In our October 2021 blog “Possession as we (don’t) know it!”, we discussed the existing position under English law in respect of electronic trade documents and the scope for reform in light of the Law Commission’s consultation paper and draft legislation “Digital assets: electronic trade documents (2021) Law Commission Consultation Paper No 254”, published on 30 April 2021.

There have now been important new developments.

The consultation paper highlighted the fundamental “possession problem” for electronic trade documents: simply put, under English law, electronic trade documents, being intangible things, cannot be legally “possessed” and so cannot function like their paper equivalents.

Following analysis of responses to the consultation paper from industry participants and academics, on 16 March 2022, the Law Commission published its revised recommendations and draft legislation in “Electronic trade documents: Report and Bill No 405” (the “Report”). The Report has already been laid before Parliament.

Whether and to what extent the recommendations will be implemented remains to be seen; notably, UK Government has already said it intends to introduce relevant legislation when parliamentary time allows. In this blog post, we take a more in-depth look at the key issues and the Law Commission’s latest proposals.

What is the “possession problem”?

Under English law, certain types of documents widely used in trade, such as bills of lading, bills of exchange and promissory notes, do not merely evidence the rights and obligations recorded in them (as is ordinarily the case for documents setting out rights and obligations) but rather embody the right to claim performance of those obligations. As a result, documents falling in this category (called “trade documents” in the terminology adopted in the Report) that are in paper form are treated as tangible assets so that possession is required to claim performance of the obligations they represent.

This means that:

(a) The right to claim performance of the obligation embodied in a trade document can be transferred by the (physical) delivery (and, if necessary, indorsement) of the document;

(b) A person in possession of the trade document has their right in that document protected from legal interference in the same way as they would with any other tangible asset (eg. under the strict liability property tort of conversion, as well as by negligence);

(c) In case of interference, the measure of damages is the value of the obligation or right embodied in the trade document;

(d) To discharge the obligation contained in the trade document, the person who owes the obligation must render performance to the holder of the document; and

(e) To the extent they can be possessed, the trade documents are capable of being the subject of bailment, possessory security interests and wrongful interference.

However, the legal treatment of trade documents in electronic form is currently different. By virtue of OBG Ltd v Allan [2007] UKHL 21 and Your Response Ltd v Datateam Business Media Ltd [2014] EWCA Civ 281, a trade document in electronic form is intangible and, therefore, not possessable and capable of functioning as a paper trade document. This is the so-called “possession problem” in relation to electronic trade documents.

Despite the apparent legal obstacles to the functionality of electronic trade documents compared to their paper counterparts, electronic trade documents have long been used. Nevertheless, given the legal limitations, their use has so far required a contractual framework under which the parties agree that the transfer of an electronic trade document will put the transferee in a similar position to that of the holder of a paper trade document. Importantly, however, the rights arising from this contractual arrangement are binding only on the contractual parties and are not enforceable against the world at large (as is the case for the proprietary rights enjoyed by those in possession of paper trade documents such as a transferable bill of lading).

The proposed reform

So, what to do?

Against the backdrop of increasing demand for digitalisation in international trade and a rapid development of new technologies in the field, the Law Commission seeks to address the legal gap by proposing criteria for electronic trade documents, which, if met, would make such documents capable of being possessed as a matter of law and so subject, on that basis, to the same legal treatment as the (already possessable) paper trade documents.

The trade documents covered by the proposal are those in relation to which possession is relevant for a person to claim performance of an obligation. The Report (and enclosed draft legislation, called the “Draft Bill”) provides the following illustrative, non-exhaustive list: (a) bills of exchange, (b) promissory notes, (c) bills of lading, (d) ship’s delivery orders, (e) warehouse receipts, (f) mate’s receipts, (g) marine insurance policies, (h) cargo insurance certificates (section 1(2) of the Draft Bill). Instruments that are entered under a “relevant system” under the Uncertificated Securities Regulations 2001 and bearer bonds are expressly excluded from the proposed legislation (section 5(2) of the Draft Bill).

The “gateway criteria”

An electronic trade document must meet the following criteria in order to be capable of being possessed and, therefore, able to function like its paper counterparts:

1. Information contained in the document: insofar as certain paper trade documents have requirements (legal or customary) as to the information they must contain to qualify as trade  documents, a document in electronic form must contain the same information to qualify as an electronic trade document.

2. Reliability: an electronic trade document system must be reliable, particularly with respect to the security standards by which it operates.

3. Integrity: an electronic trade document must satisfy integrity requirements by way of sufficient protection against unauthorised interference or alteration.

4. Exclusive control: to qualify as an electronic trade document, a trade document in electronic form must be susceptible to exclusive control, i.e. only one person (or persons acting jointly)   must be able to exercise control of the document at any one time.

5. Divestibility: the transfer of an electronic trade document must necessarily entail a transfer of both the document and the ability to control the document, i.e. after the transfer, the transferor (or another party previously having concurrent control) should no longer be able to exercise control over the document.

6. Identification of the document: a trade document in electronic form must be identifiable so that it can be distinguished from any copies.

7. Identification of persons exercising control: a trade document in electronic form must be capable of being uniquely associated with the person(s) able to exercise control of it.

The Report does not propose any changes where the existing legal framework can appropriately regulate a matter or where an issue can be left to the interpretation of the courts.

For instance, once an electronic trade document is deemed (on the basis of the above criteria) capable of being possessed, the assessment of whether it is actually possessed will be made as a matter of the existing law: a person (natural or legal) would be presumed to be in possession of an electronic trade document when they have a sufficient level and type of control over it, and when this control is accompanied by the necessary intention. Moreover, no specific provision has been made for the signing of electronic trade documents to the extent that current law already accommodates electronic signatures.

The benefits and costs of reform

The Law Commission foresees that the reform will bring about significant benefits in the form of resourcing and operational costs savings and increased productivity. Efficiency is also anticipated to increase; industry consultees saw reduced loss of time and a reduction of shipments arriving before the necessary documentation as key gains.

The changes are expected to be especially keenly felt in commodities trades with long chains of sub-sales while goods are in transit, and when delays in the delivery of paper bills of lading can result in storage and demurrage costs.

The Law Commission is also optimistic about the increased security and transparency as a result of the shift to electronic trade, although some consultees were sceptical about whether the transition could significantly reduce fraud and urged against complacency.

The environmental benefit from the transition to electronic trade documents is expected to be significant given that an estimated 28.5 billion paper trade documents are used annually. However, this benefit is seen by some as potentially offset by the anticipated increased power consumption of technology systems hosting the electronic trade. Finally, the Law Commission sees potential benefits for SMEs, port operators, shippers and exporters/importers, as well as consumers, to the extent (as observed by the LMAA) that the supply chain parties pass on the benefits to end users.

On the other side of the ledger, transition costs resulting from the need to train staff on the new systems, develop new internal processes for dealing with documents and negotiate with trading partners could be high. Some consultees feared the transition to electronic trade documents could be partial, thus leading to two systems and subsequent inefficiencies, albeit in the short term. The Law Commission also identified a potential lack of interoperability between different platforms as another anticipated risk. Unsurprisingly, a number of consultees flagged that a lack of standardisation could affect the willingness of financers to adopt electronic trade documents. Finally, as already mentioned, the increased computational capacities expected to be required and the related rise in energy consumption of the platforms is thought to have a negative environmental impact.

From a legal perspective, given the uneven recognition of the validity of electronic trade documents across different jurisdictions and the incompatibilities that will arise in international trade as a result, but also in light of difficulties inherent to digital assets (such as the difficulty in ascertaining their geographical location), it will be interesting to see the Law Commission’s recommendations on conflict of laws and emerging technology, work on which is set to start in mid-2022. Equally, we anticipate with interest the Law Commission’s consultation, set to be published in the summer of 2022, on cryptoassets and other digital assets which will expand on the work undertaken on electronic trade documents, and specifically, will consider a further extension of the concept of possession to other digital assets.

Nevertheless, for now the Law Commission’s latest proposals on electronic trade documents represent a significant step towards updating and aligning English law with the rapid technological change which brings about the digitalisation of international trade.