a part-time basis to work on this project and has contributed to this report.

• Chapter 2:    The case for reform

• 2.1    In this chapter, we set out the case for reform. First, we consider why reform in this area is necessary by briefly explaining the “possession problem” and how it affects the use of electronic documents in trade. We explain how the industry is currently navigating its way around this problem through multipartite contractual frameworks, and consider their advantages and disadvantages.

• 2.2    To illustrate the possibility of digitalised trade, we provide an overview of one of the most prominent, current means of creating trade documents in electronic form: distributed ledger technology. We also set out what our recommendations aim to achieve with reference to the Model Law on Electronic Transferable Records (the “MLETR”), an international initiative providing for trade documents in electronic form. Further, we discuss the principles underpinning our reforms, and explain why we recommend using possession as the operative concept in respect of our reforms.

WHY IS THIS REFORM NECESSARY?

A short summary of the possession problem

• 2.3    The subject matter of this report and the Bill is documents used in trade whose functionality depends, as a matter of law or commercial practice, on their being “possessed”. ³⁹This is because the right to claim performance of the obligation recorded in the document (such as the right to claim payment of a sum of money, or delivery of goods) pertains to the person in possession of the document. The right is embodied in the document, and can be transferred by the (physical) transfer of possession of the document.

• 2.4    By way of example, the concept of possession is central to the Bills of Exchange Act 1882 (“1882 Act”). A bill of exchange is a document that orders the addressee of the bill to pay a sum of money either to a specified person, or to the bearer. In the latter case, the right to receive the specified sum of money travels with the document: only the person in possession of the bill of exchange can lay claim to the sum of money specified in it.⁴⁰ This characteristic of a bill of exchange has made it a critical document in international trade and finance. Bills of exchange are commonly sold to a third party at a discount in return for immediate payment. The third party will then, as the holder in possession of the bill, receive the ordered payment from the addressee when it falls due.

• 2.5    This characteristic is not unique to bills of exchange: a variety of documents critical to trade must be capable of possession in order to fulfil their legal and commercial functions. These documents include promissory notes, bills of lading, ship’s delivery orders, warehouse receipts, mate’s receipts, marine insurance policies and cargo insurance certificates. We discuss the legal characterisation and practical use of these documents in Chapter 3.

• 2.6    The recognition that something can be possessed as a matter of law determines much about the legal treatment that it subsequently receives, and has implications for its legal functionality. For example, only things that can be possessed are capable of being subject to a bailment, or to a lien. Things capable of possession therefore have a broader range of commercial uses than those which are not.

• 2.7    The problem that prevents the widespread digitalisation of these documents is that the law of England and Wales - like that of many other significant trade jurisdictions around the world - does not recognise intangible things as being amenable to possession.⁴¹ We discuss the historical context that led to this legal position, and the law on possession in general, in Chapter 5. For current purposes, it is sufficient to say that electronic trade documents, which are considered to be intangible, cannot be possessed, and therefore cannot presently function in the same way as their paper counterparts. We refer to this as the “possession problem”.

• 2.8    There are several benefits to digitalising such documents, including significantly lower costs, increased efficiency, increased transparency, increased security, reduced errors, and greater resilience to the impact of sudden shocks such as COVID-19. The current law prevents those benefits from being fully realised.⁴²

Existing contractual frameworks

• 2.9    Only a relatively small number of jurisdictions currently recognise trade documents in electronic form as having the same legal effects as paper trade documents.⁴³ Accordingly, the industry has developed several contractual workarounds to enable trade documents in electronic form to be used in the same way as their paper counterparts. ⁴⁴Under these contractual frameworks, parties agree that transferring a trade document in electronic form will put the transferee in a similar position to that of the holder of the equivalent paper trade document. The main difference between transferring, for example, a bill of lading in paper form and one in electronic form under a multipartite contractual framework is the nature of the rights involved. Under a contractual framework, the parties have (personal) rights only against those persons who have agreed to the terms of the system. Any proprietary rights obtained depend on whether the intended effects of transactions occurring over the system are legally recognised as providing such rights. By contrast, transfer of possession of a paper bill of lading gives the holder (proprietary) rights which are enforceable against the world.

• 2.10    The International Group of Protection and Indemnity Clubs (“IGP&I”), insurance groups which underwrite risk in the industry, have so far approved seven private technical solutions that provide alternatives to paper bills of lading based on multipartite contractual workarounds. We have been told anecdotally that the use of these solutions accounts for only a small proportion of trade documents, although there appears to have been a significant increase in the usage of trade documents in electronic form as a result of the COVID-19 pandemic. The European Banking Authority noted that 27% of credit institutions that responded to its Spring 2021 risk assessment questionnaire reported that they marketed or distributed trade finance services via a digital platform.⁴⁵

• 2.11    The International Trade and Forfaiting Association has created contractual workarounds that enable parties to use electronic bills of exchange and promissory notes.⁴⁶ These documents, referred to as “Electronic Payment Undertakings”, are governed by the law of England and Wales and replicate three features of those documents. First, they are undertakings to pay (debt obligations) that are independent from the underlying agreement. Second, they create an unconditional obligation to pay. Third, the payment obligation is transmissible through assignment of the instrument itself.⁴⁷

• 2.12    While these workarounds provide many of the benefits of digitalisation, in the consultation paper we highlighted three significant shortcomings.⁴⁸

• (1)    Relying on contractual workarounds rather than the law relating to paper trade documents to transfer rights increases the complexity of transacting.

Conducting trade under a multipartite contractual framework requires all parties to agree that they will regard electronic documents as having the same effects as their paper counterparts. To achieve the same effect as transfer of the paper document, a “novation” may be required, meaning that the transferor’s rights are extinguished and identical, substitute rights are created in favour of the

transferee. Furthermore, in the case of a document of title to goods, the bailee in possession of the goods must attorn to the transferee. ⁴⁹Where parties use paper trade documents there is generally no need for these steps.

• (2)    As indicated above, the personal rights that parties acquire under these frameworks are enforceable only against their contractual counterparties. While proprietary rights may be transferred by attornment, this depends on the extent to which the applicable law recognises attornment as having this effect. By contrast, the effects of issue and transfer of paper trade documents are much more consistently recognised globally, as they derive from the transnational law merchant.⁵⁰

• (3)    The legal validity and consequences of these contractual frameworks are untested in court and so remain relatively uncertain, as compared to the very well-settled position in relation to paper trade documents.

• 2.13    We asked for consultees’ views on the advantages and disadvantages of using private contractual frameworks in this context. ⁵¹The majority of consultees, including, for example, Professor Michael Bridge QC, the London Maritime Arbitrators Association (“LMAA”), and the Digital Container Shipping Association (“DCSA”) considered that we identified the shortcomings of contractual workarounds accurately, and said that our provisional proposals would be welcomed. ⁵²While certain electronic documents on these frameworks may be able to achieve the same legal effects as paper trade documents, they are by no means a perfect substitute for legislative reform of the kind we proposed. Vale International SA told us, for example, that the terms on which parties contract can be negotiated and varied by different system users at the time they agree to them. This may lead to inconsistencies in the rights and obligations of the different parties to what should be a uniform multipartite contractual framework, with the same rules for all.

• 2.14    On the other hand, the City of London Law Society (“CLLS”) considered that our provisional proposals “carrie[d] disadvantages in relation to [the advantages of contractual frameworks]”. The CLLS considered that protections would be needed in relation to trade documents in electronic form, including:

at least some standards for the systems of record, possibly with regulatory oversight, as well as clear application of money laundering, anti-terrorism and data protection rules.

• 2.15    The CLLS said that the private contractual frameworks discussed in the consultation paper “were no doubt established to provide users with those safeguards”. They noted that the Law Commission’s proposals “do not provide any safeguards in these regards”. Similarly, IGP&I noted that private contractual frameworks offer an “apparent secure system ... on which to build confidence”. They suggested that to “maintain confidence in an open playing field, the [electronic trade documents] legislation must ensure sufficient safeguards”.

• 2.16    With regard to these comments, we consider that the Bill’s remit is simply to remove the legal blocker to the possession of electronic trade documents. Money laundering, anti-terrorism and data protection rules will apply to electronic trade documents that fall within the scope of our recommended reforms where relevant, without the need to refer to such rules expressly in the Bill. None of the issues arising from the application of these laws will be exacerbated by our recommendations, and neither will the “secure system” offered by contractual frameworks be undermined by our recommended reforms. In addition, as discussed below,⁵³ we have recommended including express reliability and integrity requirements in the Bill. These additional requirements should alleviate concerns relating to a lack of adequate safeguards in the use of electronic trade documents and related systems.

• 2.17    In any case, we do not intend to suggest that our recommendations would render contractual arrangements redundant. The London Metal Exchange (“LME”) has implemented a contractual framework for warranting metal under the existing law of England and Wales, and has said that it does not require reforms of the kind we provisionally proposed in order to maintain its current approach. The LME raised particular concerns about the impact of our proposals on such systems.

• 2.18    It is important to note that while our recommendations do not mean that parties cannot use alternative contractual arrangements, parties cannot contract out of the provisions of the Bill where they would otherwise apply. As such, if a system purports to enable the issue, transfer and accomplishment of a trade document (such as a bill of lading), and the relevant document qualifies as an electronic trade document for the purposes of the Bill, the provisions of the Bill would apply. Where, however, the document in question does not qualify as an electronic trade document, the Bill does not affect the parties’ ability to use private contractual systems to achieve the same legal result as would be achieved if the document fell within the scope of the Bill. The position is the same under the existing law for paper trade documents. That is, if a document qualifies as a bill of lading, it has certain effects as a matter of law regardless of the parties’ contractual arrangements.

New possibilities from new technology

• 2.19    The current state of the law in relation to possession was not obviously in need of reform when the technology to support electronic documents was at an early stage of development. In our 2001 advice to Government entitled Electronic Commerce:

Formal Requirements in Commercial Transactions (“2001 Advice”), we discussed the possibility of electronic bills of lading, and said the following:

Technology may in the future be capable of providing the commercial world with a true electronic equivalent of a paper bill of lading. However there is no working equivalent now. Nor, as we understand it, is there likely to be in the near future.⁵⁴

That passage ended with a footnote which stated: “we are told that there is currently no market demand for such an equivalent”.⁵⁵

• 2.20    Since publishing our 2001 Advice, new technologies have emerged, and industry calls for digitalisation have increased. Consequently, these statements are no longer a true reflection of either the available electronic alternatives to paper, or market demand. Digital technology has developed to the extent that trade documents in electronic form that are a “true electronic equivalent” of paper trade documents can be created. As explained below, the law in this area has become outdated as a result of these technological developments. This has prompted judges to call on the Law Commission to consider the law on possession with a view to reforming it.⁵⁶

Distributed ledger technology (“DLT”)

• 2.21    In recent years, DLT has been suggested as a key technological development which could support trade documents in electronic form.⁵⁷

• 2.22    We have included an explanation of this technology in Appendix 3 of this report for the sake of concision. A distributed ledger is a store of information or data. It is shared (that is, “distributed”) among a network of computers (known as “nodes”), and may be available to other participants. DLT is technology that enables the operation and use of a distributed ledger. The ledger contains a record of data, such as a history of transactions involving an electronic promissory note, and each node holds a copy of the ledger. When data is added to the ledger - to, for example, record that an electronic document has been transferred from person A to person B - every node’s copy is updated.

• 2.23    The distinguishing feature of DLT compared to traditional, centralised databases is that the ledger is not maintained or controlled by a central administrator or entity. This means that network participants do not have to reconcile their local databases with a ledger maintained by a central administrator. Under traditional account-based transactions overseen by an intermediary, such as a bank, the authority to update the ledger is delegated to the bank. It is the bank who is responsible for updating the ledger by debiting the account of the payer, and crediting the account of the payee.⁵⁸

• 2.24    Instead, in DLT systems, participants approve and eventually synchronise additions to the ledger through an agreed “consensus mechanism”. The consensus mechanism is set by the software underlying the DLT system. ⁵⁹In general, it requires some or all of the participants to determine the validity of a proposed data entry. ⁶⁰If the participants determine that the proposed entry is valid, it is eventually added to the ledger. The consensus mechanism is typically designed so that, once data is added to the ledger, the data is very difficult to amend.

• 2.25    The immutability of the ledger means that participants in the system can trust in its veracity and transact with one another in confidence. For example, any attempt by a person to transfer an electronic bill of exchange twice would be contradicted by the ledger (which would contain an immutable record of that electronic bill having already been transferred to another person).⁶¹ Similarly, any attempt to manipulate the contents of the ledger to facilitate a fraud is, practically speaking, impossible.

• 2.26    DLT offers the prospect of creating viable electronic documents for use in shipping, trade, and trade finance that mimic the salient properties of their paper counterparts. These electronic documents can be transferred between participants on the ledger without the need for a central authority, and the record of those transactions is for all practical purposes immutable.⁶² Additionally, DLT systems generally place control of an electronic document in the hands of the person with knowledge of the relevant “private key”. In general, participants in a DLT system have a private key, which is a unique string of data that is (at least initially) known only to the participant. Participants also have a “public key”, another string of data which is derived from the private key, and which can be shared with other participants. A participant’s private key can be combined with the data of a transaction to create a digital signature for the participant (which they can then use to digitally sign a transaction). The authenticity of this digital signature can be verified by the recipient of the transaction using the participant’s public key. Public key cryptography can be used to effect dealings with electronic documents, including a transfer of the document to another party. It is possible to design systems that make the content of electronic documents invisible to all but the relevant parties, thereby safeguarding commercially sensitive information.⁶³

Central registry systems

• 2.27    Many of the systems hosting trade documents in electronic form already in use, underpinned by multipartite contractual arrangements, are central registry systems which, unlike a distributed or decentralised ledger, are administered centrally. Users sign up for accounts which are accessed with a password or other security credentials. Documents with unique identifiers are allocated to a particular user account upon issue or transfer, and the relevant user can hold or transfer the document. The person or persons with knowledge of the relevant security credentials (and who are therefore able to transact on that account) can control what happens to the document while it is allocated to the relevant account. Updates to registry records (that establish to which user account the document is allocated) can be set up to occur automatically when transactions take place. Not all systems hosting trade documents in electronic form are therefore DLT-based, nor do they need to be to satisfy our recommended criteria for electronic trade documents (discussed in Chapter

• 6) .

OTHER REFORM INITIATIVES

• 2.28    Over the past few years there have been various initiatives aimed at recognising the use and legal validity of electronic documents. The principal initiatives include the United Nations Convention on Contracts for the International Carriage of Goods Wholly or Partly by Sea 2008 (the “Rotterdam Rules”), the MLETR, developments in Singapore, and the US Uniform Commercial Code. We discussed these in detail in the consultation paper, ⁶⁴and summarised the approach of other countries which have taken steps to provide for electronic trade documents.⁶⁵

• 2.29    One aspect these legislative efforts have in common is that they all attempt to address the possession problem.⁶⁶ This is because possession is fundamental to the way that trade documents operate internationally, across all legal systems. Given the recent emphasis on the MLETR, we include a brief summary below.⁶⁷

The MLETR

• 2.30    In 2017, UNCITRAL formulated the MLETR, which is aimed specifically at enabling the widespread use of electronic documents. It includes a general provision that provides that:

An electronic transferable record shall not be denied legal effect, validity or enforceability on the sole ground that it is in electronic form.⁶⁸

• 2.31    As a model law, this instrument is “a suggested pattern for law-makers in national governments to consider adopting as part of their domestic legislation”.⁶⁹ At the time of publication of this report, legislation “based on or influenced by” the MLETR has been adopted in the Abu Dhabi Global Market, Bahrain, Belize, Kiribati, Paraguay and Singapore.⁷⁰

• 2.32    The MLETR applies to “transferable documents or instruments” in electronic form, which does not include straight bills of lading or “documents or instruments, which are generally transferable, but whose transferability may be limited due to other agreements”.⁷¹

• 2.33    In order to have functional equivalence with a transferable document or instrument, an electronic record must satisfy a number of requirements. It must:

• (1)    contain the information that would be required to be contained in its paper equivalent; and

• (2)    a reliable method must be used to (i) identify it as the electronic transferable record; (ii) render it capable of being subject to “control” from its creation until it ceases to have any effect or validity; and (iii) retain its integrity so that the information in the record remains complete and unaltered.

• 2.34    The MLETR also sets out the functional equivalence of possession, being control. Article 11 requires that a “reliable method” be used to establish “exclusive control” of an electronic transferable record by a person, and to identify that person as the person in control. Paragraph (2) of article 11 provides that transfer of control will have equivalent effects at law to the transfer of possession of a paper document. “Control” is not defined but the Explanatory Note says that it is intended to operate as a functional equivalent to the fact of possession.⁷²

• 2.35    The “reliable method” referred to in articles 10 and 11 must be “as reliable as appropriate” having regard to criteria set out in article 12.

• 2.36    Amendments to the Singapore Electronic Transactions Act 2010 were adopted in 2021, implementing reforms in line with the MLETR. ⁷³The most significant divergence from the MLETR in the Singapore legislation is that the Singapore legislation envisages the possibility of an accreditation system for reliability. Section 16O provides that, if an electronic transferable record is associated with an electronic transferable record management system provided by an approved provider, the methods used by that management system are presumed “reliable”. Singapore is yet to introduce an accreditation system and, unless and until such a system is set up, reliability is assessed in the same way as under the MLETR.

CONSULTEES’ SUPPORT FOR REFORM IN ENGLAND AND WALES, AND VIEWS AS TO IMPACT

• 2.37    In the consultation paper, we made provisional proposals for reform of the law in England and Wales to allow for trade documents which depend on possession to be used in electronic as well as paper form. Consultees expressed strong support for this objective and for our proposed approach. Some themes that emerged from their responses include the need for paper and electronic documents to have equivalent effect, a preference for law reform that is technologically neutral, and a preference for the least interventionist approach to reform. These themes are addressed in turn below.

• 2.38    Some consultees, while supportive of the overall aims of our work, queried whether expanding the notion of possession was the correct approach. We address these arguments separately below from paragraph 2.63.

• 2.39    Consultees also told us what they thought the impact of our recommended reforms would be.

General support for reform

• 2.40    Many consultees placed emphasis on the need for electronic trade documents to have the same legal effect as paper trade documents.

• 2.41    The LME expressed support for:

any initiative that would allow it to create electronic documents of title in respect of metal for use within its own settlement system, in particular where such arrangements are capable of being recognised as valid under other legal systems.

• 2.42    The LMAA said that they were “entirely supportive of the objective behind this draft bill”, and added that there was an “overwhelming case for promoting electronic trade documents in place of their paper equivalents”. The Grain and Feed Trade Association, an international trade association representing nearly 2,000 member companies, said that they were “in favour of measures to facilitate and increase the use of electronic documents to support the international trade in Agri-commodities”. ICC International Maritime Bureau said:

The IMB supports the Law Commission’s open and public consultation into reform to enable the legal recognition of electronic trade documents such as bills of lading and bills of exchange.... There are clearly benefits in the UK removing the legal blocker to EBsL - particularly for enabling faster trade transactions, cost savings and other efficiencies provided.

• 2.43    As these remarks show, consultees supported the focused aim of enabling electronic documents to be used in the same way as their paper counterparts. Sullivan &

Worcester LLP recommended that the Law Commission should focus on “the issue of possession to enable recognition of electronic trade documents in English law”.

• 2.44    Consultees identified various advantages to reforming the law to ensure that electronic trade documents have the same effect as their paper counterparts. The LMAA said it would save time and money, and noted that “the maritime and financial sectors are pushing for paperless trade to be recognised and enforceable and will welcome this Act”. The British Insurance Law Association said that the speed of electronic documents was an obvious advantage over paper, and that the platforms for electronic trade documents “appear[ed] to be a secure system to adopt”.

• 2.45    The Centre for Commercial Law at the University of Aberdeen set out numerous policy reasons for reform. They said:

We agree that there is a pressing need for law reform in the UK in this area to facilitate the use of technology in trade, provide legal certainty and predictability regarding the legal status of electronic trade documents and give these documents the legal recognition that their paper counterparts have. This will significantly help speed up the overdue transition to paperless trade to better safeguard and maintain the global trade flow of information relating to the trade in goods and build resilience to shocks such as COVID-19.

• 2.46    There was also support for extending our provisional proposals for reform beyond England and Wales. Professor Andrew Steven, former Scottish Law Commissioner, said:

I favour strongly UK-wide implementation. Much of the existing legislation, notably the Bills of Exchange Act 1882 and the Carriage of Goods by Sea Act 1992 applies to Scotland as well as south of the border. Despite the differences in property law this has not proved problematic.

A technology-neutral approach with minimal intervention

• 2.47    The importance of reforming the law in a way that is technology neutral was another theme of consultees’ support for our provisional proposals. ⁷⁴D2 Legal Technology commended the simplicity of the provisional proposals, and supported the aim of “future-proofing” by keeping them technology neutral. The Mining and Metals Digitalisation Forum also agreed that a technology neutral approach was the right one. They considered that the standards for electronic document platforms and systems should be determined by the industry. The LME and DCSA similarly expressed support for a technology neutral approach.

• 2.48    An additional theme that arose from consultee responses was the importance of a restrained approach to law reform in this area.⁷⁵ Professor Sir Bernard Rix said that the Law Commission was:

in principle right to restrain [itself] from trying to legislate in the new world of ETD, which in any event is changing so fast. And the legislator cannot pretend to be a technologist.

• 2.49    Dr Simone Lamont-Black agreed that it would be useful to “leave matters as close to undisturbed as possible while bringing [the law] up to date to cater for business reality of the 21st century”. In a similar vein, Linklaters LLP “fully support[ed] the Law Commission’s ultimate objectives as well as its desire to adopt the least interventionist approach”.

The potential impact of reform

• 2.50    In the consultation paper, we considered the impact of our provisional proposals for reform and sought the views of consultees as to the potential benefits and costs of the transition to electronic trade documents.⁷⁶ Below, we highlight certain themes which arose in those responses, and consider them in more detail in Chapter 10.

• 2.51    As a preliminary point, we asked consultees about the number of documents that would be covered by our provisional proposals. ⁷⁷We estimated that the total global number of paper trade documents used in contained shipping was approximately 28.5 billion.⁷⁸ Although some consultees agreed with our estimate, others said that it was too high, and most consultees agreed that the number of documents used in a transaction would vary depending on factors such as the sector and type of transaction.⁷⁹ It is clear, however, that a very large number of documents would be covered by our recommendations.

Potential benefits

• 2.52    Consultees told us that our provisional proposals for reform of electronic trade documents could have the following potential benefits.

• (1)    Costs savings, both in relation to resourcing and operational costs (for example, costs associated with paper, printing/photocopying, postage/courier services, filing, storage and staffing).

• (2)    Increased productivity (for example, not having to re-enter information, saving time searching for lost documents and eliminating the risk of mistakes).

• (3)    Increased efficiency in trade processes and labour. The main efficiency gains identified by consultees were the reduction in instances of time lost to delays, and of documentation arriving only after the shipments to which it relates.

• (4)    Increased transparency of supply chains. Most consultees agreed that a shift to trade documents in electronic form, facilitated by our provisional proposals, would increase supply chain transparency. Others noted that supply chain transparency would also depend on the systems used, the wishes of parties and the nature of the transactions.

• (5)    Environmental benefits. Some consultees said that the transition would mean reduced reliance on paper and couriers which would benefit the environment. Other consultees agreed with this but considered that it is not clear that the transition to electronic documents would create environmental benefits overall, particularly given the energy consumption of some DLT-type systems.

• (6)    Benefits for small and medium-sized enterprises (“SMEs”) and consumers. Some consultees agreed that our provisional proposals could provide particular benefits for SMEs and consumers, in the form of lower costs of financing and reduced delays. However, there is a question as to whether these potential benefits would actually be passed on to SMEs and consumers rather than being kept by other players within the supply chain, such as those involved in carrying or storing the goods.

Potential costs

• 2.53    As well as identifying possible benefits associated with adopting our recommended reforms, consultees also mentioned potential costs. In the consultation paper, we said that the most immediate costs would be transitional, arising from the need to train staff on new systems, develop and refine new internal processes, and negotiate with trading partners.⁸⁰

• 2.54    The energy consumption of some DLT platforms continues to be a source of concern. The essential nature of the problem is the power required by network users of some DLT systems employing computational capacity to verify blockchain transactions. At a time of increasing global efforts to combat climate change, the scaling up of a highly energy intensive technology must be carefully evaluated. Consultees noted that not all DLT systems involve the same energy consumption and that systems can be configured to minimise energy consumption by, for example, using proof-of-stake rather than proof-of-work protocols.⁸¹

The effect of potential reform on fraud

• 2.55    In the consultation paper, we commented on the perceived comparative security of electronic trade documents.⁸² We said the features of trade documents in electronic form which satisfy the requirements of the Bill “will be significantly more secure than their paper counterparts”. As we discuss in Chapter 10,⁸³ some consultees made a strong, cogent argument that the nature of fraud in international trade and, in particular, the incidence of collusion, means that electronic documents will not necessarily reduce the risk of fraud. As Professor Michael Bridge QC said, “fraud will always find a way. Computers can be hacked. Imaginary shipments can be concocted out of thin air”.

• 2.56    Our recommendations require the digital architecture of an electronic document system to ensure that no more than one person (or persons acting jointly) at any one time can use, transfer or otherwise dispose of a trade document in electronic form. Additionally, the movements of such documents will be recorded in a manner which makes tampering very difficult to achieve. However, as we explain in Chapter 10, we agree that there are some types of fraud to which paper trade documents and electronic trade documents are equally susceptible.

REFORMING THE LAW TO ALLOW FOR TRADE DOCUMENTS IN ELECTRONIC FORM

• 2.57    The support from consultees, and the evidence received concerning the benefits of reform in this area, have confirmed our provisional view that there is a strong case for law reform in this area. In this report, therefore, we make recommendations for reform which would allow documents in electronic form that satisfy certain criteria to have the same functionality as their paper counterparts.

• 2.58    We have developed our provisional proposals in the consultation paper, and refined our final recommendations in this report and in the Bill, based both on principles and on considerations of how parties use electronic trade documents in practice. In particular, our reforms have been underpinned by three general principles, all of which were generally supported by consultees:

• (1)    adopting the least interventionist approach;

• (2)    technological neutrality; and

• (3)    the importance of international compatibility.

We discuss each below.

THE LEAST INTERVENTIONIST APPROACH

• 2.59    The law of England and Wales functions highly effectively in relation to paper documents, and is currently trusted by a large number of commercial entities engaging in cross-border trade. Throughout this project, we have aimed to take the least interventionist approach to reform. We intend that, if our recommended reforms are implemented, industry can continue to operate in accordance with the same rules and according to the same practices as they currently do, but with a choice as to whether to use electronic or paper trade documents.

• 2.60    Central to this least interventionist approach is our view that trade documents in electronic form should be capable of being possessed, and that the same laws and practices should apply to trade documents whether in paper or electronic form. We explain this approach in more detail below. We then explain why we think there is a need for legislative intervention rather than common law development, although the courts would nevertheless retain an important role.

Allowing for possession of trade documents in electronic form

• 2.61    In the consultation paper, we provisionally proposed that a trade document in electronic form should be capable of being possessed, provided that it satisfied certain criteria designed to ensure that it replicated the salient features of paper trade documents.⁸⁴ In the following chapters, in particular Chapters 3 and 5, we provide a full explanation of possession and possessory concepts and their fundamental role in relation to the types of documents with which this project is concerned. However, it is helpful to explain up front our reasons and justifications for focusing on possession, as it underpins our approach throughout this report and in the Bill.

Consultees’ views

• 2.62    Below, we draw on responses received to the digital assets call for evidence as well as to the consultation paper on electronic trade documents. We received similar comments in both sets of responses, and many of the concerns raised considered the position of digital assets generally, rather than electronic trade documents as a particular subset of digital assets.

• 2.63    Some consultees suggested that possession is too intrinsically linked to tangibility, or already too complex and burdened a concept. For example, Dr Michael Crawford said that rendering digital assets possessable “would further complicate the already complex concept of possession”. Professor Kelvin Low said that making digital assets possessable:

would be quite undesirable ... the extension of “possession” unavoidably employs a metaphor which is likely to be difficult to apply. The result would be that the development of the law will be left to the vagaries of litigation.

• 2.64    Professor Michael Bridge QC said he was “not in favour of introducing possession into the equation: it will have to be defined in terms of control anyway”.

• 2.65    CLLS said:

We have serious reservations about the application of certain complex and nuanced elements of the law relating to possession (such as, the animus possidendi) to modern legal and technological systems that are intended to give primacy to the ledger as a primary record of entitlement to or in relation to a particular digital asset.

• 2.66    Professor Sir Roy Goode suggested that expanding the concept of possession is unnecessary and that a concept such as control, which does not imply physical custody or control, would be more suitable. Relatedly, some consultees suggested that digital assets should be neither things in action nor things in possession, but belong instead to a third category of personal property which is distinct from either of these.

• 2.67    In respect of digital assets generally, Professors Fox and Gullifer said:

Our concern is that possession has a highly specialised meaning that has developed to govern its use in transactions involving natural persons and tangible assets such as land or goods. Much of the law has developed in relation to situations where tangibles are not in the actual physical control of the person who is claiming to be in possession of them or who is claiming to sue on a possession-based title (eg someone who has temporarily lost something). To accommodate these, the common law has developed subtly different grades of possession (such as actual vs constructive possession and factual vs legal possession) to explain the incidence of rights between the parties and the world at large. It may well be that such accretions are not necessary or desirable for the law relating to digital assets.

• 2.68    Professor Duncan Sheehan said that he agreed that “expanding possession to include [electronic trade documents] more easily brings electronic trade documents into the same regime as paper ones”. However, he sounded a note of caution:

Simply that from a linguistic point of view talk of possession of intangibles is unusual. While it is novel as a proposition given the courts’ predilection for concentrating on tangibility what matters here is use and control of a separable thing. I noted [previously] that other “things” than just electronic trade documents such as bitcoin meet these criteria. That remains my view and it will be important that any legislation specifically make clear that it applies only to these documents.

• 2.69    We agree that the correct approach may differ as between electronic trade documents and other digital assets, including cryptoassets. We also take the view that the existence of “subtly different grades of possession” is a virtue for the purposes of our recommendations. The nature of relative rights to electronic documents is likely to make conclusions about factual possession as fact-dependent as they are in relation to conventional objects of property rights.

Discussion and our recommended approach

• 2.70    We remain of the view that using possession as the operative concept in respect of trade documents in electronic form is the right approach. As explained in the following chapter, possession has a core role in the current functionality of paper trade documents, both at common law and in domestic statutes, in terms of establishing who may have certain rights and entitlements. Possession is also central to a number of other concepts that are relevant to the ways in which paper trade documents are used or protected, including being custodied in possession-based arrangements such as bailment, and used as collateral in possessory security arrangements such as a pledge. It makes them protectable through proprietary torts such as conversion. In order to ensure that electronic trade documents are treated in law as equivalent to their paper counterparts, we think it desirable to maintain the same language and substantive legal characterisation in relation to both.

• 2.71    As discussed in Chapter 5, control is a fundamental element in the assessment of possession and will therefore be relevant for the purposes of establishing what constitutes possession of an electronic trade document. However, using control on its own without any reference to possession could give rise to a situation where, although an electronic document is identical in substance to its paper counterpart, it would be treated differently because it could not be the subject of possessory treatments and remedies.

• 2.72    Using possession as a determinative concept allows electronic trade documents to be plugged directly into an existing legal framework of commercially useful concepts, with which the international trading community is already familiar. This is an especially important consideration given that the law of England and Wales underpins a significant amount of international trade. We think this approach allows for the least disruption to existing legal arrangements and analyses.

• 2.73    As discussed in the following chapter, paper trade documents which function on the basis of possession are already unique in law, being legal claims which take a physical form, and which are therefore characterised as things in possession. We think it is logical to extend this to their electronic equivalents. We demonstrate in Chapters 5 and 7 that many of the factors which are relevant to the possessability of paper documents can be replicated in the electronic environment. The extension can therefore be achieved without significant change to existing concepts which are relevant to assessing possession.

• 2.74    We note also that the MLETR retains a role for the concept of possession in respect of electronic transferable records, given its centrality to their function. Although control is the central concept in the MLETR, it is said to be a “functional equivalent to the fact of possession”, and the MLETR seeks to preserve and plug in to the legal consequences arising from possession in any given jurisdiction.⁸⁵ Under the MLETR, if a document is in someone’s exclusive control, any legal requirement that it be in someone’s possession in order for certain consequences to follow will be treated as met. ⁸⁶In order to benefit from the existing law on possession and to ensure that there is no difference in legal treatment between documents in different forms, we think it is clearer and more direct to extend the application of the concept of possession itself.

• 2.75    Consultees agreed with us that particular arguments point in favour of possession in respect of electronic trade documents. For example, although in favour of a different approach in respect of digital assets more generally, Professors Fox and Gullifer said:

We acknowledge the advantage of using the concept of digital possession to explain the transfer of property in electronic trade documents. The reason is that the proposed electronic regime is modelled directly on existing transactions with tangible documents. The delivery of the documents is the key concept in explaining how title in them is transferred.

• 2.76    Similarly, the Cloud Legal Project in its response to the digital assets call for evidence said:

We recognise that digital possession may bring advantages in terms of facilitating trade ... if a digitised version of [a bill of lading] were also capable of possession these commercial transactions [such as a pledge for an advance of funds] could be expected to continue without any need for further legal change. It may therefore be helpful to introduce digital possession as a simple way of preventing the need to reinvent those transactions.

• 2.77    Our recommendations will mean that parties can use the law that currently applies to paper trade documents when transacting with electronic trade documents. There will be no need for separate regimes with equivalent effects.

Recommendation 1.

• 2.78    Trade documents in electronic form should be capable of being possessed as a matter of law, provided that they meet certain criteria which ensures that they can replicate the salient features of paper trade documents.

Cryptoassets and other digital assets

• 2.79    We acknowledge that the same arguments do not necessarily apply in respect of other forms of digital assets, including cryptoassets. This is primarily because other digital assets generally do not seek to replicate the legal functionality of a specific and idiosyncratic form of tangible personal property in the way that electronic trade documents attempt to replicate exactly the legal functionality of paper trade documents. In fact, cryptoassets were intentionally created to avoid replicating certain of these features. As a result of this, cryptoassets and certain other digital assets have idiosyncratic features that make drawing wholly-applicable analogies with existing categories of personal property particularly difficult.

• 2.80    These differences and idiosyncrasies might mean that the automatic application of legal rules developed for more traditional assets would be undesirable in the context of certain digital assets. There is therefore an argument (echoed by the responses of consultees above) that the opportunity should be taken to develop concepts, such as that of control, which are better suited to the unique nature of digital property.

• 2.81    In addition, the argument for preserving the status quo has less force in relation to digital assets in general, for which there is less settled market practice compared with trade documents. Indeed, this is particularly the case for nascent digital assets such as cryptoassets, where market practice is evolving almost daily.

• 2.82    In our forthcoming consultation paper on digital assets, we will explore other possible approaches to the legal categorisation and treatment of digital assets more generally. We do not consider that such a fundamental re-think is necessary or justified in respect of electronic trade documents, where a workable solution can be found to bring them within the category of things in possession.

The need for legislation

• 2.83    As we discuss in detail in Chapter 5, the existing law of possession in this area is governed by the common law. The UKJT’s legal statement on cryptoassets and smart contracts recognised “the ability of the common law to stretch traditional definitions and concepts to adapt to new business practices”. ⁸⁷We have therefore considered whether it would be possible to leave it to the courts to develop laws allowing for trade documents in electronic form to be capable of possession. However, extending the concept of possession to any type of intangible property would be a significant development.

• 2.84    In two leading cases, it was observed by the court that while there were powerful arguments for extending possessory rights to intangibles, such a step would be too big a one for the courts to take; it needed to be done by Parliament. In Your Response v Datateam Business Media Ltd, Lord Justice Moore-Bick included a plea that Parliament develop a statutory means of accommodating digitalised material.⁸⁸ Similarly, both Lord Walker and Baroness Hale in OBG Ltd v Allan felt it was more appropriate for such a reform to come from Parliament, after consideration by the Law Commission.⁸⁹ Given the iterative and mostly incremental nature of common law development, it is perhaps not surprising that judges have been cautious about making such a significant change in a single case, even though it might be justifiable on legal and policy grounds.

• 2.85    In addition, we think that in order to be treated in law as equivalent to a paper trade document, a trade document in electronic form must exhibit the distinctive characteristics that make paper documents and other tangible objects possessable. This means that only electronic documents that satisfy certain criteria should be capable of being used in place of paper trade documents. Given the complexity of the issues, it is important that the criteria for trade documents in electronic form to qualify as “electronic trade documents” are set out clearly, and in a way that generates sufficient market certainty for suitable systems to be developed. Ad hoc development through the common law would not provide the requisite degree of clarity.

• 2.86    We therefore recommend that this step be taken by means of legislative reform so that, provided they fulfil certain criteria, trade documents in electronic form should be treated in law in the same way as their paper equivalents. This would mean that they would give rise, by their issue, transfer and surrender, to the same effects (in statute, common law and commercial practice) as their paper counterparts.

Reform via secondary legislation?

• 2.87    We are aware of suggestions that reform in this context could be facilitated by secondary rather than primary legislation. For example, section 8 of the Electronic Communications Act 2000 (“ECA 2000”) contains a power to amend “any enactment or subordinate legislation” or any schemes set out in an enactment or subordinate legislation for the purposes of facilitating electronic communications or storage. Sections 1(5) and 1(6) of the Carriage of Goods by Sea Act 1992 (“COGSA 1992”) give a power to make regulations to enable bills of lading, sea waybills and ship’s delivery orders issued by electronic means.⁹⁰

• 2.88    As we said in the consultation paper, we do not consider that either of these provisions is wide enough to accommodate the reforms we are recommending.⁹¹ The power in the ECA 2000 is restricted to making changes to legislation. Regulations made under this power could therefore amend the 1882 Act for bills of exchange and promissory notes, and potentially COGSA 1992 for bills of lading. However, some of the documents with which we are concerned are entirely creatures of the common law, and the ECA 2000 does not provide a power to amend the common law. The power in COGSA 1992 is limited to the documents covered by that Act and again would not reach far enough. We therefore consider that the reforms must be made through primary legislation.

Recommendation 2.

• 2.89    There should be legislative reform to allow for trade documents in electronic form that satisfy certain criteria to be possessed and therefore to have the same legal effects as their paper equivalents.

The role of the courts

• 2.90    Our recommendations are for a statutory “framework” to allow trade documents in electronic form that satisfy certain criteria to be treated as equivalent to paper trade documents.⁹² This would allow them to “plug in” to the existing legal framework for paper trade documents, rather than being made subject to a bespoke set of rules applicable only to trade documents in electronic form.

• 2.91    If our recommendations are implemented, the courts will be central in interpreting and applying the provisions of such legislation in light of the existing common law applicable to paper trade documents, adapted for digital subject matter. We think this is the least interventionist approach and allows the industry to continue to operate according to laws and practices with which they are already familiar.⁹³

• 2.92    In general, an Act must be read and applied in the context of the general body of law into which it is assimilated. ⁹⁴It has been said that:

it is a sound rule to construe a statute in conformity with the common law, except where or in so far as the statute is plainly intended to alter the course of the common law.⁹⁵

• 2.93    The overarching requirement is for the court to give effect to the intention of the legislator, as objectively determined having regard to all relevant indicators and aids to construction.⁹⁶ These may include, among other things, explanatory notes to legislation, ⁹⁷as well as any relevant Law Commission reports.⁹⁸ In Cooke v United Bristol Health Care, Carnwath LJ said:

Where a Bill is based wholly or partly on a Law Commission recommendation, it is appropriate to take account of the report to find the mischief to which the provision was directed.⁹⁹

• 2.94    In this regard, we are reminded of the words of Lord Scarman in Duport Steels:

our law requires the judge to choose the construction which in his judgment best meets the legislative purpose of the enactment.¹⁰⁰

• 2.95    In particular, where terms are undefined in the legislation, such as the term “possession”, ¹⁰¹the role of the courts is to apply the existing common law to ascertain the meaning of those terms, and to provide them with suitable content.¹⁰²

• 2.96    Where the Bill is silent on how certain concepts apply to electronic trade documents (for example, timing of transfer of possession, delivery, rejection and acceptance),¹⁰³ the role of the courts is to apply the existing principles of those concepts to electronic trade documents, subject to any necessary adaptations of the common law to cater for their digital nature. In this regard, Lord Hoffman has noted in Johnson v Unisys Ltd that:

judges, in developing the law, must have regard to the policies expressed by Parliament in legislation ... . The development of the common law by the judges plays a subsidiary role. Their traditional function is to adapt and modernise the common law. But such developments must be consistent with legislative policy as expressed in statutes. The courts may proceed in harmony with Parliament but there should be no discord.¹⁰⁴

Other aspects of our recommendations which aim to ensure a smooth introduction of trade documents in electronic form

• 2.97    As discussed later in this report, we aim to make change of medium of a trade document (that is, a change of form from electronic to paper or vice versa), and crossborder movement of electronic trade documents, easier. This is particularly important in the context of trade documents because it is likely that paper documents will continue to be used alongside electronic documents for a number of years, and the same legal rules should apply regardless of the form of the document. In the interests of consistency and certainty, the medium of the document should not affect its legal treatment.

• 2.98    Our approach to electronic trade documents is also to create a facilitative, rather than mandatory, regime. If parties wish to continue using paper trade documents, they can do so. Equally, our recommendations do not affect the ability of parties to use an entirely different system for recording and recognising rights and obligations, operating on the basis of contractual arrangements, provided the electronic document does not otherwise fall within the scope of the Bill. ¹⁰⁵Our recommendations, if implemented, will not affect the validity or operation of these systems.¹⁰⁶

TECHNOLOGY NEUTRALITY

• 2.99 The law’s current approach to possession made sense when technology did not exist to allow the creation of electronic documents that had the same legally relevant properties as physical pieces of paper. That is, documents capable of a sufficient degree of control, with a mechanism to prevent double spending.¹⁰⁷

2.100 Digital technology has now, however, reached a point where electronic documents can be created which do indeed represent what the 2001 Advice called a “true electronic equivalent” of a paper trade document. The law has not kept up with these technological developments.

2.101 That said, our recommendations and draft legislation are technology neutral. They are not predicated on the functionality of a particular technology. Instead, the starting point for our work has been the following question: as a matter of law, what features must trade documents in electronic form have in order to be equivalent to paper documents, and therefore amenable to possession? We have not sought to set out in legislation how such features may or must be achieved.

2.102 We consider that our approach will foster innovation and allow more flexible commercial arrangements to be reached. It will also circumvent the risks of referring to particular technologies which may quickly become outdated or obsolete, and of excluding other potential existing or future solutions.¹⁰⁸

2.103 Consultees have said that users would need to be able to “trust” the relevant systems in order for electronic trade documents to be used widely. We expect that commercial parties will consider questions of security and risk when choosing an electronic trade documents system. However, we also acknowledge that our recommendations constitute a fundamental change to the law. We think that there is a role for legislation in helping to establish that trust, and in Chapter 6 we discuss our recommendations that the Bill should include provisions requiring the integrity of electronic trade documents, and the reliability of electronic trade document systems.¹⁰⁹

2.104 We have considered whether including these requirements is compatible with our technology neutral approach. On balance, we think that such requirements are consistent with our approach. We do not suggest that they - or any other requirements in the Bill - can be met only with one particular type of technology.

2.105 We also recognise that allowing for the legal recognition of electronic trade documents is not the end of the matter. There are practical considerations which parties will have to take into account, including the reliability of the relevant system and the extent to which it may be compromised. It will also be for industry to facilitate interoperability between different systems. ¹¹⁰We hope, though, that this will be made easier by the legal recognition of electronic trade documents, and the way in which that is likely to lead to greater investment in platform and technology development.

How electronic trade document systems will work

2.106 We have developed our recommendations on the basis that electronic trade documents will be issued, held and transferred on systems operated by professional providers, much like the existing systems based on the contractual workarounds discussed above.¹¹¹

2.107 Some consultees, including the CLLS and IGP&I, expressed concern that our provisional proposals did not set this assumption out expressly, and that the Bill did not outline the requirements for an electronic trade document system. For example, the CLLS response expressed concern that most of our provisional proposals did not necessarily pre-suppose a “system which holds or records the trade document, rather than it just being an electronic document like this submission or even an email with the relevant content”.

2.108 We do not envisage that an electronic trade document system could be, as suggested, “an email with the relevant content”. Nor would the relevant system exist in a vacuum. The Bill (both the version consulted on and our recommended final version which appears at Appendix 4), presupposes the existence of a reliable system which can prevent double spending, and secure the divestibility of electronic trade documents.¹¹²

2.109 We also expect that an electronic trade document system would be subject to its own internal governance structure, including the terms and conditions agreed to by the operator and users of such a system. We would expect such terms and conditions to include provisions on liability, confidentiality and data protection, as well as service level provisions.¹¹³ They could also include requirements that the system must be fit for purpose. Parties making use of electronic trade document systems and agreeing to such terms and conditions would be well-advised to adopt, for example, a provision requiring an operator to ensure that their system satisfies the criteria in the Bill. Adopting such a provision would ensure that parties could be confident that their electronic documents fall within the scope of these recommended reforms.

INTERNATIONAL COMPATIBILITY

2.110 Trade documents are used widely for the performance of cross-border transactions. This means that a piece of paper - whether embodying a right to claim delivery of goods, such as a bill of lading, or a right to payment, such as a bill of exchange - may be transferred by and to multiple parties in various jurisdictions. While the law of England and Wales is chosen very frequently as the governing law of transactions involving these documents,¹¹⁴ the vast majority of jurisdictions have similar laws and recognise the legal effects of being in possession of certain paper trade documents.

2.111 Whilst specific issues arising from conflict of laws are beyond the scope of our work, we are conscious of the importance of international compatibility insofar as this is possible. It is vital that electronic trade documents can move between different jurisdictions, and be recognised worldwide as legally equivalent to paper forms of those documents. We discuss the interaction of our recommendations and private international law in Chapter 8.

Our approach to the MLETR

2.112 In developing our provisional proposals for reform, we have been mindful of international initiatives and similar reforms in other countries, particularly the MLETR, which we discuss above.¹¹⁵ We consider the overall approach of MLETR to be sound in principle, and we have sought alignment with it insofar as possible. However, our recommendations are tailored specifically to the law of England and Wales.

Chapter 3: Current law - trade documents

• 3.1    The documents with which this report is concerned are widely used in trade and finance to perform key commercial functions and rely, for their functionality, on being possessable. This chapter begins with a brief overview of the unique characteristics of the documents to which possession is relevant. It then gives an account of the key documents with which this report is concerned. We make recommendations as to which documents should be covered by our recommended reforms in the next chapter.

DOCUMENTS TO WHICH POSSESSION IS RELEVANT: A BRIEF INTRODUCTION

• 3.2    It is not unusual to reduce performance obligations to writing and to record them in documents. The documents thus produced are recognised as evidence in law, but the paper itself does no more than record the fact that one person owes another person something. If Alice and Bob have entered into a contract, Alice does not herself need to be in possession of the piece of paper in order to enforce her claim against Bob. Conversely, if Charles is in possession of the paper document recording the obligation, Charles would not normally become the person to whom performance is due.

• 3.3    Commercial practice has, however, resulted in certain types of documents being used as symbols (or embodiments) of the right to claim performance of the obligations recorded in them, making such right transferable by transfer of the document itself. Over time this commercial practice came to be recognised in law, so that the transfer of rights upon transfer of the document became legally recognised.

• 3.4   These documents can be issued either as “bearer documents” or as “order

documents”. This determines the means whereby the document is transferred.¹¹⁶

• (1)    A “bearer document” is one in which the party to whom performance is owed is generally designated as “bearer” in the document itself. The obligation is validly performed if performance is made to whoever is in possession of the document at the time of performance. To transfer a bearer document, the bearer simply delivers the document to another party (the “transferee”).¹¹⁷

• (2)    In an “order document”, the obligation is owed to a person named in the document, who is in possession of it. To transfer the document, this person (the “transferor”) must indorse the document. An “indorsement” is an annotation in writing on the back of a document instructing that the obligation recorded therein be performed either (i) to the order of a named person, or (ii) simply “to order” (called a “blank indorsement”). This instruction must be signed by the transferor, and is usually completed by delivery. If the indorsement is to a named person, any subsequent indorsement must be by that person. This is what is meant by a “connected and unbroken chain of indorsements”.¹¹⁸ If the indorsement is a blank indorsement, the possessor of the document, whoever they may be, may further indorse the document when it is in their possession.

• 3.5    Critically, the transfer of such a document does not require the consent of any other party, nor does it require any actions to be taken other than those which we describe in the previous paragraph. In both cases, the right to claim performance of the relevant obligation simply “travels with the document”.¹¹⁹

• 3.6    The rules governing the effects of issue and transfer of such documents have their origins in the medieval law merchant, a transnational body of customary law, which eventually integrated itself into states’ domestic laws. These origins are significant because they mean that these documents have substantially the same legal effects wherever they are used.

• 3.7    The effect of these rules is that possession of such a document can confer on the possessor certain rights.¹²⁰ This effect is what enables such documents to perform the crucial commercial functions set out in this chapter. Since, as explained in detail in Chapter 5 of this Report, only tangible things are currently recognised as possessable under the law of England and Wales, the assumption at law is that such a document must be in paper form (or in another tangible medium).¹²¹

Terminology

• 3.8    Various terms have been used to refer to these documents over time. Some of these terms (such as “document of title” or “negotiable instrument”) have specific legal meanings (discussed below) and refer only to certain sub-categories of such documents. Other terms, most notably “documentary intangibles”, have developed as a result of scholarly commentary and debate, and constitute an attempt to refer to the category of documents more generally.¹²²

• 3.9    In the consultation paper, we used the term “document of title” generally to refer to a document in which an obligation is recorded and which the law of England and Wales recognises as capable, by its transfer, of transferring the right to claim performance of that obligation. ¹²³We acknowledged that this meaning does not accord precisely with the technical legal meaning of “document of title”. The fact that we used the term generally and not in accordance with its precise legal meaning may have had an impact on consultees’ responses.

• 3.10    Below we discuss in more detail the different terms that may be used to refer to documents of this type, and the context in which each term tends to be used. While we consider it valuable to make these clarifications, it is not our intention to become bogged down in terminology. As discussed below, the intended outcome of our recommendations is that any document, possession of which is required for a person to claim performance of the obligation recorded in it, can be issued and used in electronic form under the law of England and Wales.

• 3.11    As a general, catch-all term, we use “trade documents” to capture the documents with which we are concerned. As discussed in the following chapter, ¹²⁴this is also the terminology used in the Bill.

TRADE DOCUMENTS - NEGOTIABILITY AND TRANSFERABILITY

• 3.12    The law of England and Wales recognises two related but distinct concepts: transferability and negotiability. ¹²⁵Both these concepts relate to the legal rights and entitlements that are consequent on possession of a document. Possession of the document may be insufficient by itself to give rise to these rights and entitlements. For example, the possessor of the document may be required to show that they came into possession of the document pursuant to a valid transfer and that they received it in good faith. However, possession of the document is a necessary condition for a person to be able to lay claim to those rights and entitlements.

• 3.13    As we noted in the consultation paper,¹²⁶ the terms “transferable” and “negotiable” are often used interchangeably but in legal terms they generally mean different things. In this report, we do not use “negotiable” to refer to all transferable documents (its broad meaning) but only to those the transferee of which may acquire rights greater than those of the transferor (its narrow meaning). ¹²⁷As we explain below, there are subtle differences in the legal consequences of transfer and negotiation respectively.

However, both of these concepts are premised on possession of the document. Since we are mainly concerned with the possessory element, the differences between them are not of any great significance to our project. Our recommendations seek to extend possession to trade documents issued in electronic form. They are not intended to result in any change to the legal effects that ensue when a trade document of a particular type is transferred or negotiated.

• 3.14    That said, we think it is important to include a brief explanation of the different legal expressions which denote that the relevant document is one the possession of which may be required for the exercise of certain rights.

Negotiability and negotiable instruments

• 3.15    Negotiability in the law of England and Wales applies to documents embodying the right to claim performance of an obligation to pay a sum of money. They are known as “negotiable instruments”. ¹²⁸The person who owes the obligation (the “obligor”) is deemed to have validly performed the obligation if they pay out the money to the document’s holder, that is, the person in possession of the document to whom the document was validly negotiated. “Negotiation” here refers to the document’s transfer.

• 3.16    As a general rule, a transferor cannot give better title to something than they themselves have.¹²⁹ This is not the case, however, where the thing in question is negotiable in the strict legal sense. ¹³⁰The key characteristic of negotiability is that the transferee of the document can acquire a better right or entitlement than the transferor had, upon due negotiation of the document. ¹³¹Due negotiation occurs when all legal requirements are fulfilled when transferring the document. These legal requirements usually include good faith on the part of the transferee. ¹³²Where the document is made out to the order of a named person, due negotiation requires an unbroken chain of indorsements,¹³³ showing all indorsees down the chain, unless and until the document is indorsed “in blank”, that is, without naming the transferee. ¹³⁴A blank indorsement has the effect of turning the bill into a bearer bill.

• 3.17    If a document is negotiable, the transferee does not have to investigate the history of the transferor’s title in order to rely on the integrity of the transaction. If, for example, if there is a defect in the transferor’s title, a good faith transferee for value will nonetheless take free of that defect.¹³⁵

Transferability and documents of title to goods

• 3.18    “Transferability” mainly relates to documents of title to goods. It is distinguishable from negotiability in that the transferee of the document receives no better title to the goods recorded in the document than the transferor had,¹³⁶ although certain exceptions apply. ¹³⁷General or special property in the goods is instead transferred as a consequence of the underlying contract or arrangement between the transferor and transferee, be it a contract of sale or a pledge.¹³⁸

Documents of title to goods at common law

• 3.19    Documents relating to goods which are documents of title at common law confer upon the holder “constructive possession” - or the right to immediate possession - of the goods.¹³⁹ This ability to transfer constructive possession of the goods by transferring the document is of crucial importance in international trade, in that delivery of the goods to the buyer is one of the seller’s core obligations under the contract of sale.¹⁴⁰ There is only one type of document which is considered to be a document of title to goods at common law, namely a “shipped” bill of lading (that is, one that contains a statement that the goods have been loaded on board a ship), which is not marked “non-negotiable”. For this reason, its use is central to cross-border sales to which English law applies.

Documents of title to goods under statute

• 3.20    Other types of bill of lading (for example, received-for-shipment bills and bills marked non-negotiable) as well as other documents containing an obligation to deliver goods are not considered documents of title at common law. They do not therefore give the holder constructive possession of the goods. However, possession of these documents is still considered to have certain effects at law. Some of these documents fall within the scope of statutory definitions of “document of title to goods”, ¹⁴¹and can function as documents of title for the purposes of those statutes. This means that the exercise of certain rights may be dependent upon possession of the relevant document. The law’s recognition of the effects of possession in these cases tends to be tied to the way in which these documents are used as a matter of business practice. The statutory definition of “document of title” is broader than the common law meaning of the term and encompasses:

any bill of lading, dock warrant, warehouse-keeper’s certificate, and warrant or order for the delivery of goods, and any other document used in the ordinary course of business as proof of the possession or control of goods, or authorising or purporting to authorise, either by endorsement or by delivery, the possessor of the document to transfer or receive goods thereby represented... .146

• 3.21    Possession of a document may also be legally significant in a situation where the document is marked “non-negotiable”. This is because, while the document cannot be freely transferred to anyone of the holder’s choosing, the person entitled by its terms to claim performance of the obligation recorded in it has to surrender it in order to do so. A non-negotiable (or “straight”) bill of lading, discussed in further detail below, ¹⁴²is such a document.

Assignable documents

• 3.22    Insurance documents issued to evidence cover of maritime cargoes may be used to transfer the right to claim against the insurer for damage to or loss of the cargo, when the cargo itself is sold. Accordingly, cargo insurance certificates are often transferred alongside bills of lading relating to the same cargo. Rights against the insurer are therefore assigned by the transfer of the document itself.

• 3.23    Insurance documents widely used in trade are therefore more commonly referred to as being “assignable” rather than “transferable” or “negotiable”, although the basic notion is the same: if the document is (indorsed and) delivered to the assignee, the latter acquires standing to claim against the insurer, provided additional requirements are satisfied, as discussed below.¹⁴³

• 3.24    Being in possession of the assignable document by itself is not sufficient to entitle the holder to claim against the insurer. The assignee must also have acquired an insurable interest in the subject-matter of the insurance (the cargo), as discussed below. ¹⁴⁴The document by its terms or as a matter of commercial usage, may also require indorsement in the event of assignment. However, possession of the document can be a core requirement for making a claim.

• 3.25    As with negotiable and transferable documents, we are concerned only with ensuring that the possession requirement relating to the assignment of these documents is capable of being satisfied when they are issued in electronic form. Our recommendations are not intended to change the legal effects consequent upon assignment in any way.

Why are these features useful?

• 3.26    There are several consequences of a right being embodied in a document.

• (1)    Delivery (and, where necessary, indorsement) is sufficient to transfer the right to claim performance of the obligation. The consequent ease with which rights may be transferred promotes efficiency and convenience in commercial dealings. If the document were merely evidence of an obligation, it would require some further step to transfer the obligation, ¹⁴⁵such as a formal assignment or a novation (the signing of a new contract between transferee and carrier, to replace the one between transferor and carrier).

• (2)    In the law of England and Wales, a trade document can be the subject of a bailment. ¹⁴⁶A bailment is an arrangement in which one party has voluntary possession of goods belonging to another. Trade documents are often bailed as part of a pledge, which means that the document is held as security.

• (3)    A person in possession of a trade document has their right in that document protected from interference in the same way as they would with any other tangible asset. This is because these documents are treated as tangible assets in themselves, meaning they are covered by the strict liability property torts of trespass and conversion, ¹⁴⁷as well as by negligence.¹⁴⁸ In contrast, interference with purely intangible rights is not covered by the property torts, leaving claimants to resort to the economic torts (such as inducing breach of contract or causing loss by unlawful means), which require establishing a certain type of intention on the defendant’s part.¹⁴⁹

• (4)    In terms of remedies for interference, trade documents are treated differently from other paper documents. For ordinary documents, the measure of damages in conversion would be the nominal value of the paper, whereas for trade documents that embody the right, the measure of damages is the value of the obligation or right embodied in the document.¹⁵⁰

• (5)    To discharge an obligation contained in a trade document, the obligor must render performance to the holder of the document. Rendering performance to any party other than the holder of the document will not discharge the obligation.¹⁵¹

TYPES OF TRADE DOCUMENTS AND HOW THE LAW WORKS IN RELATION TO THEM

Bills of exchange

• 3.27    A bill of exchange is an unconditional written order to pay a certain sum of money. It is addressed by one party to another and it requires the party to whom it is addressed to pay the sum of money to a specified person, or to their order, or to the bearer of the bill.¹⁵² It must be signed by the person giving the order and delivered. ¹⁵³Delivery of a bill of exchange is defined as “the transfer of possession, actual or constructive, from one person to another”. ¹⁵⁴The person to whom the bill is addressed (the drawee) signifies their assent to the bill by accepting the bill. ¹⁵⁵Such acceptance must be in writing and signed by the drawee. ¹⁵⁶Acceptance may be general or qualified. ¹⁵⁷A qualified acceptance varies the terms of the bill as drawn. ¹⁵⁸Non-acceptance of the bill by the drawee constitutes dishonour of the bill.¹⁵⁹

• 3.28    Bills of exchange are rarely encountered domestically, although one type of bill that has remained popular until relatively recently is the cheque.¹⁶⁰ In contrast to the domestic market, bills of exchange remain in widespread use in international trade.

• 3.29    A bill of exchange has three main characteristics. First, it can be transferred by delivery alone. The transferee will receive the same title to the sum of money specified in the bill that the transferor had. However, the transferee will receive better title than the transferor had if the bill is duly negotiated.¹⁶¹ Second, if the transferee is a “holder in due course”, ¹⁶²they take free from most defects in the title ¹⁶³of prior parties and from the defences against them.¹⁶⁴ Almost every holder of a bill of exchange is presumed to be a holder in due course. ¹⁶⁵Third, the transfer of a bill of exchange is valid without consideration.¹⁶⁶

• 3.30    A bill of exchange has three main functions. Bills of exchange are a means of payment in international trade.¹⁶⁷ They are also frequently used in trade finance where a party does not wish to pay a sum of money immediately. They are also evidence of a payment owed by the drawee to the relevant payee.¹⁶⁸

Promissory notes

• 3.31    A promissory note is an unconditional promise in writing, signed by the maker, to pay a sum of money to, or to the order of, a specified person or the bearer.¹⁶⁹ A promissory note differs from a bill of exchange in that the maker of the note, rather than a third party, is required to pay.¹⁷⁰ Like a bill of exchange, however, a promissory note is a negotiable instrument, ¹⁷¹or “document of title to money”.¹⁷²

• 3.32    Promissory notes may be transferred by indorsement and delivery or, if payable to bearer, by delivery alone. For the contract in a promissory note to be complete, the note must be delivered to the payee or bearer.¹⁷³

• 3.33    In international trade, promissory notes usually serve as security for instalments under medium or long-term credit transactions, ¹⁷⁴and are sometimes used in transactions covered by export credit guarantees.¹⁷⁵ In domestic trade, where the authors of Chitty on Contracts suggest they are more popular, promissory notes serve two main functions. ¹⁷⁶First, promissory notes issued by a debtor (such as a purchaser from whom the price of goods is due) can act as security for the discharge of a sum payable pursuant to an underlying contract. The creditor can bring an action to enforce the promissory note, and may prefer this action to suing on the underlying contract as the debtor cannot plead all the defences that would be available to them on an action under the contract.¹⁷⁷ Second, the holder of a promissory note can sell it at a discount (for example, to a financial institution) to raise finance.¹⁷⁸

Bills of lading

• 3.34    Bills of lading are documents used in the carriage of goods by sea. A carrier who transports goods will sign and issue a bill of lading to a shipper who wants the goods to be transported. ¹⁷⁹The bill will state that the carrier has received or loaded the goods delivered by the shipper. ¹⁸⁰They began as receipts for goods received by the carrier. A mercantile custom later developed whereby the bill of lading was used to transfer constructive possession of the goods while they were at sea and this custom became recognised by law. ¹⁸¹A bill of lading is not negotiable in the legal sense, but is transferable by indorsement (where necessary) and delivery. ¹⁸²Upon transfer of a bill of lading, the transferee acquires only those interests that the transferor had and does not take free from defects in the transferor’s title.¹⁸³

• 3.35    Under the law of England and Wales, bills of lading are governed by the Carriage of Goods by Sea Act 1971 (“COGSA 1971”), the Sale of Goods Act 1979, the Carriage of Goods by Sea Act 1992 (“COGSA 1992”) and the common law. COGSA 1971

implements the Hague-Visby Rules,¹⁸⁴ an international convention that applies to bills of lading and sets out requirements of form and content.¹⁸⁵ The Hague-Visby Rules do not say that a bill of lading must be in paper form, but the need to be able to possess the document, enshrined in section 5(2) of COGSA 1992, implies such a requirement.

• 3.36    Traditionally, bills of lading are said to have three functions. They are a receipt for the goods taken by the carrier, ¹⁸⁶evidence of the contract of carriage, ¹⁸⁷and a document of a title to the goods described in the bill.¹⁸⁸ Since a bill of lading is not negotiable in the strict legal sense, however, as mentioned above, the transferee obtains no better title to the goods than the transferor had.¹⁸⁹ Exceptions apply where the bill is transferred by a person who has previously sold the goods but remains in possession of the bill of lading. ¹⁹⁰Alternatively, by a person who has received the bill of lading having contracted to purchase the goods, even though that person has not yet acquired ownership of them.¹⁹¹ The transferee in these cases is required to receive the bill in good faith.

• 3.37    As mentioned above,¹⁹² a shipped bill of lading that is not marked “non-negotiable” is a document of title at common law. However, some bills of lading are not considered documents of title at common law, such as “straight” bills of lading. “Straight” bills of lading specify a named consignee to whom the goods are deliverable. The essential difference between order or bearer bills and straight bills is that the latter “either contain no words importing transferability or contain words negating transferability”.¹⁹³ A straight bill of lading is not a document of title at common law.¹⁹⁴ However, having possession of it, and being able to demonstrate that one is in possession of it, is an essential part of using it, because it must be surrendered by the named consignee when the latter claims delivery of the goods from the carrier. ¹⁹⁵Where the consignee is the buyer of the goods, and the bill of lading is issued to the seller (who has shipped them), possession of the bill of lading must be transferred to the consignee before the latter can claim delivery. In this sense, therefore, straight bills of lading are considered to be “a bill of lading or similar document of title” for the purposes of COGSA 1971.¹⁹⁶

• 3.38    Bills of lading are often issued in sets of three originals, each stating “any one of which being accomplished, the others shall be void”.¹⁹⁷ If the carrier delivers the goods against any one of the three originals, they are considered to have fully performed their obligations under the carriage contract and as bailee on terms. However, the practice of issuing bills of lading in sets has long been criticised by the courts because it has the potential to cause confusion and difficulty by separating title to the goods from possession of the bill. ¹⁹⁸Legal recognition that bills of lading are capable of being in electronic form may well reduce the need to issue them in triplicate and lead to a change of practice in this regard.

Ship’s delivery orders

• 3.39    A ship’s delivery order is issued typically by the holder of a bill of lading to the carrier to instruct them to deliver different parts of a bulk cargo to different persons, each one being named in a different delivery order. ¹⁹⁹If the delivery order is signed by (or on behalf of) the carrier and is made out “to order”, the right to claim delivery of the goods can be transferred to another person by indorsement and delivery of the delivery order.²⁰⁰ The transferee of a ship’s delivery order may claim from the carrier delivery of the goods to which that order relates,²⁰¹ although the order is not a document of title at common law. Transfer of a ship’s delivery order by valid indorsement and delivery will not give the transferee title to the goods at common law.²⁰² It will, however, confer on the transferee contractual rights against the carrier under COGSA 1992.²⁰³ It is also worth noting that a ship’s delivery order is considered to be a document of title by section 1(4) of the Factors Act 1889 (which governs the activity of mercantile agents, through which commercial goods are often sold) and section 61 of the Sale of Goods Act 1979.

• 3.40    As with a bill of lading, the assumption for a ship’s delivery order made out “to order” is that possession of it is key to claiming delivery from the carrier. Additionally, the existence of section 1(5) COGSA 1992 may imply that ship’s delivery orders must be in paper form, unless the Secretary of State exercises the power set out in that provision.²⁰⁴

Warehouse receipts

• 3.41    A warehouse receipt (also called a warehouse warrant ²⁰⁵or a warehouse-keeper’s certificate²⁰⁶) is a document issued by a warehouse keeper acknowledging that they hold the goods as “bailee” for the person to whom the receipt is issued (the “bailor”).

• 3.42    Warehouse receipts are not documents of title at common law, although the definition of “document of title” in the Factors Act 1889²⁰⁷ encompasses warehouse receipts,²⁰⁸ and they have been described by the courts as “effectively documents of title”. ²⁰⁹The transfer of a warehouse receipt will not give the transferee constructive possession of the goods.²¹⁰ However, warehouse receipts can be made out to a named person (the bailor) “or order”, making them transferable and required for the purpose of claiming delivery of the goods.²¹¹ Constructive possession may be transferred by attornment by the warehouse keeper to the indorsee. ²¹²Multipartite agreements may be entered into to enable this attornment to occur easily upon a transfer being effected.²¹³

Mate’s receipts

• 3.43    A mate’s receipt is a document issued by a shipowner when they receive a shipment of goods. It serves as an acknowledgment of receipt of the goods but also contains a description of the goods and states their order and condition. A mate’s receipt was described in Naviera Mogor SA v Society Metallurgique de Normandie (The Nogar Marin) as a “simple receipt”, ²¹⁴and in Kum v Wah Tat Bank Ltd as “not ordinarily anything more than evidence that the goods have been received on board”.²¹⁵ However, a mate’s receipt may later be presented to the shipowner in exchange for bills of lading ²¹⁶and so, in addition to its function as a receipt, can be good evidence of the contract of carriage before bills of lading are issued.²¹⁷

• 3.44    Possession is relevant to the function of a mate’s receipt if transferring it results in property in the shipped goods passing. The general position is that a mate’s receipt is not a document of title at common law,²¹⁸ although there is no reason in principle why a document of title should not be created by local custom, as was accepted by the Privy Council in Kum v Wah Tat Bank Ltd. ²¹⁹In the circumstances of that case, it was found to be a usage of the trade in Singapore that mate’s receipts were documents of title,²²⁰ although the usage did not apply to the particular documents issued in the case, which were marked as “non-negotiable”. ²²¹It should also be noted that mate’s receipts fall within the definition of “document of title” that applies for the purposes of section 61 of the Sale of Goods Act 1979 and section 1(4) of the Factors Act 1889.

• 3.45    A seller may retain a bill of lading until payment of the price of the goods to which it relates, and thereby retain property in the goods. ²²²By way of analogy, we consider that the terms of a mate’s receipt and the terms of the contract of sale may give rise to inferences that retention of that document may similarly prevent the passing of property even after the goods have been delivered by the carrier to the buyer.

Marine insurance policies

• 3.46    An insurance policy is a document issued by insurers that contains the terms of their contract with the insured person to compensate them for loss caused by a covered risk. The Marine Insurance Act 1906 (“MIA 1906”) applies to policies concerning “the losses incident to marine adventure”.²²³ The rights under such a policy may be assigned by assigning the document itself, ²²⁴which involves indorsing it and delivering it to the assignee. The case law suggests that indorsement may not be necessary unless expressly required by the document itself.²²⁵

• 3.47    In 2010, a joint issues paper published by the Law Commission of England and Wales and the Scottish Law Commission concluded that the MIA 1906 probably did not prevent a marine policy from being in electronic form. ²²⁶However, the authors of that paper were of the view that “the issue is not entirely beyond doubt”.²²⁷

Cargo insurance certificates

• 3.48    A cargo insurance certificate is evidence that a cargo is insured. If goods are being shipped under a cost, insurance, freight (“CIF”) contract, the seller must tender to the buyer a document demonstrating that insurance cover has been obtained, ²²⁸and often this document will be a cargo insurance certificate.

• 3.49    Certificates are assignable at common law.²²⁹ It appears that delivery of a certificate is sufficient to transfer the benefit of the insurance, unless the certificate expressly requires indorsement. ²³⁰Transferring cargo insurance certificates is effected in practice through (indorsement and) delivery of the paper document. An electronic cargo insurance certificate would therefore need to be capable of possession and delivery in order to be used in the same way as its paper counterpart.

HOW TRADE DOCUMENTS ARE USED IN PRACTICE

Use between buyers and sellers

• 3.50    As between buyers and sellers in cross-border sales of goods, the documents discussed above are mainly used to perform, or to evidence performance of, contractual obligations.

• 3.51    The contract of sale will often require the seller to load the goods on board a ship by a certain date, in a certain place and bound for a certain destination.²³¹ The contract may also specify the kind of sea-going vessel to be used for transportation. The seller can use a bill of lading, signed and issued by the carrier, to evidence that all these stipulations have been fulfilled. ²³²Similarly, the contract may require the seller to insure the goods in transit and the insurance document tendered by the seller to the buyer will provide evidence to the latter that this contractual term has been performed.²³³ Negotiable instruments can be used by the buyer to defer payment, giving the seller a liquid promise to pay that can be discounted before maturity.

• 3.52    If the contract is what is called a “documentary sale”, ²³⁴the seller will be required to tender certain documents to the buyer (including “a transport document” or “proof of insurance”). The specific type of document to be tendered will sometimes be named in the contract ²³⁵(for example, “a shipped bill of lading issued to order”). When documents are required to be tendered under the contract, obtaining the documents and tendering them to the buyer is itself required for the seller to perform the contract of sale, ²³⁶and the documents do not just provide evidence of performance.

• 3.53    As discussed above, documents of title to goods which give the holder constructive possession of the goods can be used by the seller to deliver the goods to the buyer under the contract of sale. ²³⁷In this sense, the document is being used to perform the delivery obligation under the contract of sale and a valid transfer of the document to the buyer is a key element of such performance.

Use by banks

• 3.54    Banks act as service-providers in international trade transactions by (i) processing payments, (ii) collecting documents for the buyer, and/or (iii) financing transactions. Banks perform these roles within a context of long-standing practice and usage, much of which has been codified in bodies of rules by the industry, mainly by the International Chamber of Commerce (“ICC”). These rules include the Uniform Rules for Collection, ²³⁸the Uniform Customs and Practices for Documentary Credits,²³⁹ and the International Standard Banking Practice.²⁴⁰ They become binding by their incorporation into contracts between relevant parties. These rules envisage the relevant documents being examined manually, whether they are in paper or electronic form, but supplemental rules have been adopted to provide for electronic presentation.²⁴¹ A more recent set of rules adopted by ICC, the Uniform Rules for Digital Trade Transactions, have moved away from the paper form entirely and envisage submission of electronic records rather than presentation of paper documents. They contemplate “control” of an electronic record as meeting a legal requirement for possession of a document.²⁴²

• 3.55    In practice, banks will expect to take possession of documents of title to the goods being traded, most commonly the bill of lading, for a number of reasons. In a documentary collection arrangement, they will simply be checking the documents’ compliance with agreed terms on behalf of the buyer. If they are financing the transaction, they may wish to take possession of the documents in order to obtain legal rights or entitlements. For example, if a bank obtains possession of a bill of lading pursuant to a valid transfer so as to become the holder, it effectively has a possessory security over the goods. In this case, the transfer of possession of the document to the bank is an essential element of transferring the document itself. As discussed below,²⁴³ merely being in possession of the document may not be enough to make the bank its holder and to give the bank constructive possession of the goods. Other elements (such as indorsement and acceptance by the bank) may also be required. However a transfer of possession remains essential.

• 3.56    However, it should be noted that banks may also wish to take possession of documents of title without also obtaining title to the goods. As Norton Rose observed in their consultation response:²⁴⁴

The ability for documents to be held to order, or indorsed in blank, is important in the trade finance world. Some banks do not wish to be named [sic] on bills of lading, fearful of potential liability (eg for environmental matters) but are happy to take possession of the documents (which does not transfer title to the goods) with the ability for the documents to be transferred to a third party on enforcement.

As discussed in the following chapters, our recommendations and the Bill are concerned with possession as a matter of fact (rather than being concerned with legal rights).

• 3.57    It is worth noting here that as a matter of industry practice, “full sets” of bills of lading are required to be submitted when a documentary presentation is made to a bank.²⁴⁵ This ensures that banks effectively obtain an assurance, in situations where multiple originals are issued, that nobody else may lawfully claim delivery of the cargo, whether the bank obtains title to the goods or not.

• 3.58    One final observation to be made about the ways in which banks use trade documents is in relation to the discounting of bills of exchange and promissory notes. Since these documents are negotiable instruments and embody unconditional undertakings to pay a certain sum of money, banks do not need to concern themselves with the underlying transaction pursuant to which the document was issued. This means that they can buy these documents at a discount from the holder, and claim the full amount from the obligor when the document matures. This facilitates the provision of liquidity to businesses involved in international trade.²⁴⁶

DELIVERY AND BEING A HOLDER

• 3.59    Putting the intended transferee in (physical) possession of the trade document is an essential step in transferring the document. However, a valid transfer of the document will require not only that the transferee receives possession of the document, but also that they accept the transfer. If a document is made out to order, indorsement will also be required. It is only once a valid transfer has taken place that the transferee becomes the document’s holder. For example, section 5(2)(b) of COGSA 1992 provides:

References in this Act to the holder of a bill of lading are references to any of the following persons, that is to say ... (b) a person with possession of the bill as a result of the completion, by delivery of the bill, of any indorsement of the bill or, in the case of a bearer bill, of any other transfer of the bill... .

• 3.60    A transferee who receives the document in good faith may also qualify as the document’s “lawful holder”,²⁴⁷ or “holder in due course”.²⁴⁸

• 3.61    A transfer of possession is therefore a necessary but insufficient condition for a valid transfer of the document to take place. “Delivery” of a trade document is defined in domestic law slightly differently for different purposes. As mentioned above, ²⁴⁹for the purposes of the Bills of Exchange Act 1882, delivery is defined as “transfer of possession, actual or constructive, from one person to another”. ²⁵⁰The Sale of Goods Act 1979 defines delivery as a “voluntary transfer of possession from one person to another”. ²⁵¹The Sale of Goods Act 1979 is not just concerned with the delivery of goods but also with the delivery of documents, including documents of title as therein defined.²⁵² For the purposes of section 5(2) of COGSA 1992, quoted above, ²⁵³the courts have held that:

completion of an indorsement by delivery requires the voluntary and unconditional transfer of possession by the holder to the indorsee and an unconditional acceptance by the indorsee.²⁵⁴

• 3.62    While these definitions differ, all of them require a transfer of possession. This transfer of possession will usually take place in performance of an underlying contractual obligation. For example, under a free on board (“FOB”) sale contract,²⁵⁵ the seller has the obligation of shipping the goods on board the vessel nominated by the buyer,²⁵⁶ thus obtaining the bill of lading which the seller then tenders to the buyer.²⁵⁷ In order to obtain payment under a documentary credit arrangement, a beneficiary (seller) must present to the bank documents that comply with the credit. These usually also include a document of title to the goods (the bill of lading) and an insurance document.²⁵⁸

• 3.63    However, such tender or presentation by itself is not enough for the transfer of the document to be completed. The Erin Schulte case provides that if one is in possession of a bill of lading without having accepted it, one is not the holder.²⁵⁹ The court essentially held that the language of section 5(2)(b) of COGSA 1992:

is inconsistent with the proposition that an indorsee in possession of the bill becomes the holder regardless of his wishes or of the circumstances in which that has come about.²⁶⁰

We discuss acceptance and rejection below.

Acceptance and rejection

• 3.64    It would appear that while, as indicated above, acceptance is necessary for a transfer of the document to be complete, it does not need to be explicit, and it does not require any action dependent on the document’s tangibility.

• 3.65    If one does not reject explicitly, that person may be presumed to have accepted. A lapse of time may be important, but no positive action appears to be required by the recipient to accept.²⁶¹ Therefore, there may be an interval of time when it is not clear whether the documents have been accepted or not, even though they are in the possession of the intended transferee.²⁶²

• 3.66    Rejection, on the other hand, must be explicit, although it may be accomplished by a simple notice. ²⁶³Return of the documents to the tenderer or presenter normally follows rejection.²⁶⁴ We have been told that in practice, banks rejecting documents for non-compliance can simply transfer physical possession of the documents back to the transferee (with any necessary indorsement).

Amendment and curing of errors

• 3.67    In general, paper documents can be amended by inserting an amendment in writing on the document. With documents of title, amendments to the document must be acceded to by the document’s issuer or accepter. Unilateral amendments by the person in possession of the document would be considered alterations that make the document void. Section 64(1) of the Bills of Exchange Act 1882 provides:

Where a bill or acceptance is materially altered without the assent of all parties liable on the bill, the bill is avoided except as against a party who has himself made, authorised, or assented to the alteration, and subsequent indorsers.

Provided that, where a bill has been materially altered, but the alteration is not apparent, and the bill is in the hands of a holder in due course, such holder may avail himself of the bill as if it had not been altered, and may enforce payment of it according to its original tenor.²⁶⁵

• 3.68    Thus, where the document contains an error, the issuer and/or accepter(s) of the document will need to be involved in correcting the error. In practice, correcting errors in a trade document may involve cancelling and reissuing the document with the correct information.²⁶⁶

Surrender and accomplishment

• 3.69    Once paper trade documents have served their purpose, they are considered spent. Bills of lading, for example, are usually stamped as “accomplished” and taken out of circulation, once the cargo is delivered. From that point, they no longer give the person in possession of them the right to claim the goods described in the document.²⁶⁷ The Bills of Exchnage Act 1882 Act provides for “discharge” of a bill including by payment, ²⁶⁸or cancellation, ²⁶⁹but does not require any particular process to be followed to mark the bill as discharged.

FURTHER CONSEQUENCES OF PAPER TRADE DOCUMENTS BEING CAPABLE OF POSSESSION

• 3.70    Possession is important not only in the context of the legal effect and functionality of trade documents, but also in other respects.²⁷⁰ If the law recognises that something is possessable, it is capable under the law of England and Wales of being the subject of, for example:

• (1)    bailment;

• (2)    possessory security interests; and

• (3)    wrongful interference (conversion).²⁷¹

We discuss each briefly below, including their relevance to paper trade documents.

Bailment

• 3.71    A bailment arises whenever one person (the bailee) takes voluntary possession of goods belonging to another (the bailor). ²⁷²The bailor (or their agent) must give actual or constructive possession (that is, the right to possession) ²⁷³of the thing bailed to the bailee.²⁷⁴ The bailor retains ownership²⁷⁵ of the thing, but wholly divests themselves of possession in favour of the bailee. ²⁷⁶The bailor also has a reversionary interest in the thing, ²⁷⁷which means that at the end of the bailment, the bailee must either return the thing ²⁷⁸to the bailor or deal with the thing as the bailor directs.²⁷⁹

• 3.72    The law of bailment applies to things in possession²⁸⁰ - that is, things which are capable of possession. ²⁸¹As a result of their special status, paper trade documents (including bills of lading) can be pledged under English law,²⁸² a pledge (discussed further below) being a type of bailment.

Security interests

• 3.73    Security can be taken over paper trade documents in various ways. The relevant securities can be possessory or non-possessory. ²⁸³As the name suggests, under a possessory security, the party taking security has possession of the subject of security. As such, only things that are possessable can be the subject of possessory security arrangements.

• 3.74    Pledges and liens are possessory securities which, unlike non-possessory securities such as charges, ²⁸⁴do not require registration to be perfected. Both are regularly used in international trade and trade finance. In addition, as discussed below, a security interest to which possession is relevant arises under section 39 of the Sale of Goods Act 1979.

Pledges

• 3.75    A pledge involves a debtor (the pledgor) transferring possession of the property serving as security to the creditor (the pledgee). ²⁸⁵It is therefore a type of bailment, as indicated above. The concept of pledge is particularly important in the international trade context. For example, in international sale transactions where the seller requires an undertaking from a bank as to payment, or where the buyer wants to obtain credit to finance the sale transaction, arrangements may be made for the seller to be paid through a bank that has given a personal undertaking to pay. This is often in the form of a letter of credit addressed to the seller as beneficiary. In these instances, the bank may require a pledge of the goods sold as collateral.²⁸⁶

• 3.76    If a bill of lading is pledged to a bank, the bank will hold a pledge over the goods that the bill describes because bills of lading are documents of title and give the holder constructive possession of the goods in respect of which they are issued. The transfer of possession of the bill of lading constitutes a pledge of the goods that it represents, as opposed to a transfer of the ownership of them, if it is made with the appropriate intention.²⁸⁷

• 3.77    Having taken a pledge over the goods, banks often release the bill of lading to the debtor/buyer of the goods to enable them to take delivery of the goods and sell them on in the course of business. They do this against a trust receipt.

A trust receipt or letter of trust is used where a bank-pledgee having possession of documents of title or actual or constructive possession of the goods, received from or on behalf of the owner, delivers them to the owner or to a third party, who undertakes to hold them and, if sold, the proceeds, in trust for the bank.²⁸⁸

• 3.78    By issuing a trust receipt, the debtor undertakes to hold the goods or the proceeds of their sale, in trust for the bank.

Liens

• 3.79    A lien is a right to retain possession of a thing until a claim or debt has been satisfied. Liens may arise by operation of law, by statute or under a contract between the parties.²⁸⁹

• 3.80    For example, under the MIA 1906, a marine insurance policy is capable of being the subject of a broker’s lien.²⁹⁰ In 2001, the Law Commission concluded that the nature of liens implied that a marine insurance policy must be in tangible form. ²⁹¹This was on the basis that, as a lien consists of a right to retain possession of goods, it cannot exist over intangible property.²⁹²

• 3.81    In 2010, however, the joint report of the Law Commission of England and Wales and the Scottish Law Commission instead concluded that, even if the broker’s lien was limited to tangibles, this did not mean that the marine policy must be in tangible form. This was because not all marine policies need to be subject to the broker’s lien.²⁹³ This argument is supported by the provision in the MIA 1906 for parties to dispense with the broker’s lien by agreement.²⁹⁴

Possessory security arising by operation of law

• 3.82    A security right involving possession can arise as a matter of statutory law under the Sale of Goods Act 1979. Section 39(1) provides that, notwithstanding that the property in the goods may have passed to the buyer, the unpaid seller of goods has various rights including a lien on the goods or right to retain them for the price while he is in possession of them.²⁹⁵ “Possession” under section 39(1)(a) includes constructive possession of the goods as holder of a bill of lading. Indeed, in order to retain the lien after having shipped the goods the seller must retain the right of disposal, ²⁹⁶usually through being the holder of the bill of lading or the person entitled to claim delivery under it.²⁹⁷ Section 41(2) provides that the seller may exercise the lien or right of retention notwithstanding that the seller is in possession of the goods as agent or bailee or custodier for the buyer.

• 3.83    Section 39(1)(b) also provides the unpaid seller, in the event of the buyer’s insolvency, with a right of stoppage in transit, if at this time the goods are still in transit to the buyer. Section 46(1) provides that:

the unpaid seller may exercise his right of stoppage in transit either by taking actual possession of the goods or by giving notice of his claim to the carrier or other bailee or custodier in whose possession the goods are.

• 3.84    Although it was not a case to which the Sale of Goods Act 1979 applied, in AP Moller Maersk AS (trading as Maersk Line) v Sonaec Villas Cen Sad Fadoul²⁹⁸ the unpaid seller recovered possession of the goods by requesting from the carrier cancellation of a straight bill of lading naming the buyer as consignee and the issue of one to the order of the seller in substitution. The contract of carriage in the bill of lading was governed by English law and the consignee sued in the English courts.

Conversion

• 3.85    When someone’s property is interfered with by another (for instance, when it is stolen, taken without their permission or destroyed), they can sue in the tort of conversion. This is the law of England and Wales’ primary means of protecting interests in personal property. As discussed in Chapter 5, OBG Ltd v Allan confirmed that, under the current law, there can only be a claim in conversion in respect of things capable of being possessed.²⁹⁹

• 3.86    Interference with a paper trade document can give rise to an action in conversion.³⁰⁰ Importantly, though, the damages available will be calculated based on the value of the obligation embodied by the document, rather than on the (negligible) value of the piece of paper itself.³⁰¹

Chapter 4: Recommendations - the types of documents covered by our recommended reforms

• 4.1    In the previous chapter, we explained the concept of “trade documents” generally, their legal status, the relevance of possession and how they are used in practice. In this chapter, we make recommendations as to the trade documents which we consider should be captured by our recommended reforms. We explain that we have developed our thinking since the consultation paper based on consultees’ responses and, in particular, why we now recommend a general “umbrella” provision as well as a specific list of documents.

OUR PROVISIONAL PROPOSALS IN THE CONSULTATION PAPER

• 4.2    In our consultation paper, we provisionally proposed that our reforms should apply to a defined list of documents, which we labelled “trade documents”. We provisionally proposed that that list should cover bills of exchange, promissory notes, bills of lading, ship’s delivery orders, marine insurance policies, cargo insurance certificates and warehouse receipts.³⁰⁷ This list was set out at clause 1(2) of the consultation Bill.

• 4.3    We provisionally proposed to include an exhaustive list of documents for two reasons. First, to provide certainty for users of the legislation. Second, because as explained in Chapter 3 of this report, not all of the documents which we wish to capture have precisely the same legal character, although possession is an important part of how they all function.

• 4.4    We did not include documents such as sea waybills and air waybills in our provisional proposals. While these documents are used in shipping and trade finance, they do not require possession to fulfil their legal and commercial functions.³⁰⁸ We also did not include bearer bonds, or other documents such as banker’s drafts, traveller’s cheques, and dividend warrants. Our discussions with stakeholders suggested that their legitimate commercial use has diminished, and there is no need for them to be made electronic.³⁰⁹

• 4.5    We acknowledged that, in the future, evolving trade practices may warrant a variation of the categories of document included in this list. We provisionally proposed, therefore, that the Secretary of State should have the power to vary the list by adding, removing, or amending an entry.

Consultees’ views

General approach

• 4.6    Some consultees commented specifically that they approved of our provisional proposals. Dr Simone Lamont-Black, for example, considered that using a list was a

• ³⁰⁷    Consultation paper, para 3.18.

• ³⁰⁸    Consultation paper, from para 3.66.

• ³⁰⁹    Consultation paper, from para 3.71.

“very attractive” proposal and “eliminates other lengthy discussions and the need for slow development via case-law of what may fall within”. However, Dr Lamont-Black also made suggestions for additional documents to be included, particularly multimodal bills of lading.³⁰²

• 4.7    The majority of consultees agreed with the list of documents in clause 1(2). Bolero International Ltd, for example, said “[i]n the context of facilitation these documents are most commonly used”.

• 4.8    Other consultees raised concerns that our provisional proposals were insufficiently flexible, in that they resulted in the Bill being applicable only to a closed list of document types. For example, Dr Jenny Jingbo Zhang and Dr Liang Zhao suggested that the Bill should adopt a broader approach:

As long as the criteria for electronic documents in the Bill are met and the substantive law recognises their paper counterparty as a document of title to transfer constructive possession of goods or monetary commitments, they should fall into the scope of this Bill. The explanatory note for the Bill can certainly provide an indicative list of documents to guide the practice.

• 4.9    Linklaters LLP also noted that not all of the documents in the proposed list “have the same legal status in relation to the rights that they represent”. They gave the example of a bill of exchange (a “negotiable instrument”), a bill of lading (which is “not negotiable in the full sense”), and a warehouse receipt (which they considered “sometimes constituting a document of title and sometimes not”). They also suggested that the list should provide for the possibility of evolution through the law merchant, rather than being added to by means of a statutory instrument.

• 4.10    Professor Christian Twigg-Flesner, answering “other”, considered our provisional proposals to be workable in practice. However, he suggested that it might be preferable to adopt an approach closer to the MLETR, which would involve including a non-exhaustive list of documents in a schedule to the Bill. Professor Twigg-Flesner considered that this approach was preferable for “future-proofing” purposes and avoiding the delays of using the power to make delegated legislation.

Sea and air waybills

• 4.11    Most consultees agreed that sea and air waybills need not be included. ³⁰³A small number of consultees considered that they should be included. For example, the London Maritime Arbitrators Association said that the Bill should cover all three documents covered in the Carriage of Goods by Sea Act 1992 (that is, bills of lading, sea waybills and delivery orders) “for consistency”.

• 4.12    WAVE BL considered that sea waybills should be included so as to “encourage the market adoption and transforming to the digital world”, as well as to make the law of

England and Wales as competitive with other jurisdictions that had recognised electronic sea waybills.

Bearer bonds and other documents of title

• 4.13    In the consultation paper, we provisionally proposed:

that bearer bonds and other documents of title including banker’s drafts, certificates of deposit payable to bearer, bearer scrip certificates exchangeable for shares, mate’s receipts, traveller’s cheques, and dividend warrants need not and should not be included.

We asked consultees if they agreed, and a majority did.³⁰⁴

• 4.14    Minerva Global Ltd said that “[w]e do not have a need for those electronic documents at the moment”. The Law Society of Scotland agreed, so long as the documents included were intended to be confined to those used in relation to trade in goods, and the City of London Law Society (“CLLS”) said that confining the scope of the reforms in this way was the correct policy.

• 4.15    Two consultees argued strongly in favour of including bearer bonds: the International Capital Market Services Association (“ICMSA”) and International Capital Market Association. The ICMSA said that definitive bearer bonds have “virtually disappeared in terms of new issuance of bonds”,³⁰⁵ but that global bearer bonds, ³⁰⁶“as a valid form of immobilisation, represent a significant portion of the overall current volumes in the international market”. They said that around 40% of the total individual securities held in global form are bearer bonds, and that physically storing global bearer bonds was “unsustainable” and caused “operational inefficiencies”.

• 4.16    The CLLS, in contrast, said that bearer bonds in particular should be excluded, as there were “existing regulatory requirements” in place such that “these forms of instrument are [not] suitable for the proposed treatment”. They made the further point that bearer bonds:

are already capable of being safely, efficiently and effectively dealt with electronically and inclusion in these schemes would simply cause anomalies and confusion.

• 4.17    Some consultees (including Norton Rose Fulbright, the Institute of International Shipping and Trade Law at Swansea University (“IISTL”), and Dr Lamont-Black) suggested a relatively wide range of other documents that should be added to the list.

These include bills of exchange, CMR consignment notes, certificates of origin, bank guarantees, stand by letters of credit, powers of attorney, freight forwarder’s certificates of receipt, warehouse warrants, multimodal transport bills of lading, health certificates and other certificates presented to customs.

• 4.18    The Digital Container Shipping Association (“DCSA”), answering “other”, recognised that the documents listed were “the most important and urgent documents to be included in the draft Bill”. However, they expressed concern that these documents “cannot be fully separated from waybills, consignment notes or other forms of contracts of carriage”, as the latter documents were “an integral part of the sets of documents needed to move and trade goods in an international environment”. DCSA worried that their exclusion would indicate that “only part of the needed documentation can be digital”, leading to a “slower uptake of digital documentation and efforts to digitalise the listed documents might be lost”. DCSA considered it should remain possible for these documents, at least, to be included at a later stage.

POTENTIAL RISK OF ACCIDENTALLY CREATING DOCUMENTARY INTANGIBLES

Our position in the consultation paper

• 4.19    In our initial discussions with stakeholders, a small number asked whether our provisional proposals could risk allowing some of the legal doctrines associated with bills of exchange to permeate into other types of commercial transactions. This concern arose because the statutory definition of a bill of exchange is potentially capable of being met by a diverse range of electronic payment instructions. It was suggested to us that a number of electronic records that parties do not intend to be bills of exchange would, in fact, be regarded by the law as that type of document as a result of our reforms. This would make them subject to the provisions of the Bills of Exchange Act 1882.

• 4.20    In the consultation paper, we said we did not think that our provisional proposals would create any additional risk that documents which are not intended to be documentary intangibles would become so by virtue of the Bill. We did not propose any changes to the content or form of the relevant trade documents, nor to their function.

Consultees’ views

• 4.21    Most consultees did not think that our provisional proposals for reform created an additional risk that documents which are not intended to be documentary intangibles will become so by virtue of the Bill.³⁰⁷ As the Centre for Commercial Law at the University of Aberdeen observed, the proposals “do not attempt to change the nature of a document”, but instead “introduce the possibility of having an electronic format of it functionally equivalent to its paper format”. A few consultees raised concerns, however.

• 4.22    Dr Jenny Jingbo Zhang and Dr Liang Zhao were concerned that our provisional proposals would blur the boundary between what they regarded as true documentary intangibles and documents that embody mere contractual rights and potential proprietary rights.

• 4.23    The CLLS expressed a concern that, under our Bill, documents that are not connected with trade in goods will become treated as if they were. For example, they observed that bills of exchange and promissory notes have different uses in the financial markets and may be dealt with under the arrangements applicable to eligible debt securities set out in the Uncertificated Securities (Amendment) (Eligible Debt Securities) Regulations 2003.

Discussion

• 4.24    In the consultation paper, we defined a “documentary intangible” as a document that is recognised in law as embodying the right of which it is also evidence.³⁰⁸ Taking into consideration the comments raised by Dr Zhang and Dr Zhao, in this report we have sought to emphasise that what is important is the fact that transfer of possession of all of the documents with which we are concerned can result in a transfer of rights. We have therefore minimised our use of the term “documentary intangibles”, as we can see that this caused concern among consultees.

• 4.25    We do not consider that our recommendations create a risk that does not already exist for paper documents. We do not recommend any changes to the content or form of the relevant trade documents, or to their function. Indeed, we recommend that a trade document in electronic form must contain all the information that would be required to be contained in a paper equivalent.³⁰⁹

• 4.26    The extent to which our recommendations impinge on the different uses of such documents outside the context of international trade, and certain modifications to our provisional proposals to avoid affecting those different uses, are considered below.³¹⁰

OUR RECOMMENDATIONS

• 4.27    Having considered these concerns, we have revised the provision on the scope of the Bill. We no longer suggest an exhaustive list of documents. Rather, we recommend that the scoping provision should include:

• (1)    an “umbrella” provision;

• (2)   a non-exhaustive list of documents; and

• (3)    an exclusion for certain documents.

• 4.28    We explain our revised approach below.

General approach

• 4.29    As seen above, several consultees expressed concerns that the provisionally proposed list of “trade documents” was too narrow, as any document of a type not listed would be automatically excluded. They indicated that certain documents, the functioning of which depended to some extent on possession, were not listed despite being subject to the same legal blocker as the documents originally included in our proposed list.

• 4.30    Some consultees made arguments about the desirability of having a more expansive approach such as that adopted in the MLETR. Article 2 of the MLETR provides as follows:

“Transferable document or instrument” means a document or instrument issued on paper that entitles the holder to claim the performance of the obligation indicated in the document or instrument and to transfer the right to performance of the obligation indicated in the document or instrument through the transfer of that document or instrument.

• 4.31    Our further research confirmed that our provisionally proposed list of documents excluded certain documents, possession of which may be relevant in certain circumstances to claim performance of an obligation, even though that relevance is not always clear-cut. While we do not go through each in turn in this report, since a comprehensive list may in any case be impossible, we accept that any fixed list risks excluding documents possession of which is or may sometimes be relevant. In the case of warehouse receipts and ship’s delivery orders, some, but not all, of these documents operate as transferable documents. As we acknowledged in the consultation paper, the way they are made out and the context in which they are used can be crucial to the determination of the question of whether possession matters. The relevance of possession in each case will depend on the express statements included in the document. This applies equally to mate’s receipts, which were excluded from our proposed list.

• 4.32    Some consultees suggested that we should list only “true documentary intangibles” at common law. This would include bills of exchange, promissory notes and bills of lading, possession of which is relevant as a matter of law to claim performance of an obligation.³¹¹ Historically, for example, “a custom of merchants” developed whereby a bill of lading was used to transfer constructive possession of the goods while they were at sea, and this custom became recognised by law.³¹² However, for some documents (such as warehouse receipts) while similar custom may not be recognised at law, possession may be relevant as a matter of commercial practice. ³¹³Although they are not strictly speaking documents of title at common law, possession of these documents remains relevant to the determination of legal rights as a matter of commercial practice. ³¹⁴For example, in the context of warehouse receipts, it has been noted that:

At common law, warehouse receipts are not treated as negotiable documents of title (unlike bills of lading). However, though not in itself conferring possession of the goods on the holder, possession of a warehouse receipt in effect gives the holder the right to possession of the goods.³¹⁵

• 4.33    For some of these documents, the relevance of possession is recognised in statute, in that they fall within the definition of “document of title” in section 61 of the Sale of Goods Act 1979 and section 1(4) of the Factors Act 1889. Our research suggests that the legal blocker prevents these documents from being used in electronic form in the same way as they would be used in paper form.³¹⁶ While these documents are not necessarily capable of precise legal categorisation, we do not think that is a reason to exclude them. If we did not take this opportunity, such documents could be left in a limbo. In this respect, we take a pragmatic rather than purist approach. Our approach was supported by consultees who approved of the list of documents, including the IISTL, Professor Djakhongir Saidov, the British Insurance Law Association, and industry stakeholders.³¹⁷

• 4.34    Indeed, other consultees suggested that we should be much more inclusive in our approach and include all documents used in trade. These consultees were concerned that concentrating on a sub-category of documents could suggest that other documents, which are already used in electronic form, are not in fact legally valid. We do not agree that we should adopt this approach. Our recommended reforms are aimed at documents which rely on possession in order to fulfil their legal and commercial functions, and are irrelevant to documents that are already able to function in electronic form. These documents are and should be unaffected by our recommended reforms. Our recommended reforms set out certain criteria intended to ensure that documents which rely on possession are susceptible to a particular type of control when issued in electronic form, which would make them capable of being possessed as a matter of fact. It is unnecessary for documents that do not rely on possession to meet these criteria. We wish to avoid a situation where documents which can already be used in electronic form become subject to these additional burdens. Our recommendations and the Bill should not be taken to suggest that, for example, sea waybills, air waybills, customs documents or certificates of origin, quantity or quality cannot be used in electronic form unless they meet these criteria. These documents are already routinely digitalised.

• 4.35    We have therefore revised our approach based on the following two propositions.

• (1)    Our recommendations and the Bill should cover only those documents in relation to which possession is relevant for a person to claim performance of an obligation. In practice, we think it is likely that this obligation will be set out in or referred to in the document.

• (2)    The approach should be sufficiently broad such that any paper document used in trade to which possession is relevant (as a matter of law or commercial practice) for a person to claim performance of an obligation can have the same effect in electronic form.

• 4.36    We consider that the best way to do this is to adopt an “umbrella” provision to extend application of the recommended reforms to any document possession of which is relevant for a person to claim performance of an obligation. We consider that this addresses consultees’ concerns that we might otherwise inadvertently exclude particular documents.

• 4.37    That said, we think that including a list of specific documents that function on the basis of possession and which we know to be routinely used in trade is beneficial, as it will provide industry with the certainty that was desired by consultees. Intended to be used in combination with the umbrella provision, this list is illustrative rather than exhaustive.

An “umbrella” provision

• 4.38    As we noted above and in Chapter 3, not all of the documents encompassed by our recommended reforms are capable of legal categorisation by use of a single term such as “document of title” or “negotiable instrument”. This was one of the reasons in the consultation paper for not proposing a general definition. ³¹⁸In particular, straight bills of lading, warehouse receipts and ship's delivery orders are not documents of title at common law, but possession is an important part of how they function. It is our intention (subject to certain specific exceptions) that any document to which possession is relevant for a person to claim performance of an obligation should be caught, regardless of its precise legal or commercial nature. Accordingly, we recommend that the reforms and Bill should cover all documents, possession of which is relevant as a matter of law, custom and/or practice, to the determination of rights and entitlements.

• 4.39    We have considered whether the scope of such an umbrella provision should be limited by the use of expressions such as “documents used in trade (and trade finance)”, given that this industry is the focus of our recommendations. However, these expressions do not have any precise definition and we consider that their inclusion in legislation could lead to unnecessary uncertainty. A phrase such as documents “in commercial use” is unlikely to add anything of substance because all the relevant documents are, almost exclusively, commercial in nature.³¹⁹ We do not, therefore, recommend a qualification of this nature. Instead, we think that certain types of document should be explicitly excluded, and we discuss this below.

• 4.40    Our recommendations may, therefore, be used to enable the digitalisation of documents that are not routinely used in trade and not among those discussed in Chapter 3, but which are not specifically excluded. The recommended reforms are intended to be facilitative, not mandatory, so users of such documents would not be forced to switch from paper if they or their industry do not wish to do so. However, where electronic documents would be beneficial for the relevant users, our recommendations as to the criteria that such documents must satisfy in order to be possessable will ensure that the same legal effects can be achieved if the document is used in electronic form.

A non-exhaustive list

• 4.41    While recommending a broad umbrella provision, we nevertheless consider that we should also retain a list of specific documents, albeit non-exhaustive. Consultees said that such a list of documents would provide certainty with respect to key documents in widespread use.

• 4.42    We recommend that the list should contain all the documents listed in the consultation paper, with the addition of one further document: mate’s receipts. We recommend including mate’s receipts because, like ship’s delivery orders and warehouse receipts, they are explicitly mentioned in the definition of “document of title” that applies for the purposes of the Sale of Goods Act 1979 and the Factors Act 1889. ³²⁰Therefore, for statutory purposes, possession of mate’s receipts can have certain legal consequences. Additionally, a number of consultees indicated that they should be included. We discuss mate’s receipts in more detail in Chapter 3.

• 4.43    There are other documents, for example, consignment notes, that we have not included within the list because our research yielded no evidence that these rely on possession for the purposes of law. However, they would be covered by the umbrella provision if there were circumstances in practice where they need to be possessed in order to function effectively.

• 4.44    We continue to think that possession is not relevant to sea and air waybills, and our research shows that these documents are already used in electronic form with no difficulty. We do not therefore recommend including them in the list. However, if possession were ever relevant to them, they would be captured by the umbrella provision. We hope that this will satisfy consultees who were of the view that such documents should be included for completeness.

• 4.45    Since possession is only relevant to some of the documents in our list in certain circumstances, we consider that a document which falls within the list should only be caught by our recommendations if possession is required for a person to claim performance of an obligation. That is, the non-exhaustive list should be subject to the umbrella provision.

Recommendation 3.

• 4.46    Subject to certain explicit exclusions, legislation should make provision to allow for electronic forms of trade documents, possession of which is required as a matter of law or commercial practice for a person to claim performance of the relevant obligation, to be treated in law as equivalent to their paper counterparts.

Recommendation 4.

• 4.47    Legislation should specifically allow for the following documents to be used in electronic form, provided that possession is required as a matter of law or commercial practice for a person to claim performance of an obligation:

• (1)    bills of exchange;

• (2)   promissory notes;

• (3)    bills of lading;

• (4)    ship’s delivery orders;

• (5)    warehouse receipts;

• (6)    mate’s receipts;

• (7)   marine insurance policies; and

• (8)    cargo insurance certificates.

The Bill provisions

• 4.48    The overall effect of the Bill is to provide that a trade document in electronic form is capable of being possessed if it meets certain criteria. A document that satisfies these criteria is an “electronic trade document” within the meaning of the Bill.

• 4.49    The first criterion relates to the types of trade documents which, when in electronic form, can qualify as electronic trade documents. Clause 1 defines the documents in paper form which, under our recommendations, should be equally capable of taking electronic form.

• 4.50    Clause 1 provides for the definition of a “paper trade document” as:

• (1)    A document is a “paper trade document” for the purposes of this Act if —

• (a)    it is in paper form, and

• (b)    possession of the document is required as a matter of law or commercial custom, usage or practice for a person to claim performance of an obligation.

• (2)    The following are examples of documents that, if they fall within subsection (1), will be paper trade documents —

• (a)   a bill of exchange;

• (b)   a promissory note;

• (c)    a bill of lading;

• (d)   a ship’s delivery order;

• (e)   a warehouse receipt;

• (f)    a mate’s receipt;

• (g)   a marine insurance policy; and

• (h)    a cargo insurance certificate.

  • 4.51    The reference to “paper trade documents” excludes bare legal rights such as debts.³²¹ Note that clause 1(1)(b) deliberately avoids the use of the word “entitles” which features in the equivalent MLETR provision. This is because, as explained above, our definition is intended to include not just documents possession of which is significant as a matter of law, but also documents which are not documents of title for all legal purposes. We think that “entitles” might narrow the definition unnecessarily by suggesting that the document must be a document of title or negotiable instrument for all legal purposes in order to be included.

Exclusions

• 4.52    We consider it important also to exclude certain types of documents that may otherwise be caught by our recommendations and the scope of the Bill. This is for two reasons. First, the way in which negotiable instruments are defined in the law of England and Wales may have the unintended effect of extending the application of our recommendations to documents which should not be included, as they are already provided for separately in specialist legislation. Second, the fact that we now recommend an umbrella provision necessarily means that our recommendations and the Bill may capture documents that are not explicitly listed. We think there are some documents which, while arguably falling within the scope of the umbrella provision, are better dealt with separately rather than in legislation intended principally to apply to documents used in international trade.

Instruments entered under a relevant system

• 4.53    The first type of instruments we recommend should be excluded explicitly from our recommendations are instruments which are entered under a “relevant system” under the Uncertificated Securities Regulations 2001 (“USRs”). ³²²In their response to the consultation, the CLLS said that bills of exchange and promissory notes “have uses in the financial markets outside of the field of international trade in goods”. In particular, the CLLS said that:

certain instruments which are technically of these types are used in the money markets and may be dealt with under the arrangements created for “eligible debt securities” by the Uncertificated Securities (Amendment) (Eligible Debt Securities) Regulations 2003.

• 4.54    The “money market” is “the unsecured deposit market, including the issue of, and trading in, certificates of deposits and commercial paper”. ³²³It is a market which deals with short-term investments. Commercial paper is a type of debt security and is “a promissory note issued by a large corporation or financial institution usually for a short period but cannot be issued for longer than 364 days”.³²⁴

• 4.55    Commercial paper may be issued in the same way as bonds (discussed below in relation to bearer bonds). ³²⁵Most commercial paper are ³²⁶issued as bearer instruments, which are then held physically by a common depository. ³²⁷Entitlements to a share or unit of a bond are maintained on an electronic register.

• 4.56    The USRs provide the legal regulatory framework for securities (such as shares) held and transferred in electronic “book entry” form. ³²⁸Securities which are held on CREST, an electronic register, must comply with the USRs. These regulations also apply to certain debt securities following amendment by the Uncertificated Securities (Amendment) (Eligible Debt Securities) Regulations 2003.³²⁹ They define “eligible debt security” in regulation 3 as:

a security that satisfies the following conditions —

• (i)    the security is constituted by an order, promise, engagement or acknowledgement to pay on demand, or at a determinable future time, a sum in money to, or to the order of, the holder of one or more units of the security; and

• (ii ) the current terms of issue of the security provide that its units may only be held in uncertificated form and title to them may only be transferred by means of a relevant system;

• 4.57    Section 83(1) of the Bills of Exchange Act 1882 defines “promissory note” as:

an unconditional promise in writing made by one person to another signed by the maker, engaging to pay, on demand or at a fixed or determinable future time, a sum certain in money, to, or to the order of, a specified person or to bearer.

• 4.58    Therefore, commercial paper (which is technically a promissory note) may meet the requirements of both regulation 3(i) and fall within our umbrella provision.³³⁰ Depending on whether the other requirements are met, two statutory regimes in relation to electronic instruments could apply.

• 4.59    We have considered whether this could cause problems in practice. On balance, we think that it would be pertinent to exclude the application of the Bill to instruments entered in a “relevant system” under the USRs, in order to avoid potential confusion. We have not consulted on the application of the Bill to such instruments and their inclusion could cause issues for the special procedure given that at least one stakeholder has concerns.

Recommendation 5.

• 4.60    Instruments entered in a “relevant system” under the Uncertificated Securities Regulations 2001 should be excluded from the scope of legislation allowing for trade documents in electronic form.

The Bill provisions

• 4.61    Clause 5(1) and 5(2)(b) exclude instruments entered in a “relevant system” under the Uncertificated Securities Regulation 2001 from the scope of the Bill. They provide:

• (1)    Sections 1 to 4 of this Act do not apply in relation to a document or instrument listed in subsection (2).

• (2)    The list is as follows —

• (b) an uncertificated unit of a security that is transferable by means of a relevant system in accordance with the Uncertificated Securities Regulations 2001 (S.I. 2001/3755).

• 4.62    Clauses (or, once implemented, sections) 1 to 4 are the operative clauses of the Bill.

Bearer bonds

• 4.63    The second type of instrument which we recommend that the Bill should exclude from its application is bearer bonds, which otherwise may fall within the new umbrella definition of “trade documents”. The reason for excluding this document type is that it is used in the financial markets and not in trade.

• 4.64    The majority of consultees said that bearer bonds should not be within the scope of the Bill. Although some consultees argued strongly that they should be included,³³¹ we think that bearer bonds are better dealt with in the Law Commission’s general digital assets project.

• 4.65    As we discuss above in relation to commercial paper, bearer bonds are usually issued as a global bond in paper form which is held physically by a common depository. Entitlements to a share or unit of a bond are then maintained on an electronic register.

• 4.66    We have considered whether excluding instruments entered under a “relevant system” under the USRs would necessarily exclude all bearer bonds. Although bearer bonds may be covered by the USRs, to the extent that they are not, we do not think that they should come under the Bill (in contrast with, for example, promissory notes).³³²

• 4.67    We also took into account the fact that the MLETR similarly excludes instruments that are mainly used for the purposes of finance and investment. Article 1(3) of the MLETR provides:

This Law does not apply to securities, such as shares and bonds, and other investment instruments ... .

• 4.68    This exclusion would seem to cover both instruments covered by the USRs and bearer bonds. However, we considered that using the word “securities” might give rise to uncertainty in the English law context. For example, section 14 of the Banking Act 2009 defines “securities” as including “any other instrument creating or acknowledging a debt” which we thought might be too broad for our purposes, as it would seem to include bills of exchange and promissory notes.

Recommendation 6.

• 4.69    Bearer bonds should be excluded from the scope of legislation allowing for trade documents in electronic form.

The Bill provisions

• 4.70    Clause 5(1) and 5(2)(a) exclude bearer bonds from the scope of the Bill. They provide:

• (1)    Sections 1 to 4 of this Act do not apply in relation to a document or instrument listed in subsection (2).

• (2)    The list is as follows —

• (a) a bearer bond ... .

POWER TO ADD, REMOVE OR AMEND AN ENTRY IN THE LIST OF DOCUMENTS

• 4.71    In the consultation paper, we acknowledged that in the future, evolving trade practices may warrant a variation of the categories of document included by virtue of what was, under our provisional proposals, an exhaustive list. We therefore provisionally proposed that the Secretary of State should have the power to vary the list by adding, removing, or amending an entry in the list. Although consultees generally agreed with this provisional proposal, the same reasoning no longer applies. Given that we now recommend a non-exhaustive list with a general umbrella provision, we no longer consider that such a power is required.

• 4.72    However, we do consider that a power is needed to allow for the exclusions to be added to, removed from, or otherwise amended in future. For example, the Uncertificated Securities Regulations 2001 may be amended, necessitating consequential amendments to the exception provision in the Bill. The power could also be used to remove the exclusion of bearer bonds from the scope of the reforms if this was considered desirable at a future point.

• 4.73    More generally, it may be determined that some documents which fall within the umbrella provision require more bespoke provisions to allow for their digitalisation, or that they should not be capable of being used in electronic form. We have not identified any such documents beyond those for which we have already recommended exclusions. However, given that the Bill could lead to a significant change in practice for certain types of documents, we think it is important that the legislation includes a power to make further carve-outs if it proves necessary or desirable. We recommend that any secondary legislation laid pursuant to such a power should be subject to the affirmative rather than negative parliamentary procedure.

Recommendation 7.

• 4.74    Legislation should contain a power to make secondary legislation, subject to the affirmative procedure, to add to, remove from, or otherwise amend the list of documents which are excluded from the scope of the Bill.

The Bill provisions

• 4.75    Clauses 5(3), (4) and (5) of the Bill provide:

• (3)    The Secretary of State may by regulations made by statutory instrument add, remove or amend an entry in the list in subsection (2).

• (4)    Regulations under this section may make incidental, consequential, transitional or saving provision.

• (5)    A statutory instrument containing regulations under this section may not be made unless a draft of the instrument has been laid before and approved by a resolution of each House of Parliament.

• Chapter 5: Current law - possession

• 5.1    The subject matter of this report and the Bill is documents whose functionality depends on their being possessed, whether as a matter of law or commercial practice. ³³³As explained briefly in Chapter 2, the law of England and Wales - like that of many other significant trade jurisdictions around the world - does not recognise intangible things as being amenable to possession. This means that electronic documents, which are considered to be intangible, cannot be possessed and therefore cannot presently function in the same way as their paper counterparts. We refer to this as the “possession problem”.

• 5.2    In this chapter, we explain the possession problem in detail. We trace its origins and explain the consequences for the type of documents with which we are concerned. We then provide a summary of the complex area of possession in the law, identifying elements which we think can be extrapolated to electronic trade documents. In Chapter 7, we explain our recommendations for expanding possession to electronic trade documents.

CATEGORIES OF PROPERTY: THE DISTINCTION BETWEEN “THINGS IN ACTION” AND “THINGS IN POSSESSION”

• 5.3    Property can be divided into two categories: real property (interests in land) and personal property. Personal property is further divided, at least traditionally, into:

• (1)   things in possession; and

• (2)    things in action.

As we will see below, things in possession and things in action are susceptible to different types of legal treatment.

• 5.4    The concept of possession has long been used as a proxy to distinguish between claims that were enforceable only against a particular party (in personam), and those which were enforceable against the whole world (in rem), the former giving rise to personal rights and the latter to proprietary rights. A bare personal right has no independent form and exists only insofar as it is recognised by a legal system as a claim against a specified person (hence “in personam”). This means that its presence in the world is dependent upon there being both a party against whom it can be claimed and a legal system willing to recognise the claim. Such claims are categorised as “things in action”. A “thing in action”, at least traditionally, describes any personal property that can only be claimed or enforced through a court action.³³⁴ Common

examples of “things in action” are debts, rights to sue for breach of contract, and shares in a company.

• 5.5    A proprietary right, by contrast, applies in relation to a thing that has an existence of its own, independent of any individual or claim. Such things are categorised as “things in possession”. The distinctive feature of things in possession, and what sets them apart from things in action, is that they exist regardless of whether anyone lays claim to them, and regardless of whether any legal system recognises such claims. Under the current law, a “thing in possession” is any object which the law considers capable of possession.³³⁵ This category includes assets which are “tangible, moveable and visible and of which possession can be taken”.³³⁶ An example of this is a bag of gold: possession of a bag of gold gives its possessor a property right which is good against the whole world. ³³⁷A paper trade document is a thing in possession.³³⁸

• 5.6    Whilst a bag of gold is obviously tangible, a contractual right is obviously intangible. Until relatively recently, this tangible/intangible dichotomy tracked precisely the distinction between those things that have an independent existence and those that are bare rights, dependent for their existence on legal recognition and enforcement. It is perhaps not surprising, then, that, over time, tangibility became synonymous with the former, and intangibility with the latter. At a time when most personal property was tangible in form, “tangible” was a description capable in its own right of discriminating between those things which had an independent existence and those which did not.

• 5.7    To some extent, this distinction between tangible things and everything else makes sense. If a person has possession of a tangible object such as a bag of gold or a paper trade document, they are generally in physical control of it by, for example, holding it in their hand. For larger objects, such as goods in a warehouse, it could be sufficient physically to control the key to the warehouse in order factually to possess everything inside.³³⁹ An intangible object, however, cannot be physically possessed in this way, and at first glance this may justify a difference in legal treatment. It is factually possible for someone to interfere with tangible property, by grabbing the piece of paper or other item from a person’s hand, or breaking into the warehouse and stealing its contents. By contrast, because a thing in action (as traditionally defined) has no existence independent of legal persons or systems, such interference is not factually possible; the thing itself is not separable from the person who holds it.

• 5.8    In Colonial Bank v Whinney, Lord Justice Fry said: “all personal things are either in possession or action. The law knows no tertium quid [“third thing”] between the two”. ³⁴⁰As a result, the current law assumes that all objects must fall within one or other of the two categories. ³⁴¹As discussed below, the courts have held that intangibles cannot be things in possession. ³⁴²This means that the category of things in action, perhaps necessarily, has been described as something of a residual category encompassing everything that is not a thing in possession.³⁴³

• 5.9   Tangibility has therefore been elevated from a description of those things historically

amenable to possession into a necessary criterion for the law’s recognition of amenability to possession. The authors of The Law of Personal Property argue that the distinction between things in possession and things in action has become, as a matter of practice, a distinction between tangible and intangible property.³⁴⁴

• 5.10    Although not currently capable of being possessed as a matter of law, an electronic document exists as a matter of fact, regardless of the recognition given to it by any legal system, and regardless of whether anyone lays a claim to it. Certain types of electronic document and other digital assets may be susceptible to similar types of control, and to similar means of interference, as tangible objects. They are things over which parties have rights, rather than being bare rights in themselves. The same cannot be said of a debt or of a right to sue. The question therefore arises as to whether the legal distinction between things in action and things in possession is sustainable in all cases, merely on the basis that the former cannot be physically possessed. A further question is whether electronic documents and other digital assets can properly be said to be things in action.

• 5.11    Some recent judgments have recognised a potential third category of property, such as Armstrong v Winnington, which held that EU carbon emission allowances could be characterised as “other intangible property”, distinct from a thing in action or thing in possession.³⁴⁵ We also note that, in the recent case of AA v Persons Unknown, the High Court of England and Wales said that “[cryptocurrencies] are neither [things] in possession nor are they [things] in action”.³⁴⁶ Nonetheless, in that case, the court held that cryptocurrencies were a form of property.³⁴⁷ It is sufficient for current purposes to recognise that electronic trade documents cannot, under the current law, be things in possession.

• 5.12    This can be seen from two main cases.

Key cases

• 5.13    The leading authority is the 2007 case of OBG Ltd v Allan.³⁴⁸ In this case, the House of Lords considered whether an action in the tort of conversion could lie where the relevant property was intangible (on the facts, a set of contractual rights). The court (by a three to two majority) ruled that no such action could lie, because a conversion is an interference with possession and intangibles cannot be possessed. The bare contractual rights in question were deemed to be classic things in action. However, the case did not concern digital property, and so the court was not asked to consider the nature of such property. Neither did the court address the question of whether assets in digital form could be possessed, regardless of the fact that they are regarded as intangible.

• 5.14    That issue did, however, come before the Court of Appeal in Your Response Ltd v Datateam Business Media Ltd (“Your Response”).³⁴⁹ The relevant question was whether a possessory lien, a form of security which requires the holder of the security to be in physical possession of the secured property, could be exercised over an electronic database. The question of whether an intangible (digital) asset could be possessed was therefore central to the outcome of the case.

• 5.15    Lord Justice Moore-Bick considered the following questions:

What at common law is understood by actual possession, whether it is possible to have actual possession of an intangible thing, whether it is open to this court to recognise the existence of a possessory lien over intangible property and if so, whether it would be right for it to do so.³⁵⁰

• 5.16    The key question was therefore whether the intangible property could be “possessed”. Lord Justice Moore-Bick found, following OBG Ltd v Allan, that it could not.

• 5.17    In particular, he rejected Your Response Ltd’s argument that the database was a form of intangible property different from a thing in action, and the consequential argument that the reasoning in OBG Ltd v Allan therefore did not apply:

In my view that decision makes it very difficult to accept that the common law recognises the existence of intangible property other than [things] in action (apart from patents, which are subject to statutory classification), but even if it does, the decision in OBG Ltd v Allan prevents us from holding that property of that kind is amenable of possession so that wrongful interference can constitute the tort of conversion. It follows, in my view, that it is equally not amenable to the exercise of a possessory lien.³⁵¹

• 5.18    Lord Justice Moore-Bick recognised that this and other arguments made by Your Response Ltd:

owed a debt to a scholarly volume entitled The Tort of Conversion, in which Sarah Green³⁵² and John Randall QC make a powerful case for recognising that the essential elements of possession can be exercised over digitised materials, of which a database is a prime example. ³⁵³

• 5.19    However, his Lordship did not feel able to take this step judicially, saying that it would:

involve a significant departure from the existing law in a way that is inconsistent with the decision in OBG v Allan. That course is not open to us - indeed, it may now have to await the intervention of Parliament.³⁵⁴

• 5.20    The current relationship between personal property, possession, and tangibility in the common law can therefore be summarised as follows:

• (1)    in order to be possessed, something must be deemed to be a thing in possession; and

• (2)    in order to be a thing in possession, something must be tangible.

• 5.21    The decision in OBG Ltd v Allan is perhaps unsurprising given that, on the facts, the thing in question was a bare contractual right, as opposed to a digital asset with an existence independent of persons or the legal system. However, the decision has the effect of excluding all intangible property from the category of things in possession. As a result, the Court of Appeal in Your Response (being bound by OBG Ltd v Allan) was not able to consider arguments that digitised material, while intangible, also has features that make it in some senses comparable to a tangible object.

• 5.22    In our consultation paper, we suggested that the court in OBG Ltd v Allan might have been more inclined to make a modest expansion to conversion, or to the concept of possession generally, to cover electronic versions of certain trade documents. We described this hypothetical expansion as modest because the law already recognises documents in paper form as belonging to a special category of property. ³⁵⁵We think there is a strong case for this expansion, and it forms the basis of our recommendations for reform. However, as the current law stands, intangible assets, including trade documents in electronic form, are not possessable.

Consequences of the current law

• 5.23    Whatever the nature of the relationship that may exist between a person and an electronic document, the law does not currently recognise it as "possession". Possession is not necessarily synonymous with ownership; a person can be in possession of an object that is owned by someone else. For example, if A borrows a car from B, A is in possession of the car while B remains the owner. While the possessor is not necessarily an owner, possession can nevertheless have significant consequences in determining the legal relationship between the possessor and the thing possessed ³⁵⁶and, as such, amounts to a very valuable interest.

• 5.24    Under the law of England and Wales, the recognition that something can be possessed as a matter of law determines much about the legal treatment that it subsequently receives, and has implications for the legal functionality and treatment of different forms of property. Things which cannot be possessed are excluded from a range of commercially useful legal concepts.

• 5.25    Critically for our purposes, the documents with which we are concerned depend on possessability for their basic functionality. However, electronic versions of trade documents currently cannot be used in the same way as their paper counterparts to embody an obligation. For example, unlike its paper counterpart, an electronic document:

• (1)    cannot, as a matter of property law, be delivered or held. For example, a party cannot be the “holder” of such a document for the purposes of statutory provisions, such as section 29 of the Bills of Exchange Act 1882;³⁵⁷

• (2)    cannot be negotiable instruments or documents of title, either at law or under statute, and therefore cannot derive the benefits associated with these documents, as set out in Chapter 3;

• (3)    cannot be the subject of a possessory security;

• (4)    cannot be bailed; and

• (5)    cannot be protected by the property torts such as conversion (nor by the special rule concerning the measure of damages for interference with a document embodying a debt or obligation).

POSSESSION BEYOND TANGIBILITY

• 5.26    In the consultation paper, we considered two key questions.

• (1)    What are the salient properties of physical things which make them possessable as a matter of law?

• (2)    How can those properties be extrapolated to electronic trade documents?

We consider the first of these questions in this chapter. We look at how the concepts can be extended to electronic trade documents in Chapter 7.

• 5.27    In order to consider how the concept of possession could be extended to certain electronic documents, an obvious place to start is to consider what possession “means” and how it is established. Unfortunately, this is not straightforward. As Earl Jowitt has observed, “in truth the English law has never worked out a completely logical and exhaustive definition of ‘possession’”.³⁵⁸ It is used in a range of legal contexts, including in statute,³⁵⁹ and is sometimes qualified or forms part of a legal fiction (as in the case of constructive possession, discussed below). In most case law in which possession is a relevant issue, it is considered a matter to be proved by evidence as it is fundamentally a factual question. There is, therefore, not as much case law directly analysing the legal principles underlying possession as one might expect for such a foundational concept.

The core case of possession

• 5.28    It is important to make clear that we are concerned with the “core case” of possession (sometimes called “actual” or “de facto” possession), which is a factual relationship between a person and an object, and from which certain legal consequences follow.³⁶⁰ This is because our recommendations are aimed at enabling trade documents in electronic form to function in the same way as their paper counterparts. To achieve this, we need to identify the criteria that they must fulfil so as to be capable of possession in fact, and then ensure that such possessability is recognised in law. We do not wish to affect in any way the existing legal consequences of possessing a trade document.

• 5.29    As we discuss below, the law on “actual” possession (which in this report we generally refer to as “possession”) indicates that, in order to be possessable, a thing must be capable of exclusive control, which is a matter of fact. Establishing whether a person is in possession of a thing may, however, require the examination of rights rather than, or in addition to, facts. That is, one may have possession of a thing as a matter of law albeit not in fact. We discuss this type of “legal” or “constructive” possession below for completeness, as it is relevant to electronic trade documents. However, our recommendations and the Bill are concerned directly with possession as a matter of fact.

• 5.30    Possession as the factual relationship between a thing and a person is made up of two parts - an exclusive control element and an intention element.³⁶¹ In respect of a paper trade document or any other tangible object, it is not enough merely to be in physical possession of it or to have the means to control it.

• 5.31    In the recent case of The Manchester Ship Canal Co Ltd v Vauxhall Motors Ltd (“MSCC”), the Supreme Court endorsed the following statement of the law:

There are two elements to the concept of possession: (1) a sufficient degree of physical custody and control (“factual possession”); (2) an intention to exercise such custody and control on one's own behalf and for one's own benefit (“intention to possess”). What amounts to a sufficient degree of physical custody and control will depend on the nature of the relevant subject matter and the manner in which that subject matter is commonly enjoyed. The existence of an intention to possess is to be objectively ascertained and will usually be deduced from the acts carried out by the putative possessor.³⁶²

• 5.32    MSCC was a case about real property (land) rather than personal property. However, the statement is nevertheless helpful for identifying the elements of possession, being factual custody and control, and an intention to exercise such custody and control, both objectively assessed. Similar descriptions of possession comprising these two elements appear in a number of personal property cases.³⁶³

• 5.33    In general, then, the law will deem a person to have acquired possession of a paper trade document or other object when they have a sufficient level and type of control over it, and when this control is accompanied by the requisite intention.³⁶⁴

The first element of possession: control

• 5.34    The first element of possession requires a person to exhibit a certain type of control over the relevant object of property.³⁶⁵ Such control must be “exclusive”, although it can be consensually shared or “joint”.³⁶⁶ In other words, “exclusive” possession does not necessarily mean “singular” possession (in other words, possession by a single person). Exclusivity describes the nature of the relationship between persons and a thing; not its extent. In addition, possession does not need to be unassailable: common law title is relative and not absolute, as discussed further below.

• 5.35    As Pollock and Wright observed, in their seminal work on possession in the common law:

Exclusive occupation or control, in the sense of a real unqualified power to exclude others, is nowhere to be found. All physical security is finite and qualified. ³⁶⁷

• 5.36    In MSCC, all members of the Supreme Court agreed that a person in possession has “a sufficient degree of physical custody and control” over the relevant object of property.³⁶⁸

• 5.37    Although this formulation refers to “physical” control, the nature of the relevant control will correspond to the nature of the property in question. It must be judged against “the nature of the relevant subject matter and the manner in which that subject matter is commonly enjoyed”.³⁶⁹

• 5.38    For land, the relevant type of control will be physical control. In J A Pye (Oxford) Ltd v Graham, ³⁷⁰for example, the farming land in question was enclosed by hedges and accessible only through a padlocked gate.³⁷¹ The key was held by the defendants and so the land was “within their exclusive physical control”. ³⁷²This can be contrasted with the decision in Red House Farms (Thorndon) Ltd v Catchpole. ³⁷³In this case, a possessor’s control of a piece of land was rooted in the fact that they had regularly shot at birds over the land for a number of years, and had determined when others could do the same. This somewhat unusual factual basis was found to be sufficient because:

what constitutes possession of any particular piece of land must depend upon the nature of the land and what it is capable of use for .. the only profitable use of this land was for shooting.³⁷⁴

• 5.39    For tangible chattels, the relevant type of control will also be physical control, and each case will similarly turn on its facts. The way that control is exerted over a small object such as a paper trade document will be different from they way that control is exerted over larger objects. This is borne out in the case law. In Parker v British Airways Board, for example, Parker found a gold bracelet on the floor, picked it up, and then handed it over to an official in British Airways’ lost property department.³⁷⁵ These acts were sufficient to constitute control.³⁷⁶

• 5.40    In contrast, some objects are less amenable than a bracelet or piece of paper to being held in one’s hand, and control becomes more than a matter of tactile contact. In The Tubantia, for example, the relevant object was the wreck of a Dutch steamship which had sunk to the bottom of the North Sea. ³⁷⁷Work on the wreck was rendered intermittent by the depth to which the vessel had sunk, as well as by adverse weather conditions and changing tidal patterns. Nevertheless, the claimant salvage company was found to have the level of control necessary for possession. This was grounded in the fact that the claimant had worked on the wreck when conditions permitted, placed buoys to mark the wreck’s position, and kept vessels and divers at the site of the wreck both to work upon it and to prevent any opportunistic “new-comers” (competitors) from doing work upon it.³⁷⁸

• 5.41    One may also have possession of a something which is locked in a safe or a warehouse, for example, by having the key to the safe or warehouse, rather than having the thing in one’s immediate physical possession.³⁷⁹

• 5.42    Not all objects are amenable to the same types of control. Pollock and Wright say that:

it is not possible, as a matter of fact, to possess a house, a wood, or a field in the same manner as we possess money in our pockets, or the owner of a cart and horse possesses them when he is driving the horse in the cart. There can only be a more or less discontinuous series of acts of dominion. What kinds of acts, and how many, can be accepted as proof of exclusive use, must depend to a great extent on the manner in which the particular kind of property is commonly used.³⁸⁰

• 5.43    Similarly, Rostill, writing much more recently, says:

what counts as effectively determining how a thing is dealt with depends, in part, upon the nature of the thing, for divergent things admit of different forms and degrees of control.³⁸¹

• 5.44    Importantly, as we sought to draw out in our consultation paper, the fact that control is object-sensitive does not mean that there are not overarching themes that apply across different types of property. Those that emerge as the most salient to the assessment of exclusive control are the ability to access and use the object, judged against the nature of the particular object under consideration (including the way in which that type of object is commonly dealt with). As we said in the consultation paper and explain in the following chapters, we think that electronic trade documents that meet certain criteria can be susceptible to control according to the same standards. Lady Justice Arden (as she then was) in Mainline Private Hire Ltd v Nolan said of the relevant object (in this case, a Peugeot taxi):

It is common ground that, to have possession of land or a chattel, a person must have ... the requisite degree of actual custody and control.³⁸²

• 5.45    The reference to “actual” rather than “physical” control allows this test to be read as a more universal concept, not reliant on tangibility. ³⁸³It also makes clear that control is factual or conduct-based, rather than based on the rights or claims a person has to the relevant object.

The second element of possession: intention

• 5.46    Control is a necessary condition for possession. However, it is not sufficient on its own. For possession, that control must also be accompanied by the requisite intention,³⁸⁴ being “intention to exercise such custody and control on one’s own behalf and for one’s benefit”. ³⁸⁵This intention is referred to in older authorities as the “animus possidendi”. ³⁸⁶In J A Pye (Oxford) Ltd,³⁸⁷ the House of Lords approved the description given by Slade J in the earlier case of Powell v McFarlane:

the animus possidendi involves the intention, in one’s own name and on one’s own behalf, to exclude the world at large ... so far as is reasonably practicable and so far as the processes of the law allow.³⁸⁸

• 5.47    A possessor does not have to demonstrate an intention to own the relevant paper trade document or other object; a person’s intention to possess can co-exist with the knowledge that there is a person with a better title to the object. Additionally, intention is, like control, a question of fact that, in the event of dispute, falls to be proved by the party asserting possession. Intention is demonstrated by way of inference from facts about the world, including a person’s actions and, in particular, those actions through which a person satisfies the control element of the test. ³⁸⁹Intention can also be passive in the sense that a person can be deemed to have the requisite intention, for example, to possess everything in a particular drawer, safe or warehouse.³⁹⁰

• 5.48    The question of intention is less dependent on the nature of the thing compared to the question of what amounts to control. The existence of intention is perhaps also less likely to be disputed; however, debates as to intention do arise³⁹¹ and, if challenged, intention would have to be demonstrated in order for possession to be established.³⁹²

• 5.49    When a person has exclusive control over something, and the requisite intention towards it, the law will deem them to have acquired possession of it. The next issue is how possession is lost.

Losing possession of an object - dispossession and abandonment

• 5.50    In J A Pye (Oxford) Ltd v Graham, Lord Hope stated that:

Once possession has begun ... possession is presumed to continue. But it can be transferred from one person to another, and it can also be lost when it is given up or discontinued.³⁹³

• 5.51    The law therefore recognises two ways in which possession can be lost:³⁹⁴

• (1)    dispossession, which includes both (a) consensual delivery from one person to another, and (b) non-consensual taking by one person from another; and

• (2)    deliberate abandonment.

• 5.52    Thus, a possessor remains in possession of a paper trade document or other object until they give it away, have it taken away, or throw it away. Again, this is to say nothing about the transfer of a person’s legal interests in the object - here, we are concerned only with the factual state of affairs.

• 5.53    Once a person has acquired possession of an object, they need not continually retain the same degree of control over it in order to remain in possession. As possession can only be lost as a matter of law in one of the two ways outlined above, “once the requisite degree of control [over an object] has been established, it is unnecessary to prove its continuance”. ³⁹⁵The discussion of this point in The Law of Personal Property is worth quoting at length:

It has been observed that the law of possession is concerned primarily with its acquisition or loss, and not retention. Once acquired, a person with possession will readily be assumed as a matter of law to have retained his possessory interest. Oliver Wendell Holmes stressed that once acquired possession is easily retained: “the general tendency of our law is to favour appropriation. It abhors the absence of proprietary or possessory rights as a kind of vacuum”. Holmes went on to give the example of [a] finder of a purse of gold leaving it unattended in a remote and unsecure country house. Nonetheless until a burglar takes active steps to take the purse it remains in possession of the finder. Sir Frederick Pollock went a stage further, instancing the careless banker who leaves the bank “open and unguarded”. Nonetheless the banker remains in possession of the cash and securities.³⁹⁶

• 5.54    Having now considered the core case of possession, we look briefly at a number of related terms which may be relevant to electronic trade documents if they are amenable, as a matter of law, to being possessed as a matter of fact. Possession is a complex area and it is beyond the scope of this report to cover it in detail. Instead, we highlight the key issues that we think will be important to the use of electronic trade documents. We talk in this chapter about the general law as it applies now to paper trade documents and other objects. In the following chapters, when explaining our recommendations, we touch on how these concepts could apply to electronic trade documents. Below, we generally refer to “objects”, which includes paper trade documents.

Other concepts of possession

Joint possession

• 5.55    Whilst control of a paper trade document or other object needs to be exclusive, the law recognises that possession can be consensually shared between a group of persons acting in concert. ³⁹⁷As Professor Sheehan explains, although “adverse claimants cannot share possession”, parties acting as a group can. ³⁹⁸Two or more people will acquire possession jointly when, together, they exercise exclusive control over an object and when they have a common intention to exercise that exclusive control in both their names.³⁹⁹

Custody and vicarious possession

• 5.56    When a person has exclusive control of an object, but is not in possession of it, they are said to have merely “custody” of the object.⁴⁰⁰ This occurs in three situations: (a) where a person has exclusive control without the requisite intention; ⁴⁰¹(b) where a person has exclusive control but an intention to exercise that control in someone else’s name ⁴⁰²(“vicarious possession”⁴⁰³); and (c) where a person has exclusive control and the requisite intention, but acquires the object in the course of their employment or agency⁴⁰⁴ (a second form of “vicarious possession”⁴⁰⁵).

The right to possession (legal possession / constructive possession)

• 5.57    This is a particularly significant issue for our purposes. It is important to distinguish between: (a) a person in possession of an object; and (b) a person with the (unconditional) right to possession of an object. A person with an unconditional right to possession is often said to have “legal possession” or “constructive possession” of the object.⁴⁰⁶ Professor Sheehan explains this as follows:

A party is either in possession or at law entitled to possession. Alongside actual possession the right to take immediate possession, otherwise referred to as constructive possession, also counts as possessory title. Such rights to possession may be created by contract. My right as a bailee to possess the asset may be, and usually is, founded in contract. An example of this might be the right of a warehouseman to retain possession of assets belonging to his clients and stored in the warehouse.⁴⁰⁷

This distinction is important in circumstances where one person has (actual) possession of an object, but another person has a (better) right to possession of it.

• 5.58    Often, a person in possession and a person with the right to possession will be one and the same. This is because the legal interest acquired by the act of independently taking possession includes a right to possession, so that someone who independently acquires actual possession of an object thereby acquires legal possession of it.⁴⁰⁸ Additionally, although this legal interest is generated by taking possession, it does not depend upon a person remaining in possession - that is, it is not extinguished when someone is dispossessed. This right is normally transferred as part of any transfer of an object (for example, by way of gift). This is why “a person in legal possession will usually be in actual possession”.⁴⁰⁹

• 5.59    However, Bob could take possession of a cup in circumstances where Alice nevertheless retains the right to possession of the cup because, for example, the goods are held to her order on terms that she can have re-delivery at once. ⁴¹⁰In this case, Alice will have constructive possession of the goods but will not be in (actual) possession.⁴¹¹ A useful way to identify the person with legal or constructive possession is to look for the person with “the ultimate right to decide who has the factual use of the asset at a given time”.⁴¹² For this reason, a term bailor does not have constructive possession during the term of the bailment, ⁴¹³because the bailor does not have the right to take back the bailed property during this time. ⁴¹⁴It is only once the term bailment comes to an end that the bailor regains the right to possession, and so once more has legal or constructive possession. Similarly, the right to possession is not retained by a pledgor in a security arrangement; indeed, this would defeat the purpose of such an arrangement.

• 5.60    What is important about legal or constructive possession is not (actual) possession, but the right to (actual) possession. Legal possession is therefore a “rights-based”, rather than a “facts-based”, concept,⁴¹⁵ unlike the core case of possession with which our recommendations and Bill are directly concerned. That said, if our recommendations are implemented such that electronic trade documents will be amenable to (factual) possession, then the concept of legal or constructive possession will apply in the same way as it currently does in relation to paper documents.

• 5.61    We understand that similar issues arise in Scots law, but the language is different. In Scots law, possession can either be natural or civil. Natural possession arises where a party has actual physical possession of an item. Civil possession arises where a party does not physically hold an item, but the item is held on their behalf by another party. To give some examples, an employer may possess goods which are in the custody of their servants, or a landlord may possess a house, although it is lived in by their tenant.⁴¹⁶

Vindicatory possession

• 5.62    The concept of possession plays an important role in the various means by which the law protects objects of property against unlawful interference. A person will have standing to bring a claim in trespass or conversion, for example, only if they have either possession or the right to (immediate) possession of the relevant object.

• 5.63    In this context, some writers use the additional label of “vindicatory possession” to encompass the two (sub-) types of possession that can give a person standing to bring such a claim: that is, (actual) possession and constructive possession (meaning the right to possession).⁴¹⁷ In fact, it might be more accurate, and perhaps less confusing for our purposes, to note simply that a party can bring a claim in trespass or conversion if their possessory right is superior to the defendant’s.⁴¹⁸

Competing claims to an object: relativity of title and hard cases of possession

• 5.64    The law is frequently required to deal with competing claims to an object of property. We distinguish between two types of situations that can be said to involve “competing claims”:

• (1)   multiple concurrent interests: situations where the law must rank competing

interests in an object; and

• (2)    hard cases of possession: situations where it is unclear which (if any) parties have an interest in an object, and the law must adjudicate the parties’ “competing claims” to different interests.

Multiple concurrent interests

• 5.65    The law of England and Wales employs a system of relative title. This means that the law recognises that different persons can, at the same time, have different titles to the same object,⁴¹⁹ and that the law has rules to rank these concurrent titles.⁴²⁰ In theory, all possible titles to an object could be ranked but, in practice, when disputes are litigated, the court will generally only concern itself with which of the two parties before it has the better title.⁴²¹

• 5.66    For things in possession, including paper trade documents and other objects, the priority rule for concurrent titles is straightforward: a title created earlier in time is stronger (that is, it ranks higher) than a title created later in time. ⁴²²The rule is the same for titles to things in action: an earlier title takes priority over a later title.⁴²³

• 5.67    The term “ownership” is often used to designate the best interest in an object that exists, and the person with the best interest in an object is accordingly described as the object’s owner.⁴²⁴

Hard cases of possession

• 5.68    This final section focuses on the following categories of factually complicated possession cases.

• (1)    Has a person acquired possession of an object?

• (2)    Does a person retain possession of an object?

• (3)    What is transferred and at what moment in time does a change of possession occur?

• 5.69    We discuss each question briefly, but the answer in any given situation will be highly fact-specific. The important point for our purposes is that the courts have mechanisms by which to consider these matters, and would have analogies to draw on if faced with questions in the context of electronic trade documents - including cases and circumstances that involved paper trade documents. We discuss possession of electronic trade documents in Chapter 7.

Has a person acquired possession of an object?

• 5.70    The question of whether a particular person has acquired possession of a particular object is an entirely fact-sensitive question. As we have explained above, it will depend on the nature of the object and the surrounding circumstances. Essentially, a person in possession will be the person who enjoys a “sufficient” level of exclusive factual control over the object; they can determine where it is in the world at any given moment in time, and when and how it is dealt with. ⁴²⁵The fact that the required level of control is a “sufficient level” means that possession is to some extent a question of policy. The law identifies what, for a particular type of object, is sufficient.

• 5.71    Imagine a lost wallet on a table surrounded by Alice, Bob, and Caroline, each of whom wants it. While the wallet is on the table, it is difficult to say that any one of them is in possession. If Caroline reaches out and takes the wallet, it seems reasonable to say that she has taken possession of it (assuming she has the requisite intention in relation to it). If so, the type of control to which the wallet is amenable is being grasped in one’s hands and put in one’s pocket or bag. Thus, if Caroline does this - thereby preventing Alice and Bob from doing the same - she will be exercising the sort of exclusive control over it that, when combined with the requisite intention, can amount to possession.

• 5.72    Suppose instead that the wallet is locked in a safe. It seems fairly uncontroversial to say that, in most cases, the person who has put it in there and who has the key or knows the passcode has possession of the wallet, particularly if there is only one key (or nobody else knows the passcode).⁴²⁶

Does a person retain possession of an object?

• 5.73    Where matters become more complicated is when a person is in possession of an object, and another person acquires the very same means of accessing and dealing with that object. In the tangible world, this could be the case where another person has, for example, a copy of the relevant key, or knowledge of the code for a safe. In such a case the question becomes: does the possessor remain in possession? We have seen above that the possessor remains in possession until they abandon the object, or are dispossessed of it. In the scenario under consideration, the possessor has neither abandoned the object nor have they been dispossessed of it. They therefore remain in possession unless and until the third party uses the means of access to exercise control of the asset, at which point the third party takes (actual) possession of the object (assuming they have the requisite intention). However, in doing so, the third party does not, without more, usurp the original possessor’s right to possession.⁴²⁷

What is transferred and at what moment in time does a change of possession occur?

• 5.74    When an object of property is intentionally transferred, the transferee normally acquires the transferor’s title. Conversely, when an object of property is subject to an unauthorised transfer, the transferee (who we will assume has taken possession of the object) acquires instead an original legal interest which is relatively weaker than the transferor’s subsisting interest.

• 5.75    There are also ancillary questions about the moment in time at which a person acquires possession. A person can take possession of an object despite not initially knowing of its existence - for intsance, where a person exercises control over an area and has an intention to exercise control over objects that end up in that area from time to time. ⁴²⁸For example, if Alice sets up a mailbox outside her front door, her intention to possess whatever is put in the mailbox can be inferred, even though she might not know what is in there. This analogy might also apply to a person that exercises control over digital assets associated with a particular public address - the purpose of creating and using a public address (and related private key) being to enable the exercise of control in the first place. We discuss this in relation to electronic trade documents in Chapter 7.

Chapter 6: Recommendations - the “gateway” criteria

• 6.1    In the previous chapter, we considered the current law on possession. We explained that things which are currently possessable are susceptible to exclusive control which can be transferred from person to person. In this chapter, we introduce the first part of our recommendations for reform to solve the “possession problem” for trade documents in electronic form.⁴²⁹ We examine the requirements that such a document must satisfy in order to qualify as an “electronic trade document” for the purposes of the Bill. We consider that trade documents in electronic form that satisfy these criteria are capable of performing the same functions as their paper counterparts. These requirements - including amenability to exclusive control and divestibility - are referred to as the “gateway criteria”. In the next chapter, we explain our recommendations to make electronic trade documents (those that satisfy the gateway criteria) “possessable”, and discuss what that would mean in practice.

THE “GATEWAY” CRITERIA

• 6.2    The starting point for our approach has been the following question: what requirements must trade documents in electronic form satisfy to be considered capable of performing the same functions as their paper counterparts? Below we discuss each of the “gateway criteria” that a document in electronic form must satisfy in order to qualify as an “electronic trade document” for the purposes of our recommendations and the Bill.⁴³⁰

• 6.3    If the gateway criteria are not satisfied, the trade document in question would not qualify as an electronic trade document for the purposes of the Bill. This does not, however, necessarily mean that the document has no validity or effect, nor that underlying transactions executed pursuant to it are invalid or null and void. The parties could nonetheless agree, as they currently do, that a particular action taken over an electronic system will put the transferee in a similar position to that of a holder of a paper trade document. ⁴³¹Outside of such a specific contractual arrangement, however, the electronic document would not be able to have the same legal effect, or function in the same way as, a paper trade document. As discussed above, ⁴³²the existing law of England and Wales does not permit the possessability of trade documents in electronic form.

FIRST CRITERION: THE INFORMATION CONTAINED IN AN ELECTRONIC TRADE DOCUMENT, AND THE MEANING OF “DOCUMENT"

• 6.4    Some paper trade documents which fall within our recommendations have requirements as to the information they must contain in order to qualify as that trade document. ⁴³³These requirements may derive from statute, the common law, or custom or practice.

The information contained in an electronic trade document

Our position in the consultation paper

• 6.5    In the consultation paper,⁴³⁴ we provisionally proposed that information required to be contained in a paper trade document must also be contained in any electronic form of such documents for them to fall within the scope of the Bill. We said this requirement was important to ensure that electronic trade documents were treated in the same way as their paper counterparts. We also noted that this provision establishes the link between the document in electronic form and its paper counterpart. It entails that, for example, not every electronic payment instruction will suddenly become a bill of exchange and subject to the requirements of the Bills of Exchange Act 1882.⁴³⁵ An electronic promissory note would need to include an unconditional promise to pay the bearer a sum certain in money in order to fall within the scope of the Bill.⁴³⁶

• 6.6    Our provisional proposal was also consistent with the approach in the MLETR, which provides that an electronic record must contain the information that would be required to be contained in a transferable document or instrument.⁴³⁷

• 6.7    We asked consultees if they agreed that there should be a statutory requirement that trade documents in electronic form must contain the same information as would be required to be contained in a paper equivalent.⁴³⁸

Consultees’ views

• 6.8    The majority of consultees who responded to this question agreed with our provisional proposals. For example, Enigio Time AB strongly agreed with our proposal, saying that this is “an absolute requirement for electronic trade documents to be accepted widely”.

• 6.9    Some consultees, including the British Insurance Law Association (“BILA”), Dr Simone Lamont-Black and Dr David Gibbs-Kneller, said that such a requirement would provide certainty. For example, BILA said that our provisional proposals “will bring certainty, will ease the transition period and will increase the efficiency in adapting to the new system”. Dr Lamont-Black said that our proposals “will ensure that all legal requirements will be met by the electronic document and that this can be established easily”. The Centre for Commercial Law at the University of Aberdeen noted that our provisional proposals will enable a change of medium.

• 6.10    Professor Michael Bridge QC said that there was no reason to exclude the information that is essential to paper trade documents. However, he noted that certain types of trade documents are “highly variable as to content”. He said that the question of whether the Bill deals with “nominate type of document or, generically, with all purportedly transferable documents” is relevant.

• 6.11    While there was general support for this requirement, some consultees queried whether it was essential. Linklaters LLP asked whether documents in electronic form need to contain “precisely the same information as would be required to be contained in a paper equivalent” in order to qualify as electronic trade documents. Legal Innovation Ltd said such a requirement was not necessary, so long as “all the information that a buyer/financier needs” is included in the document in electronic form.

• 6.12    Rio Tinto Commercial provided a detailed response, discussing what is meant by “information” in the context of electronic trade documents and smart contracts. They assumed that “information” meant “all information including both data points [such as “quantity of goods”] and legal verbiage/text which would be included in a paper document”. They said:

We note that this would tend to exclude smart contracts ... as being taken to be one of the electronic trade documents (since such contracts are purely code-based and therefore probably don’t contain the required legal verbiage, despite the fact they may be intended by the parties to have the same legal effect).

Discussion and our recommended approach

• 6.13    After considering consultee responses, we remain of the view that it is important that a trade document in electronic form contains the same information as would be required to be contained in the paper equivalent. Such a requirement establishes the link between the document in electronic form and its paper counterpart, and should therefore be one of the gateway criteria. We agree with consultees that including such a requirement will:

• (1)    provide certainty as to content requirements for documents in electronic form to qualify as electronic trade documents;

• (2)    increase parties’ confidence and facilitate wider acceptance of electronic trade documents;

• (3)    reduce the potential for conflicts and disagreements as the market transitions to using electronic trade documents; and

• (4)    facilitate change of medium and ensure consistency.

• 6.14    Of course, such a requirement would only apply to the extent that a paper trade document must contain certain information in order to qualify as such. Our recommendations would not introduce any new requirements as to the information that a document in electronic form should contain.

• 6.15    Whether a smart contract can constitute an electronic trade document for the purposes of the Bill will depend, in part, on whether the smart contract includes all the information required to be contained in its paper equivalent. ⁴³⁹Put differently, a smart contract in the form of executable code will not constitute an electronic trade document if the paper equivalent of such document requires content to be included that cannot be coded (for example, prescribed legal wording). However, where the document in electronic form is not required to contain information that cannot be coded, or where the smart contract is not comprised solely of code but includes natural language terms or components, ⁴⁴⁰we see no reason why such a smart contract cannot in principle constitute an electronic trade document.

Recommendation 8.

• 6.16    In order to qualify as an electronic trade document, a document in electronic form must contain the same information as would be required to be contained in the paper equivalent.

Meaning of “document” in the electronic context

• 6.17    In practice, a document in electronic form may be comprised of multiple components. ⁴⁴¹One component will always be the particular instance of a data string or data structure consisting of functional code, which is logically associated with (and specifically identifies) the human readable part of the document.⁴⁴² There might also be other components made up of human readable text (for example, a .pdf file or other type of data that can be accessed and displayed in a human readable way by a computer). Depending on the technology being used, this could be a unique cryptographic “token” allocated to a system user. The data string or data structure is recorded on or across one or more ledgers, structured records or registers.

• 6.18    When we refer below to an electronic trade document being amenable to exclusive control, it is likely that control will be exercised by means of the document’s underlying data structure (such as the token). On the other hand, the requirement that a trade document in electronic form must contain the same information as would be required to be contained in the equivalent paper trade document will likely be fulfilled by the human readable component of the document. This component is logically associated with the controllable data structure. For our recommendations to be workable, these two components of an electronic trade document must be regarded as a single document.

• 6.19    Our analysis of certain consultation responses has confirmed the importance of addressing how the concept of “document” includes both components of the document in electronic form corresponding to the paper itself. These are: the functional data structure, or “token”, and the human readable component.

• 6.20    Article 2 of the MLETR deals with the relationship between the components through the definition of “electronic transferable record”, which:

means 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... .

This definition captures both constitutive parts of the electronic transferable record.

• 6.21    The law of England and Wales already defines “document” for various other purposes. ⁴⁴³For example, section 13 of the Civil Evidence Act 1995 and Rule 31.4 of the Civil Procedure Rules 1998 both provide that ‘“document” means anything in which information of any description is recorded”. ⁴⁴⁴These definitions are broad, and have been taken to include electronic documents. ⁴⁴⁵Similarly, section 7C of the Electronic Communications Act 2000 defines a document as “anything stored in electronic form, including text or sound, and visual or audiovisual recording”.

• 6.22    Despite this, and taking into account the approach adopted in the MLETR, we have concluded that the Bill should include an explicit provision addressing this point. This is because the Bill deals with a new area of law (that is, possession of certain intangible assets) and existing definitions of “document” may not adequately capture the importance of the document’s underlying data structure.

Recommendation 9.

• 6.23    Where a trade document in electronic form comprises separate, but linked elements - a data structure consisting of functional code, and a human readable part which contains or specifies certain rights - these elements together should comprise “the document”.

The Bill provisions

• 6.24    Clause 1(3) of the Bill contains the requirement that a trade document in electronic form must contain the same information as would be required to be contained in the paper equivalent. It also sets out the concept of a “document” in electronic form for the purposes of the Bill:

Where information in electronic form is information that, if contained in a document in paper form, would lead to the document being a paper trade document, that information, together with any other information with which it is logically associated that is also in electronic form, constitutes a “qualifying electronic document” for the purposes of this Act.

• 6.25    By “logically associated” we mean electronically connected to, linked to, or otherwise cross-referenced to. This wording enables the use of different models for electronic trade documents’ management systems, in line with the principle of technological neutrality.⁴⁴⁶

Additional consultee views

• 6.26    Separately, some consultees, including Professors Louise Gullifer and David Fox (joint response) and Linklaters LLP, encouraged us to consider the relationship between the “document” (as described above) and the rights and/or obligations that are specified in that document (including when specified in the human readable component of that document).

• 6.27    For example, Professor Fox and Professor Gullifer suggested that, because the electronic trade documents’ regime is modelled on the existing paper trade documents’ regime, a principal focus for the law would be the transfer of a “document”. They noted that “the delivery of the documents is the key concept in explaining how title in them is transferred”.

• 6.28    Linklaters LLP also emphasised the importance of the relationship between the particular electronic data structure and the rights set out in the human readable component of the document in electronic form, by analogy with the existing legal regime applicable to paper trade documents:

Documentary intangibles themselves (i.e. in paper form) involve the “stapling” of legal rights or proprietary interests to a piece of paper (through the writing of the legal terms onto the piece of paper, and the associated legal fiction that any claim is “bound up” in the piece of paper) and the clear suggestion of the [Electronic Trade Documents Consultation Paper] is that electronic trade documents involve the “stapling” of legal rights or proprietary interests to [a data structure that is capable of constituting personal property].⁴⁴⁷

• 6.29    We agree with the analogy with paper trade documents. For example, the transfer of possession of a paper trade document which represents a debt (a bill of exchange or promissory note) is required in order to effect a transfer of the right to be paid that debt. Similarly, the transfer of possession of a paper bill of lading is required in order to effect a transfer of constructive possession of the goods to which it relates.

• 6.30    Our recommendations recognise that an electronic trade document may consist of multiple components: the underlying data structure which makes it amenable to exclusive control and the human readable element which may evidence rights or obligations. This amenability to exclusive control is an essential part of the document’s functionality as a trade document.

• 6.31    As we discuss in Chapters 7 and 8, any legal effect that would be achieved by the transfer of possession of a paper trade document should similarly be achievable in respect of an electronic trade document. When we talk about transfer of control (and of possession) of an electronic trade document, we effectively mean the transfer of the underlying data structure.

SECOND CRITERION: RELIABILITY OF AN ELECTRONIC TRADE DOCUMENT SYSTEM

Our position in the consultation paper

• 6.32    In the consultation paper,⁴⁴⁸ we discussed the “reliability” of an electronic trade document system.⁴⁴⁹ By “reliable” we mean that an electronic system meets certain standards in the way that it operates. We said that the notion of reliability features in the existing law of England and Wales applicable to electronic records in the context of the admissibility and evaluation of evidence in a dispute.

• 6.33    We provisionally proposed not to include an express statutory requirement for the reliability of an electronic trade document system.⁴⁵⁰ Although we acknowledged the importance of reliability, we considered that the existing law of England and Wales already deals sufficiently with questions of the reliability of systems, and that an express legislative provision requiring an electronic trade document system to be reliable was therefore unnecessary.

• 6.34    We also suggested that to require reliability of the system to be assessed as a condition precedent to a document in electronic form qualifying as an electronic trade document could disadvantage new systems or technologies. We said that users should be free to determine the level of risk they are prepared to take on when selecting a suitable system, with due awareness that selecting an unreliable system may harm their prospects of success in the event of a dispute.⁴⁵¹

The MLETR approach to reliability

• 6.35    The MLETR contains an express requirement in relation to the reliability of the relevant system.⁴⁵² Article 10 requires that a reliable method is used to identify an electronic transferable record, to make it capable of being subject to control, and to retain the integrity of that electronic record. ⁴⁵³Article 11 requires a reliable method to be used to establish exclusive control of the electronic transferable record, and to establish who has that control. Article 12(a) provides a list of factors which may be considered to establish reliability:

• (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 ... .

• 6.36    Article 12(b) provides a “safe harbour” provision such that, where the method has in fact achieved the function for which it was adopted, the enquiry as to the method’s reliability need not be undertaken.⁴⁵⁴

Consultees’ views

• 6.37    The majority of consultees agreed that it was not necessary to include an express statutory requirement for reliability. ⁴⁵⁵Some consultees, including the International Shipping and Trade Law - Swansea University (“IISTL”), the Digital Container Shipping Association (“DCSA”) and HSBC, said that such a requirement would increase complexity and add burdens to the use of electronic trade documents. Vale International SA said that the reliability of a system would be a question for industry, and Phillips 66 Ltd said that in any case industry participants would not use electronic trade documents unless the system was reliable.

• 6.38    Other consultees argued that the Bill should include an explicit reliability requirement. For example, the City of London Law Society said that a reliability requirement would be “prudent and would not prevent the use of a variety of systems”. The International Group of P&I clubs (“IGP&I”) strongly argued in favour of a reliability requirement to provide certainty for the market. They said:

The consultation has focused a lot on the legal theories of possession but does not seem to have considered the practical issues nor the market need for confidence and trust amongst users and safeguards from cyber-crime.

• 6.39    Some consultees, including Minerva Global Ltd and Legal Innovation Ltd, suggested that there should be a regulated system for electronic trade documents. For example, Minerva Global Ltd said:

If you are referring to the reliability of the implementation of the electronic trade document system, we think it is crucial that the system complies with certain reliability requirements, which would be deemed sufficient by regulators to ensure that the system can be fully trusted by users.

• 6.40    Similarly, some consultees, including Minerva Global Ltd, IGP&I and HSBC, were in favour of an accreditation process. HSBC said that “ideally the law should include at least parameters as to how to provide accreditation” and referred to the cross-border nature of trade. In relation to accreditation processes, Minerva Global Ltd said:

Parties offering electronic trade document management and transfer service should undergo a process of accreditation, involving technical evaluation of the solution to ensure that the system implementing the service does indeed function in the way it should, preventing double-spending of the electronic documents, and ensuring there is at most one possessor at any given time. This will require government-designated experts to look “under the hood” of the systems to confirm that the logic is correct.

• 6.41    On the other hand, some consultees did not think that an accreditation process should be expressly provided for in our legislative reforms. For example, Enigio Time AB said that whether an accreditation body is required is “an open question”, and that such a requirement could “significantly hamper” the adoption of electronic trade documents. Dr Simone Lamont-Black said that “to rely on an accreditation process seems too limiting”.

Discussion and our recommended approach

• 6.42    After considering consultees’ responses and undertaking further stakeholder engagement, we recommend that the Bill should include a requirement that an electronic trade document system be reliable. Although consultees were broadly in favour of our provisional proposal not to include such a requirement, several consultees made cogent and ultimately persuasive arguments in favour of such a requirement.

• 6.43    A common theme arising from consultee responses was that users would need to be able to “trust” systems for electronic trade documents to be used widely, especially given the potential risk of cybercrime identified by IGP&I. Although we expect that commercial parties will consider questions of security and risk when choosing an electronic trade document system, consultees suggested that this trust would be more likely to arise if the Bill contained a provision in relation to reliability.⁴⁵⁶

• 6.44    Whilst considering consultation responses, we corresponded with technology companies that deal with trade documents in electronic form. We asked these companies for their views on the list of factors in article 12 of the MLETR. We suggested that these might be used to demonstrate reliability, and we asked whether there were any factors in that list which could be onerous to meet. None of the organisations which responded said that they would find any of the factors difficult to satisfy. It is clear from the stakeholders we engaged with on this topic that satisfying a reliability requirement would be achievable in practice, even though some stakeholders (including some of the technology providers) thought reliability was better dealt with by industry outside the context of the Bill.

• 6.45    We also spoke to Mr Justice Fraser, the former Judge in charge of the Technology and Construction Court, who has recent and extensive experience of litigation dealing with questions of reliability of electronic systems.⁴⁵⁷ Mr Justice Fraser said that, although parties are capable of sorting out their positions from a commercial and contractual perspective, our recommended reforms would constitute a sufficiently significant change to the law that we should consider including an express reliability requirement. He suggested that, without such a provision, there could be uncertainty during a transition period as the common law catches up with electronic trade documents.⁴⁵⁸ Significantly, he also said that his view was that guidance as to the factors that a court could usefully consider when deciding whether a system is “reliable” would be helpful. Such an approach would provide welcome guidance to the judiciary as a whole.

• 6.46    We further recommend that the Bill should set out a list of factors which may be taken into account when assessing whether a system is reliable. Mr Justice Fraser said that this would be useful to judges in determining these matters. It is important to note that, in requiring a system to be reliable and in setting out various factors that may be taken into account when assessing reliability, we do not intend to prescribe any particular type of technology. We simply intend to provide a non-exhaustive list of factors that the court may take into account when assessing the reliability of a particular system. These factors are based on the factors set out in article 12(a) of the MLETR. This approach is therefore consistent with our general guiding principle that the Bill should be technology neutral.

• 6.47    We do not, however, think the Bill should make separate provisions for an accreditation process, which would guarantee a certain level of objectivity in the assessment of the reliability of the system used. Requiring specific systems to be accredited by a national regulator or state-appointed regulator would be burdensome, and could lead to delays in a move to electronic trade documents while such an accreditation system was set up. Operators could also face having to get accredited in multiple jurisdictions. We think that such issues are better dealt with by industry standards which can reflect more dynamically the development of technology to support electronic trade documents.

• 6.48    Standards specific to the use of trade documents in electronic form are already emerging, and significant progress has been made in this regard. For example, DCSA has created standards for an e-bill of lading,⁴⁵⁹ which consist of data and process standards for the submission of shipping instructions and the issuance of bills of lading.⁴⁶⁰ Other industry initiatives include ICC’s Digital Standards Initiative, ⁴⁶¹which is designed to establish standards to govern cross-border trade. Furthermore, ICC, DCSA, Swift, the Baltic and International Maritime Council (“BIMCO”) and the International Federation of Freight Forwarders Associations have recently formed the Future International Trade (“FIT”) Alliance to bring together their various sets of standards, and create one universal set of rules for the digitalisation of international trade. ⁴⁶²Standards are also being developed by international organisations in the area of distributed ledger technology.⁴⁶³

• 6.49    In addition, it is our understanding that industry participants are unlikely to want to use trade documents in electronic form unless the system that hosts such documents is reliable.

Recommendation 10.

• 6.50    In order to qualify as an electronic trade document, a reliable system must be used to ensure that the document contains certain functionality designed to replicate the salient features of a paper trade document.

Legislation should include a non-exhaustive list of factors which may be taken into account when considering whether a system is reliable, being:

• (1)    any rules of the system that apply to its operation;

• (2)   any measures taken to secure the integrity of information held on the system;

• (3)   any measures taken to prevent unauthorised access to and use of the

system;

• (4)    the security of the hardware and software used by the system;

• (5)    the regularity of and extent of any audit of the system by an independent body;

• (6)    any assessment of the reliability of the system made by a body with supervisory or regulatory functions;

• (7)    the provisions of any voluntary scheme or industry standard that apply in relation to the system.

The Bill provisions

• 6.51    The Bill contains the reliability requirement in clause 2(1). It provides that:

A qualifying electronic document is an “electronic trade document” for the purposes of this Act if a reliable system is used to ... .472

• 6.52    Clause 2(4) sets out various factors that a court may take into account when determining whether a system is reliable for the purposes of clause 2(1):

• (4)    When determining whether a system is reliable for the purposes of subsection (1), the matters that may be taken into account include —

• (a)   any rules of the system that apply to its operation;

• (b)   any measures taken to secure the integrity of information held on the

system;

• (c)    any measures taken to prevent unauthorised access to and use of the system;

• (d)    the security of the hardware and software used by the system;

• (e)    the regularity of and extent of any audit of the system by an independent body;

• (f)    any assessment of the reliability of the system made by a body with supervisory or regulatory functions;

• (g)    the provisions of any voluntary scheme or industry standard that apply in relation to the system.

Do we need a “safe harbour” provision similar to article 12(b) of the MLETR?

• 6.53    We have decided not to include a “safe harbour” provision in the Bill similar to that contained in article 12(b) of the MLETR. ⁴⁶⁴In our opinion, including such a provision could produce an unintended result in that, where the system could be shown to have done what is required in a particular case, the system’s reliability would not need to be assessed. Given that we require a system to be reliable in order for the document in electronic form to qualify as an electronic trade document, we think that an assessment of the system’s reliability should not be excluded in such cases.

THIRD CRITERION: INTEGRITY OF AN ELECTRONIC TRADE DOCUMENT

• 6.54    In the consultation paper, we also discussed whether there should be a requirement as to the “integrity” of an electronic trade document.⁴⁶⁵ By this, we mean that the document cannot be interfered with or altered without the requisite authority. We said that integrity is important for establishing that a document is original or authentic.⁴⁶⁶

From a practical perspective, the courts are unlikely to admit a trade document which is highly susceptible to alteration as evidence, and such a document would not be trusted by intended users.

• 6.55    We provisionally proposed not to include an express statutory requirement for the integrity of a trade document in electronic form. Although we acknowledged the importance of integrity, we considered that the existing law of England and Wales already sufficiently deals with questions of the integrity of documents, and that an express legislative provision requiring a trade document in electronic form to retain its integrity was therefore unnecessary.

The MLETR approach to integrity

• 6.56    The MLETR contains an express requirement in relation to the integrity of an electronic transferable record. The “criterion for assessing integrity” is:⁴⁶⁷

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.

Consultees’ views

• 6.57    The majority of consultees agreed that it was not necessary to include an express statutory requirement for integrity. ⁴⁶⁸Some consultees said that any integrity requirement is best left to industry, while others said that such a requirement may introduce unnecessary complexity. For example, Phillips 66 Ltd said that industry participants would not use electronic trade documents unless they had confidence in the underlying system, and that “requirements are likely to evolve over time”. Bolero International Ltd also said that an integrity requirement would introduce “an unnecessary complexity”.

• 6.58    Other consultees argued that the Bill should include an explicit integrity requirement. For example, the Centre for Commercial Law at the University of Aberdeen said that integrity is “an important element” and thus considered it “useful” to have an explicit statutory requirement for integrity. Enigio Time AB said that the draft Bill should contain “an explicit legal requirement that an electronic trade document must maintain its integrity throughout its life cycle”. IGP&I raised concerns that the lack of any provision in the Bill for the integrity of an electronic trade document and the reliability of an electronic trade document system would undermine industry confidence in using them. They said:

Although there is no integrity requirement for paper bills it is perhaps historical; partly because you can physically see and hold the bill and perhaps partly because the sophisticated schemes and technologies did not exist to create such elaborate scams.

Discussion and our recommended approach

• 6.59    After considering consultees’ responses, and after further stakeholder engagement, we now recommend that the Bill should include a requirement that a trade document in electronic form must retain its integrity, and must therefore be protected from unauthorised alteration or amendment. Although consultees were broadly in favour of our provisional proposal not to include an express integrity requirement, as with reliability, several consultees made cogent and ultimately persuasive arguments in favour of such a requirement. These arguments were similar to those made in relation to a reliability requirement discussed above.⁴⁶⁹

• 6.60    Importantly, consultees thought that an integrity requirement would be valuable in ensuring trust in the widespread use of electronic trade documents, and combatting the risk of cybercrime and related scams. Even though such a requirement does not exist in the context of paper documents, consultees pointed out that this could be primarily due to historical reasons. In addition, even though we consider integrity to be an existing requirement under the law of England and Wales, it is less clear whether it would operate as pre-condition to a document in electronic form qualifying as an electronic trade document. We think it is important for integrity to play such a role in relation to electronic trade documents. Mr Justice Fraser also supported the inclusion of an express integrity requirement for similar reasons to those provided in support of an express reliability requirement.⁴⁷⁰

Recommendation 11.

• 6.61    In order to qualify as an electronic trade document, a document in electronic form must be protected against unauthorised interference or alteration.

The Bill provisions

• 6.62    The Bill contains the integrity requirement in clause 2(1)(b). It provides that:

• (1)    A qualifying electronic document is an “electronic trade document” for the purposes of this Act if a reliable system is used to —

• (b) protect the document against unauthorised alteration ... .

FOURTH CRITERION: CAPABLE OF EXCLUSIVE CONTROL

The concept of “control”

• 6.63    Control is fundamental to our recommendations in two different ways.

• (1)    First, as explained in Chapter 5, control is one of the two elements which are required at common law in order for someone to be in possession of something (the other being intention). What constitutes sufficient control in respect of a particular asset will depend on the type of asset. This is a common law assessment which will be for the courts to make, assisted by existing case law, which we think can be extrapolated to electronic trade documents. We discuss what constitutes control of, and possession of, an electronic trade document in Chapter 7.⁴⁷¹

• (2)    Second, as discussed below, we recommend that amenability to exclusive control should be a necessary criterion for a trade document in electronic form to qualify as an electronic trade document. We include a concept of control in the Bill for this purpose alone (although the concept is based on notions such as “use” which are referred to in common law assessments of control/possession).

Our position in the consultation paper

• 6.64    In the consultation paper, we provisionally proposed that, for the purposes of our reforms, control in the context of the gateway criteria should be used in a factual sense and not in the sense of a legal right distinct from possession. ⁴⁷²We therefore provisionally proposed that “control” (for the purposes of the gateway criteria) should be defined as the ability (as a matter of fact) to “use, and transfer or otherwise dispose of the document”.⁴⁷³

• 6.65    We also provisionally proposed that, in order to be amenable to possession, an electronic document must be capable of being the subject of exclusive occupation or use; that is, of exclusive control.⁴⁷⁴ We discuss this criterion in more detail below.⁴⁷⁵

Consultees’ views

• 6.66    Some consultees (including Linklaters LLP, the Centre for Commercial Law at the University of Aberdeen and Dr Jenny Jingbo Zhang and Dr Liang Zhao) suggested that it is not necessary to define “control” in the Bill. For example, Dr Zhang and Dr Zhao said that the Bill should focus on the legal effect of electronic trade documents rather than introducing a new concept of “control”. Similarly the Centre for Commercial Law at the University of Aberdeen, answering “other”, queried whether there is a “real need” to define control, noting that the MLETR does not do so.

• 6.67    However, the majority of consultees supported our provisional proposal for the inclusion of a definition or concept of control. ⁴⁷⁶For example, Professor Djakhongir Saidov said that the provisional proposal is “a good and workable solution”.

Dr Michael Crawford said that the proposed definition is “very good”.

• 6.68    Although the majority of consultees agreed with our provisional proposal, the definition of “control” in the consultation Bill prompted a significant number of comments (including from consultees in favour of it). These comments included whether the definition of control should include an express element of exclusivity, whether access to a document to read or view its contents constitutes “use”, and whether the definition of control should include positive and negative control.

• 6.69    We discuss each of these points below, before setting out on recommendations and conclusions on the concept of control in the context of the gateway criteria.

Exclusivity of control

• 6.70    Dr Crawford, the Centre for Commercial Law at the University of Aberdeen (both answering “other”) and WAVE BL (answering “no”), referred to the concept of exclusive control. WAVE BL said:

We agree but the most important thing about control is having the exclusive ability effectively in a way that cannot be interrupted by any third party including the service provider. We think this should be added [to] the definition because that is the exact same value proposition of its equivalent paper document.

• 6.71    Dr Crawford said that it is not clear that an exclusivity requirement is included in the proposed definition. He asked:

If, for instance, several people are able to use or dispose of the document because they have access to the relevant encryption key, would we say that each “controls” it, or that none “controls” it?

Does “ability” mean a legal right?

• 6.72    Legal Innovation Ltd emphasised that the definition of control should focus on functionality, and not the legal right to do something with the document:

I would strongly recommend not using a definition that talks about an “ability” to do anything - particularly in light of the chain of contractual arrangements that give different “abilities” to different people at different times. We need one definition that focuses only on who from a technical perspective has the “functionality” to cause something to happen to the asset - ie we need to exclude everyone who may have contractual rights giving them the right to cause someone else to do something.

Positive and negative control

• 6.73    Some consultees raised the question of whether our proposed definition includes the correct type of control. For example, Professor Duncan Sheehan, answering “other”, said that to be possessable, it is necessary that the document must be “susceptible to control (positive or negative control)”.

• 6.74    In contrast, Professor Bridge (who agreed with our provisional proposals) said that there is “no reason for being diverted by vexed questions of negative and positive control in this context”. He made the point that:

Certainly as far as trade documents are concerned (ship's delivery orders, warehouse receipts), we are looking at short-term documents passing from hand to hand (metaphorically speaking) and therefore about positive control.

Control and existing electronic systems

• 6.75    “The London Metal Exchange, answering “other”, raised concerns about the effect of the definition of control on existing electronic systems. In particular, they cautioned against unintentionally excluding “closed” systems.

To benefit existing systems (like LMEsword) it would need to be permissible under law to restrict the transfer of electronic documents to within that system between members (for their own account or for the account of their clients) - i.e. to have a “closed” as opposed to an “open” system, without prejudice to the intended treatment of the electronic document.

The concept of “use”

• 6.76    Rio Tinto Commercial asked about the significance of “use” and suggested removing “use” from the proposed definition of control, and instead relying on the ability to transfer or otherwise dispose of the electronic trade document. They asked:

What is the intended consequence if, in an electronic system, a person has the ability to transfer an electronic trade document but does not, for whatever reason, have the ability pursuant to the system to “use” it (and nobody else has the ability to “use” at that time)? Who is then in possession? Because there are two limbs, there can be situations where one limb is fulfilled and not the other. What is the consequence for each situation?

• 6.77    Some consultees, including Sullivan & Worcester LLP, Matthew Wright from the UK Chamber of Shipping (who responded in a personal capacity) and the London Maritime Arbitrators Association (“LMAA”), asked whether viewing or accessing a document would fall within the definition of “control”. For example, Sullivan & Worcester LLP, answering “other”, said that the Bill should distinguish between “control” and “access”:

Access may be needed by a number of parties e.g. system administrator, both transferor and transferee and other parties to read the document, to check its terms before and after a transfer. Other officials may also need sight of it even if they are not the holder or owner. This, we understand, could be done by provision of a public key, in some systems.

• 6.78    In contrast, Dr Crawford, answering “other”, and Professor Saidov suggested adding the ability to access an electronic trade document to the definition of control.

Discussion and our recommended approach

The concept of control

• 6.79    After considering consultees’ responses to our provisional proposals, we remain of the view that it is necessary to include a concept of control for the purposes of the gateway criteria. Given that the concept of control is used in different ways in the law of England and Wales, explaining what we mean by control is necessary to ensure that stakeholders are clear as to what requirements must be met for an electronic trade document. We do not, however, think it is necessary for the concept of control to refer expressly to exclusivity. This is addressed by other elements of our recommendations including, in particular, the criterion discussed below that no more than one person can exercise control at any one time.⁴⁷⁷

• 6.80    The essence of the concept of control within the meaning of our recommendations and Bill is that it is a factual rather than a legal or rights-based enquiry. The references in the consultation Bill to something that a person “is able to” do were intended to convey this point. However, as is clear from consultees’ responses, the wording led to confusion. It was interpreted by some consultees as meaning a legal right. In light of consultees’ feedback, we have revised our drafting in this context to make it clearer that control is unrelated to legal rights for the purposes of the gateway criteria.

• 6.81    We agree with Professor Bridge that it is unnecessary to complicate matters by including concepts of “positive” and “negative” control in the Bill. The concept of control in the gateway criteria is concerned with what, as a matter of fact, someone who is able to exercise control over a trade document in electronic form can do in relation to that document. What is important in each case is the factual matrix in which control is present. For example, some arrangements might be structured such that control can only be exercised when all or a combination of the persons involved in the arrangement act together. This means that, although no one person can use, transfer or dispose of the document, factual control can still be exercised over the document when the requisite number of persons act together. However, this is a separate question about the person or persons who can exercise factual control, rather than being a question about whether the document is one over which it is factually possible to exercise control, or what it means to exercise control.

• 6.82    In addition, although it has provoked sophisticated reflection on the notion of control, the provision on control in the Financial Collateral Arrangements (No 2) Regulations

2003 (the “FCARs”) (as interpreted by courts in this jurisdiction and by the CJEU)⁴⁷⁸ has proved problematic for marketplace actors. In our view, it would be undesirable to try and build upon the concept of control that appears in the FCARs because it does not capture the type of control with which we are concerned in relation to the gateway criteria. Instead, our recommended approach is to employ a concept of control for the purposes of the gateway criteria that is more closely aligned with the factual notion of control that forms part of the common law concept of possession.

• 6.83    We also do not agree that the proposed drafting applied only to “open” systems, in that it implied a requirement that there must be an unfettered ability to use, transfer or dispose of a document in electronic form. The Bill presupposes the existence of a system that is reliable. It does not prescribe how particular transfers or disposals of an electronic trade document are to take place within that system. The Bill would therefore apply to all systems, regardless of whether they are “open” or “closed”.

The concept of “use”

• 6.84    After considering consultees’ feedback on the concept of “use”, we remain of the view that “use” should form part of the concept of control. In particular, there may be situations where a party is able to use the document without also being able to transfer or dispose of it. This would be the case where, for example, a party is able to hold or retain the document in order to prevent any dealings in the document by anyone else. In such a case, we think the party who has the ability to use the document should be considered to have control (and the ability to exercise control) of the document. For example, where a pledge is granted, the pledgee, to whom the document is transferred, may be precluded by the system from further transferring or disposing of it until the debtor has either repaid the loan or defaulted. This does not, however, change the fact that the document has been transferred to the pledgee and that nobody else is able, as a matter of fact, to deal with the document. The pledgee retains the document, thereby preventing any dealings in the document by anyone else. In this case, the pledgee should be considered to be using and therefore exercising control of the document, notwithstanding that they cannot transfer or dispose of it.

• 6.85    Other examples of acts that we think should constitute “use” of the document include requesting a change of medium, requesting an amendment of the document, adding an indorsement or an acceptance to the document, and presenting or surrendering the document.

• 6.86    However, our view is that reading or viewing a trade document in electronic form should not, without more, constitute ”use” of the document. Reading or viewing a trade document could arise both where a person does not otherwise have factual control of the document (and therefore the ability to exercise control), and where they do. For example, a person could have read-only access to a document, allowing them to view and read the document but nothing more. Such a person should not be considered to have the ability to use that document. This would mean that they do not have control (or the ability to exercise control) for the purposes of the Bill. For example, a stevedoring service provider (who loads and offloads cargo to or from a ship) might need to check the information in a bill of lading in the course of unloading the goods. If they are only given access to the document over the system for this limited purpose and simply view the document, this should not constitute “use” of the document for the purposes of the Bill.

• 6.87    In other cases, a person who has the ability to use, transfer or otherwise dispose of the document (and therefore the ability to exercise control) would ordinarily also be able to access the document to read or view it. If, however, the person only reads or views the document in a particular instance, that should not constitute “use” of the document and, as such, the person should not be said to be exercising control of the document. This should be the case notwithstanding the fact that the person would otherwise have control of the document that they could exercise (because they could, for example, transfer or dispose of it). In theory this means that someone could exercise control of a document while another party with control is simply reading or viewing it.

• 6.88    We think this is the right result, and could occur in the paper world too. For example, someone could be reading a piece of paper and someone else could come along and snatch it away, even if they were not supposed to. Since we are concerned with factual control, we do not think the Bill should necessarily preclude or prevent such a situation. If the industry wants to avoid such a result, and ensure that a person could not exercise control while another person with control was reading or viewing the document, system providers could design systems to prevent such an occurrence.

• 6.89    To “use” a trade document in electronic form should, therefore, be to utilise or retain the document to achieve a particular purpose. It should include causing something to happen (or preventing something from happening) to the document. For example, requesting an amendment of the document, surrendering the document, or simply retaining the document to exclude anyone else from transferring, presenting or surrendering it. Merely reading or viewing the document should not, in and of itself, constitute “use” of the document in a particular instance.

Recommendation 12.

• 6.90    For the purposes of the gateway criteria, a person should be taken to exercise control of a trade document in electronic form when the person uses, transfers or otherwise disposes of the document (regardless of whether they have the legal right to do so).

Recommendation 13.

• 6.91    “Use” of a trade document in electronic form should comprise utilising or retaining the document to achieve a particular purpose. It should include causing something to happen (or preventing something from happening) to the document, but exclude merely reading or viewing the document.

The Bill provisions

• 6.92    Clause 2(2)(a) of the Bill contains the concept of control for the purposes of the gateway criteria. It provides that:

• (2)    For the purposes of subsection (1) —

• (a) a person exercises control of a document when the person uses, transfers or otherwise disposes of the document (whether or not the person has the legal right to do so) ... .

• 6.93    Clause 2(3) of the Bill deals with use. It provides that:

Reading or viewing a document is not, of itself, sufficient to amount to use of the document for the purposes of subsection (2)(a).

Exclusivity of control as part of the gateway criteria

Our position in the consultation paper

• 6.94    In the consultation paper,⁴⁷⁹ we provisionally proposed that a trade document in electronic form must be capable of exclusive control in order to constitute an electronic trade document. We said that, to satisfy the requirement, the document in electronic form must not support concurrent use or control by multiple parties at one time independently of one another. In personal property law, a thing which has this quality is sometimes referred to as “rivalrous”.⁴⁸⁰

Consultees’ views

• 6.95    While consultees were supportive of the requirement for exclusive control and, in particular, the notion that a document in electronic form must be susceptible to exclusive control, it was clear that our provisional proposals caused some confusion. Specifically, there were concerns that our proposals excluded various situations where multiple persons could be said to have control of a document in electronic form because, for example, they all have the relevant private key or other security credentials. Similarly, there were concerns that our proposals did not cover a situation where a group of persons acting jointly could exercise control of the document (for example, in a multi-signature arrangement). ⁴⁸¹Below we discuss consultees’ responses, before setting out our recommendations and conclusions on the requirement for exclusive control.

Concurrent control by multiple parties

• 6.96    Some consultees, including Linklaters LLP, WAVE BL and Dr Crawford, asked how our provisional proposals would apply to a situation where more than one person has access to the document. Dr Crawford said:

One could imagine a situation in which numerous people have access to a private key, password or decryption device. It is not clear how the digital architecture of any particular platform would prevent people sharing this sort of information.

• 6.97    WAVE BL said:

Concurrent control by multiple parties doesn’t necessarily oppose the thought of unique control of the ETR held by a single party or by several parties acting together (or requiring approval from all “controlling parties” to perform “control-oriented action”). The ability to hold control together with another party simultaneously would allow (1) one out of a list or (2) all or some of a list to perform a transfer possession/apply signature or endorsement signature action together for them to take place. As long as, the set of rules applying to the specific ETR are visible and known to its holder there would be no reason to fully exclude the concept of multiple party control.

Exercising control jointly and multi-signature arrangements

• 6.98    Several consultees, including Professor Andrew Steven, the IISTL, Professor Sheehan, HSBC and WAVE BL, suggested that the Bill should provide for the situation where two or more parties are acting together. For example, Richard Gwynne said:

There is no obvious reason why parties with a joint interest (eg. partners in an unincorporated partnership or trustees) may not enter into a contract of carriage or be parties to a bill of exchange and so become the joint holders of a bill of lading (or bill of exchange or other trade document). It is also difficult to see any good reason why that should be precluded where there is an electronic trade document.

• 6.99 Professor Steven, answering “other” said:

it seems odd ... to exclude co-control. Two companies in a joint venture may co-own vehicles and co-possess them, so why should it not be possible to have co-control an electronic document if that is what is desired?

6.100 Linklaters LLP, answering “other”, said:

The requirements do not seem to cater for multi-sig wallet arrangements, under which multiple (separate) persons have negative control over the asset and no single person has positive control over the asset.

System administrator

6.101 Sullivan & Worcester LLP, the LMAA, Vale International SA and HSBC suggested that we consider the position of the person or organisation which administers or operates the electronic trade documents system (the “system administrator”). For example, Sullivan & Worcester LLP agreed that the provisional proposal “seems sensible” but said:

The system administrator will have to have some access in case of mistaken transfers or IT issues, but the control or access by that party should not constitute control for the purposes of the definition of “possession” in the Bill, so we propose you carve this out of either the relevant definition of possession or control.

Companies and agents

6.102 Vale International SA said that “person should also include Party (company), which may have several employees”. Rio Tinto Commercial pointed out that there could be “an individual or multiple individuals who have access to represent the Party that has possession under the digital platform”.

Discussion and our recommended approach

6.103 After considering consultees’ responses, and on further reflection, it is clear that our provisional proposals caused some confusion. These proposals, and the relevant provisions in the consultation Bill, were interpreted to mean that where multiple persons have the relevant password or private key (for example), their control is not exclusive, and therefore the document could not qualify as an electronic trade document. However, what we meant by exclusive control was that it must not be possible for more than one person (other than joint actors) to exercise control at any one time - that is, the document must be amenable to exclusive control.

6.104 That is not the same as precluding multiple people from having control at the same time. As we discuss in Chapter 5, it is possible in the tangible world for multiple people to have control (and possession) of an asset at the same time. In Chapter 7, we explain that, where multiple persons have the relevant password or private key, they can all be said to have control of the electronic trade document. ⁴⁸²However, the question of who “has control” is separate from the question of the features a document must have in order to qualify as an electronic trade document. The function of the exclusive control criterion is to address the “double spend” problem so that, for example, two people with the private key could not both transfer the document to two different places independently of each other.

6.105 In light of consultees’ feedback, and after further stakeholder engagement, we have refined our policy on exclusive control as follows.

• (1)    A document in electronic form must be capable in fact of being subject to exclusive control.

• (2)    Multiple people could have control of a document in electronic form (because, for example, of all of them have the security credentials or private key necessary to transact).

• (3)    Even though multiple people could have control of a document in electronic form, only one person (or persons acting jointly) must be capable of exercising that control at any one time.

6.106 In addition, while we think that “person” in the Interpretation Act 1978 would cover an individual, or a body of persons (corporate or incorporate), it would most likely not extend to other situations, such as multi-signature arrangements. We think that this should be addressed.

Recommendation 14.

6.107 In order to qualify as an electronic trade document, a trade document in electronic form must be susceptible to exclusive control; that is, only one person (or persons acting jointly) must be able to exercise control of a document in electronic form at any one time.

The Bill provisions

6.108 Clause 2(1)(c) of the Bill provides that:

• (1)    A qualifying electronic document is an “electronic trade document” for the purposes of this Act if a reliable system is used to —

• (c) secure that it is not possible for more than one person to exercise control of the document at any one time .. .

6.109 Clause 2(2)(b) of the Bill covers the situation where a group of persons acting jointly can exercise control of the trade document in electronic form (for example, in a multisignature arrangement). It provides that:

• (2)    For the purposes of subsection (1) —

• (b) persons acting jointly are to be treated as one person.

• 6.110    In relation to system administrators or operators, it is important to ensure that a system is not excluded from the scope of the Bill simply because its operator, as well as its user, is able to exercise control of a document in electronic form. However, given that we recommend the Bill focuses on exercising control, rather than having control, we think that this removes any concern that such a system would be excluded. Those systems where the system administrator or operator is able to exercise control of a document in electronic form may fall within the scope of the Bill (assuming they meet the other criteria and provided that it prevents double-spending).

The requirement that no more than one person can exercise control of a document in electronic form at the same time (unless they are acting jointly) ensures that where, for example, the user is transferring or otherwise using the document, the system administrator cannot do so. This links to our next criterion of divestibility.

FIFTH CRITERION: DIVESTIBILITY

Divestibility criterion

Our position in the consultation paper

• 6.111    “Divestibility” means that, as a matter of fact, a transfer of an object must entail the transferor being deprived of it. In the consultation paper,  ⁴⁸³we provisionally proposed that a trade document in electronic form must also be “divestible”, by which we meant that a transfer necessarily entailed a transfer both of the document and of the ability to control the document.⁴⁸⁴ This feature prevents an electronic trade document from being transferred more than once by the same party, or by another party having concurrent control with the transferor - the “double spend” issue.⁴⁸⁵ Divestibility singularises the right to claim performance of the obligation recorded in the document.

• 6.112    Suitable objects of property rights are necessarily divested on transfer. For physical objects, this is inherent in their material nature. For example, in the paper world, if Alice gives a paper bill of lading to Bob, Bob then has the bill of lading and Alice does not. The bill of lading is no longer in Alice’s physical possession, nor does she have factual control over it. Alice has been divested of the paper trade document and cannot purport to transfer it to another party, Charlie. Similarly, if a paper bill of lading is in a vault and both Alice and Daisy have the passcode to the vault (and therefore concurrent control and possession of the bill of lading), if Alice were to give the paper bill of lading to Bob, both Alice and Daisy would lose factual control and possession of the document.

• 6.113    We said that the divestible nature of a paper trade document was crucial to its ability to be possessed, and should therefore be replicated in the context of trade documents in electronic form. As such, when an electronic trade document is transferred to another person, the transferor (and any person who is able to exercise control concurrently with the transferor) must be fully divested of the document, and must not be able to purport to transfer it to another party. For trade documents in electronic form, divestibility will be a consequence of their technological design.

Consultees’ views

• 6.114    While the majority of consultees agreed with our provisional proposals on the divestibility criterion, not all consultees thought that such a requirement was necessary.

• 6.115 A number of consultees, including Professor Bridge and Dr Crawford, indicated that the divestibility criterion is essential to how trade documents are meant to work. For example, Dr Crawford said that the element of divestibility is “essential”.

Professor Bridge said that, on the basis that we adopt the concept of possession, he agreed with our provisional proposals. Phillips 66 Ltd agreed from an industry perspective. They said that:

The system must ensure that a party cannot perform fraudulent acts by using the trade document as security for party B but unbeknown to party B transferring the trade document to party C and not accounting for the proceeds. Electronic trade documents will not be accepted in the industry without safeguards to prevent such practices.

6.116 In contrast, Dr Tatiana Cutts, answering “other”, suggested that we remove the divestibility criterion:

It is not clear to me that the third [divestibility] characteristic adds anything for the purposes of the electronic trade documents consultation: I can think of no good example of a case in which an electronic trade document could be susceptible to exclusive control, but yet not fully divested on transfer.

6.117 Legal Innovation Ltd said:

There must be a transfer of “control” in the strict legal sense of losing the ability to give direct instructions to the system - but that does not mean that the first holder loses control in the wider sense of having rights to control indirectly the same asset.

6.118 Sullivan & Worcester LLP, answering “other”, said:

We generally agree with this but we would like clarification on how this is envisaged in reality. For example, is there an interim step, (i) the transferor has to send an instruction to transfer and then (ii) the transferee has to do something to accept the document and on that acceptance the transfer occurs which may be needed to fix the time of acceptance. We are thinking either a tick box/ click on the system, rather than just a send or indorsement instruction from the transferor. This could be relevant for erroneous instructions or mistakes in the system. Could the Law Commission consider this in relation to the Bill and how systems operate in practice.

6.119 The CLLS, answering “other”, said:

This would be the effect of system rules. However, a system may also allow the system administrator to respond to legal requirements to rectify its records in case of fraud etc. In some cases this could restore control to a transferor.

Discussion and our recommended approach

6.120 After considering consultees’ responses, we remain of the view that it is necessary to include a divestibility criterion in the Bill. However, in light of our revised approach to the exclusive control requirement, ⁴⁸⁶we think the divestibility criterion needs to be revised to refer to “exercise control” rather than “has control”. In addition, the divestibility criterion should provide for the fact that when a transfer occurs, the transferor can no longer exercise control of the document; and neither can any of the persons who were also able to do so. We think it is important that both the person who is actually exercising control, as well as any of the persons who shared the factual ability to exercise control (because, for example, they had the relevant private key), are no longer able to do so. This ensures that, following a transfer, the electronic trade document is fully divested.

6.121 To Dr Cutts’ point, we have revised our policy on control and explained that, while the document in electronic form must be capable of exclusive control as part of the gateway criteria, there may be situations in which multiple parties have control of it. This could be, for example, because multiple people have the private key to the document. In such a case, we think it is important to provide that if the transferor effects a transfer, the transferor can no longer exercise control of the document, and neither can any of the persons who shared the ability to exercise control with the transferor. As such, all those previously in control are divested of it (except to the extent that a person re-acquires control by virtue of being a transferee). While we take the point that it may be unlikely that a document susceptible to exclusive control is not fully divested on transfer, we cannot guarantee that this will always necessarily be so. As such, we think it is necessary to include an express divestibility requirement to ensure the point is covered; including a divestibility requirement is not, in our view,superfluous. Rather, we think it is particularly important to ensure there is no potential risk that a system divests the transferor of control, but not the additional persons who shared the transferor’s ability to exercise control.

• 6.122    In relation to Legal Innovation Ltd’s response, since we are referring to factual control, the divestibility criterion entails that the transferor (and any person who shared the transferor’s ability to exercise control) lose factual control of the electronic trade document. In Chapter 7, we explain that a person who transfers factual control (and consequently possession) to another person may in certain situations retain legal control (that is, legal rights) in relation to the object in question.⁴⁸⁷

• 6.123    With regards to Sullivan & Worcester LLP’s query as to how divestibility would work in practice, we think this will largely depend on the type of electronic trade document system, and its functionalities. For example, if the system permits the transferor to transfer control of an electronic trade document to the transferee for the purposes of inspecting the document, with a view to accepting or rejecting it, the transferor is divested of control. This situation can be contrasted with one where the system permits the person who has control of the document to show the document to the intended recipient for inspection purposes only. As we discuss above,⁴⁸⁸ a person who is able only to read or view a document in electronic form is not able to “use” that document, and does not have control for the purposes of the Bill. In this case, control remains with the person showing the document. We discuss acceptance of a document for the purposes of delivery in Chapter 8.⁴⁸⁹

• 6.124    The CLLS noted that system rules may allow an administrator to intervene for certain purposes. We do not think there is anything in the Bill that would exclude such a system. Our revised approach to the concept of control focuses on the actual exercise of that control. This approach removes any concern that a system with an operator or administrator who is able to exercise control of a document in electronic form would be automatically excluded.

Recommendation 15.

• 6.125    In order to qualify as an electronic trade document, a trade document in electronic form must be divestible; that is, after the document is transferred, any person who before the transfer was able to exercise control of the document is no longer able to do so (except to the extent that a person is able to exercise control by virtue of being a transferee).

The Bill provisions

• 6.126    The Bill contains the divestibility criterion in clause 2(1)(e). It provides that:

• (1)    A qualifying electronic document is an “electronic trade document” for the purposes of this Act if a reliable system is used to —

• (e) secure that a transfer of the document has effect to deprive any person who was able to exercise control of the document immediately before the transfer of the ability to do so (except to the extent that the person is able to exercise control by virtue of being a transferee).

• 6.127    It is to be noted that the word “transfer” in this context is being used in a factual and not a legal sense. As discussed elsewhere in this report,⁴⁹⁰ this is an important distinction because a transfer of the document in the legal sense (so as to make the transferee the holder) may require elements additional to a transfer of possession in order to be effective.

How divestibility is achieved in practice

Our position in the consultation paper

• 6.128    In the consultation paper,⁴⁹¹ we made the point that the divestibility requirement ensures that any system that supports electronic trade documents must be designed to exclude “double spending”. We said that we were interested to know how current systems for electronic trade documents, and those in development, achieved this.⁴⁹²

Consultees’ views

• 6.129    Several consultees confirmed that existing systems could ensure that our divestibility criterion is met, but emphasised the importance of technological neutrality in the Bill. For example, the IISTL said that the obvious ways that current technology could meet the divestibility requirement would be:

control by password access to a central registry, or the use of block analogous to its incorporation of devices for the prevention of double-spending of Bitcoin or Ethereum.

However, the IISTL warned that this matter is best left undefined by the law because it is a technical issue and legislation is likely to become outdated.

• 6.130    Robert Parson said that:

there are a variety of approaches from unmoderated blockchain to secure depositaries, all of which are technically capable of ensuring that the transferor loses the ability to control a document post transfer.

He agreed with our proposed “technology neutral” approach, and added that “this is a technical area which will likely develop over time”.

• 6.131    IGP&I said that divestibility is achieved under existing systems “by contractual terms and by system software”.

6.132 In relation to DLT, HSBC said:

DLT rules can establish the consent principle, meaning that an electronic record can only be created and filed on the ledger (or chained to the blockchain) if both parties have consented to the change (i.e. the transfer). In this respect, the electronic record becomes immutable on the system and is outside of the control of the transferor.

• 6.133    WAVE BL explained:

On WAVEBL, using a blockchain dlt [distributed ledger technology] based ledger ensures that a token representing the unique possession over a document is transferred from the transferer to the transferee thus, ensuring control of the transferer over electronic documents has ended and transferred (without approval of the transferee) to the transferee.

• 6.134    Sullivan & Worcester LLP suggested that some clarification may be necessary:

In relation to cryptoassets, we understand that every time a digital document is transferred a new set of keys is issued, which, could mean there is effectively a new cryptoasset and the old one is destroyed, however it is still meant to be binding on the issuer. We would be interested in some clarification on the point and whether the Law Commission is expecting that the control element would mean that new keys or a new password were issued and until that were done, there was not adequate “control”. If that were so, then the possession would not have passed until control was achieved. Clearly, it would be helpful to have systems input at this stage.

Discussion and our recommended approach

• 6.135    Consultees provided helpful responses explaining how, in practice, existing systems ensure that an electronic trade document is divestible, and that control is lost by the transferor when the latter effects a transfer or disposal of the document. Consultees explained that how divestibility is achieved depends on the underlying technology of the system, and its functionality. Consultees also reinforced the importance of the Bill remaining technology neutral is this regard.

• 6.136    In relation to Sullivan & Worcester LLP’s point, in some systems, when a cryptoasset is transferred or “spent”, the specific data comprising the cryptoasset is consumed and replaced by new data (or is updated or modified) on each transfer.⁴⁹³ As such, the “same” cryptoasset does not persist through a transfer. However, the notional quantity unit does.⁴⁹⁴ Similarly, in account-based systems, adjustments in balances in accounts resulting from transactions mean that the pre-transfer cryptoasset and the post-transfer cryptoasset are not necessarily the “same” cryptoasset.

• 6.137    This issue also arises within the context of electronic trade documents, albeit in a slightly different way. We have noted above that a trade document in electronic form would likely comprise multiple parts: a human readable part and a data string or data structure.⁴⁹⁵ On transfer, the data structure that forms part of the “document” will cease to have value or function. Post transfer, any human readable element of the “document” will instead be related to a new (or derivative) data structure.

• 6.138    In those cases, we recognise that a transfer “on-chain”, or within the electronic trade document system, might necessarily include a different process to a physical transfer of a paper trade document. In particular, a transfer might include replacing, modifying, destroying, cancelling, or eliminating at least the data structure element of that electronic trade document, and the resulting and corresponding derivative creation of a new electronic trade document (a derivative electronic trade document).⁴⁹⁶ Nevertheless, we consider that such a transfer is capable of effecting a transfer of control of the document.⁴⁹⁷ Such a result preserves the equivalent legal functionality of paper trade documents and electronic trade documents, and is in line with the reasoning adopted in the digital asset project undertaken by the International Institute for the Unification of Private Law (“UNIDROIT”).⁴⁹⁸

SIXTH CRITERION: IDENTIFICATION OF THE DOCUMENT

Retention of copies

• 6.139    We understand that many of the existing systems in development allow users to retain access to copies of documents for their records. This may be particularly useful where parties wish to retain a copy after they have transferred or disposed of the electronic trade document itself. This is equivalent to a party being able to take a photocopy or scan of a paper document before it is transferred or disposed of, which does not interfere with possession of the original.

Our position in the consultation paper

• 6.140    In the consultation paper,⁴⁹⁹ we said that the ability to retain a copy of the electronic trade document after transfer or disposal would not prevent the divestibility requirement from being satisfied, and would not constitute retention of control of the document itself. We did not think it was necessary to make provision in the Bill for retained copies of electronic trade documents; there is no issue with taking copies in the paper world. Even so, we asked whether consultees thought that the ability to retain a copy of an electronic trade document upon transfer or disposal could lead to problems in practice.⁵⁰⁰

Consultees’ views

• 6.141    The majority of consultees did not think that the ability to retain a copy of an electronic trade document after transfer or disposal of the document would lead to problems in practice. ⁵⁰¹Even so, some consultees expressed concerns about whether the retention of copies of electronic trade documents in general would enable parties to exercise the rights associated with the original document more than once. For example, Minerva Global Ltd said that the key is to prevent multiple transmissions of the possession of the electronic document. Only one transmission of possession should be possible.

• 6.142    DCSA was of the view that the retention of copies would not cause a problem provided that there was a clear separation between the original and the copy in terms of “use” rights and legal validity. Similarly, Legal Innovation Ltd did not consider that the retention of copies would create a problem so long as a copy did not give the holder “any rights to give instructions to the system”.

• 6.143    In the DLT context, Rio Tinto Commercial noted:

In a DLT system, what actually should matter from a legal perspective is the most recent validated record in the ledger which shows who the current holder is (because that holder will have the power to sign the next transaction e.g. to use or transfer the document). The fact that someone has a copy of the content of the document from a previous time or has a copy of an earlier part of the ledger would have no legal effect.

• 6.144    Professor Bridge agreed that “there is no immediate problem” if a copy is for a record only, and “no practical steps in relation to it can be taken by the person retaining it”. BILA answered similarly, saying that they could “see no problems with this proposal if ‘retaining a copy’ of an electronic trade document does not constitute retention of control of the trade document itself”.

• 6.145    Several consultees said that it would be important to ensure that an original electronic trade document and its copy were easily distinguishable. For example, WAVE BL said:

Nevertheless, it should be stated the actual file held by one as a copy and another as the unique documents would appear to be the same file. Similarly, to copying a PDF file without the ability to distinguish which file was the original one the copy was made of. It isn’t possible without the ledger.

• 6.146    Matthew Wright from the UK Chamber of Shipping (who responded in a personal capacity), and other consultees including Sullivan & Worcester LLP and IGP&I, all answering “other”, agreed that there should be a way of identifying that an electronic trade document is a copy. The Centre for Commercial Law at the University of Aberdeen said that the system should ensure that users can only view, and not edit, the copy. The LMAA said, “If the document, when downloaded, looks like the original, that is clearly a concern and that would be unacceptable”. Enigio Time AB said that all original electronic documents must fulfil the “requirement of singularity”, which means that it must be possible to distinguish a copy from an original.

• 6.147    DSCA noted that different parties should be able to hold copies of an electronic trade document without control or the ability to alter its contents.

• 6.148    Phillips 66 Ltd and Bolero International Ltd, answering “no”, and Vale International SA and Sullivan & Worcester LLP, answering “other”, said that the ability to retain a copy would be useful or even necessary for internal record keeping and compliance and audit purposes. Sullivan & Worcester LLP said that it should “still [allow] for contractual confidentiality between parties”.

• 6.149    Enigio Time AB and Minerva Global Ltd both said that retaining a copy would be useful. For example, Enigio Time AB said that a “verifiable copy” could be useful if the electronic trade document were to be lost.

Discussion and our recommended approach

• 6.150    After considering consultees’ responses, we remain of the view that there is no need to make explicit provision for retaining copies of electronic trade documents in the Bill. While we agree with consultees that retaining copies is likely to be useful in practice, we do not think there is anything in the Bill that prevents different parties from doing so. Holding a copy would not constitute an exercise of control for the purposes of the Bill. The ability to retain a copy of the document after transfer or disposal would therefore not prevent the divestibility requirement from being satisfied, and would not constitute retention of control of the document itself.

• 6.151    However, after considering consultees’ feedback, we now consider it necessary to include, as part of the gateway criteria, a requirement that a trade document in electronic form is identifiable so that it can be distinguished from any copies. We think that further drafting is required to ensure that copies of electronic trade documents do not enable “double spending” or use of the copy as the original. We acknowledge the importance of being able to determine which is “the document” and which is a copy in order to ensure that double spending does not occur. In addition, even though any system that supports electronic trade documents is likely to, as a commercial imperative, be designed to ensure this result, we think the Bill should provide for it expressly. This is especially so given the centrality of avoiding double spending in our recommended reforms. We note also that the MLETR contains a provision to this effect.⁵⁰²

Recommendation 16.

• 6.152    In order to qualify as an electronic trade document, a document in electronic form must be identifiable as “the document” so that it can be distinguished from any copies.

The Bill provisions

• 6.153    This requirement is captured in clause 2(1)(a) of the Bill. It provides that:

• (1)    A qualifying electronic document is an “electronic trade document” for the purposes of this Act if a reliable system is used to —

• (a) identify the document so that it can be distinguished from any copies ...

SEVENTH CRITERION: IDENTIFICATION OF THE PERSONS WHO COULD EXERCISE CONTROL OF A DOCUMENT IN ELECTRONIC FORM

• 6.154    In addition to the criteria discussed above, we now think it is necessary to include an additional requirement for a document in electronic form to qualify as an electronic trade document for the purposes of the Bill. This additional criterion is intended to capture the idea that the system in question should be capable of allowing for the identification of any person who is able to exercise control of the document, regardless of whether any person is in fact exercising that control.

• 6.155    This requirement reflects the association between the trade document in electronic form and the person or persons who are able to exercise control of that document. It ensures that, for a trade document in electronic form to qualify as an electronic trade document, the document is capable of being uniquely associated with the person or persons who are able to exercise control of it. Depending on the underlying technology, this association could be achieved by the system linking the trade document in electronic form with a particular address or security credentials, and a person being able to demonstrate that they have the relevant security credentials or other means of control. We did not include such a requirement explicitly in the consultation Bill but, on further reflection, we think an express requirement to this effect is necessary to give proper effect to our policy on control.

• 6.156    We do not mean that, by looking at the system itself, it should be possible to see who could exercise control. Rather, we mean that, if asked to evidence their ability to exercise control, a person could prove this on the system. For example, if three people have access to the private key to a document, the system should allow each of those three persons to identify themselves as persons who are able to exercise control by showing or using their private key.