The Banking LAw Journal

An A.S. Pratt™ PublicAtion

February 2018

EDITOR’S NOTE: TECHNOLOGY
Victoria Prussen Spears
VOLUME 135 NUMBER 2

HAVING YOUR ELECTRONIC SIGNATURES AND INKING THEM TOO:THOUGHTS ON CONTINUING RELUCTANCE TO CLOSING COMMERCIAL LOANS
SOLELY BY ELECTRONIC MEANS
Edgar C. Snow, Jr.
BLOCKCHAIN TECHNOLOGY FOR LETTERS OF CREDIT AND
ESCROW ARRANGEMENTS
Koji Takahashi
A LENDER’S PRIMER ON LEVERAGED ESOPs AND RECENT LITIGATION
Fredrick C. Fisher, James C. Williams, Nancy G. Ross,
Christopher M. Chubb, and Richard E. Nowak
SENIOR LENDER CONSIDERATIONS IN RESPECT OF REPRESENTATION AND
WARRANTY INSURANCE IN MIDDLE MARKET PRIVATE EQUITY TRANSACTIONS
Cari Grieb

FEBRUARY 2018

LIBOR SUCCESSOR RATE PROVISIONS IN THE SYNDICATED LOAN MARKETDavid I. Schrodt

THE BANKING LAW JOURNAL
VOLUME 135

NUMBER 2

February 2018

Editor’s Note: Technology
Victoria Prussen Spears

73

Having Your Electronic Signatures and Inking Them Too: Thoughts
on Continuing Reluctance to Closing Commercial Loans Solely byElectronic Means
Edgar C. Snow, Jr.

75

Blockchain Technology for Letters of Credit and Escrow
Arrangements
Koji Takahashi

89

A Lender’s Primer on Leveraged ESOPs and Recent Litigation
Fredrick C. Fisher, James C. Williams, Nancy G. Ross,
Christopher M. Chubb, and Richard E. Nowak

104

Senior Lender Considerations in Respect of Representation andWarranty Insurance in Middle Market Private Equity Transactions
Cari Grieb

112

LIBOR Successor Rate Provisions in the Syndicated Loan Market
David I. Schrodt

118

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Editor-in-Chief, Editor & Board of
Editors
EDITOR-IN-CHIEFSTEVEN A. MEYEROWITZ
President, Meyerowitz Communications Inc.
EDITOR
VICTORIA PRUSSEN SPEARS
Senior Vice President, Meyerowitz Communications Inc.
BOARD OF EDITORSJAMES F. BAUERLE
Keevican Weiss Bauerle & Hirsch LLCBARKLEY CLARK
Partner, Stinson Leonard Street LLP
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Professor of Law, Wayne State Univ. Law School
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iii

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iv

BLOCKCHAIN TECHNOLOGY

Blockchain Technology for Letters of Credit
and Escrow Arrangements
Koji Takahashi*
In this article, the author considers the implications of the blockchain
technology for trade finance, in particular the letter of credit transaction
and the escrow arrangement.
The blockchain technology was invented to create the Bitcoin cryptocurrency around 2009. Since then, various types of blockchains have beendeveloped. In common to all of them, the technology generates, via a chain ofblocks, append-only ledgers, which are distributed on an online network andmaintains them in sync with each other without the involvement of any trusted
intermediary.
This article consists of five sections. The first section, “Two Aspects of theBlockchain Technology,” will highlight two particular aspects of the blockchain
technology that are relevant to the subsequent analysis. The second section,“Blockchain for the Letter of Credit Transaction,” will then examine theimplementation of the technology for trade finance, looking in particular atletter of credit transactions and, in the third section, “Blockchain for the Escrow
Arrangement,” escrow arrangements. This analysis will explore the question ofwhether the blockchain technology with its ancillary functionality brings about
any advantages over the current practice. Before concluding in the fifth section,“Recapitulation,” this article will consider in the fourth section, “The Potentialof the Multisig-Fortified Escrow Service for Making an Inroad into the Marketof the Letter of Credit,” whether an escrow service fortified with the blockchain
technology has the potential of making an inroad into the market of the letterof credit and other methods of payment.
TWO ASPECTS OF THE BLOCKCHAIN TECHNOLOGY
Blockchain Technology as the Distributed Ledger Technology
The blockchain technology creates and synchronizes distributed ledgers. It
dispenses with a central registry. For this reason, the technology is often referred
to as “distributed ledger technology” (“DLT”).
*

Koji Takahashi is a professor at the Doshisha University Law School in Kyoto, Japan. This
article is based on the author’s presentation at the conference “Supply Chain Finance and theChanging Landscape of International Trade” held at the Gothenburg University (Sweden) on
October 23, 2017. The author may be reached at ktakahas@mail.doshisha.ac.jp.

89THE BANKING LAW JOURNAL

Prior to the emergence of distributed ledgers, the conventional model ofkeeping an online record of transactions has been the central registry model (orthe hub-and-spoke model). Distributed ledgers have some advantages over thecentral registry model. Thus, whereas a central registry is under the surveillanceand control of its administrator, there is no single operator who has control over
distributed ledgers. The data in distributed ledgers is, therefore, censor resistant.
And, unlike the central registry model, there is no single point of attack or
failure. The data in distributed ledgers is, therefore, tamper resistant. Resistanceto censorship and tampering enhances the security and integrity of data. It also
results in saving costs incurred in the central registry model for establishing andmaintaining back-up databases.
Blockchain Technology for Trustless P2P Trading
The blockchain technology is not just about generating ledgers or a special
way of doing it. Its greater potential for disrupting the society lies in the factthat it creates an online platform which enables the trustless peer-to-peer(“P2P”) trading of cryptocurrencies and other tokens. The core innovation of
the Bitcoin’s blockchain relates to this aspect of the technology.1 Thus, while
the online transfer of a fiat currency necessarily involves a trusted intermediarysuch as a bank, the transfer of a cryptocurrency can be carried out on a P2P
basis.
Suppose that the parties to a sales contract have chosen a cryptocurrency as
the currency of payment for their contract. If they opt for a method of payment
such as the direct advance payment or the open account, they can send andreceive payment on a P2P basis without the involvement of any intermediary.
However, it is important to acknowledge that even the payment of acryptocurrency necessarily involves an intermediary if the parties wish to avail
themselves of services provided by a third party. Thus, if the parties to a sales
contract opt to use a letter of credit, the payment process necessarily involves
a bank as an intermediary. Again, if they opt to use an escrow service, an escrowagent necessarily gets involved as an intermediary. Accordingly, the payment of
a cryptocurrency cannot be executed directly from the buyer to the seller as long1

For any trading platform to work, it is essential to avoid the double spending of the same
token. That is possible in the central registry model since the administrator of the registry, beinga trusted intermediary, can keep track of all the transactions. The blockchain technology solves
the double spending problem without the involvement of any trusted intermediary by means ofan algorithm, which guarantees a single true version of distributed ledgers. For the Bitcoin’s
solution, see its foundation paper, Satoshi Nakamoto, “Bitcoin: a peer-to-peer electronic cash
system” (2008) 3, where it explains the concept “proof of work,” available at https://bitcoin.
org/bitcoin.pdf.

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BLOCKCHAIN TECHNOLOGY

as a letter of credit or an escrow service is used as the method of payment. All
the same, it is worth considering whether any ancillary function of theblockchain technology can render such methods of payment trustless or reduce
the required level of trust, an inquiry which this article will make at a few placesin the course of analysis in the second and third sections below.
BLOCKCHAIN FOR THE LETTER OF CREDIT TRANSACTION
Advantages as a Tool for Supply Chain Management
Some recent pilot projects for the de-materialization of the letter of credit
transaction envisage the use of blockchain. Their publicity materials describe
how it works in the following terms.
Each of exporter, customs, importer, insurance, and importer bank has
a representative node connected to a private blockchain which replicates transactional information as it occurs on the network. At any
given point in time, the ledgers across all nodes are in sync.2
When a shipment of assets crosses borders, it requires approval frommultiple legal entities, customs, port authorities and tracking and rail
firms. The blockchain can be used to sign their approvals, notifying all
parties that the assets have arrived.3
From these descriptions, it appears that those projects seek to tap into the DLT
aspect of the blockchain, as detailed above. As a tool for supply chain
management, distributed ledgers will offer some advantages. Thus, by allowing
the relevant information to be shared among the stakeholders, distributed
ledgers increase the visibility and traceability of goods. A caveat is that it isneither necessary nor appropriate for all the trade-related information to beshared by all stakeholders. Another advantage of distributed ledgers is that they
are tamper-resistant. Another caveat is that the tamper-resistance of the ledgers
neither guarantees that the information which is fed into the ledgers in the firstplace is true nor does it ensure that the goods to which the information relates
are not to be tampered with. In spite of these significant caveats, the advantages
2

ING and Societe Generale Corporate & Investment Banking, “Easy Trading Connect,”available at https://www.youtube.com/watch?v=RLyiIXLEqg4 (July 14, 2016) (Last accessed on
October 25, 2017).
3

IBM Blockchain, “Streamlining Trade Finance with IBM Blockchain,” available athttps://www.youtube.com/watch?time_continue=20&v=JEYO8RuS4fM (January 12, 2017) (Last
accessed on October 25, 2017).

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might be big enough to warrant introducing distributed ledgers as a tool for
supply chain management.4
The focus of the present article is, however, different. It is to consider theadvantages of using the blockchain technology in the more specific context ofa letter of credit transaction. To examine this question, we need to break down
the stages involved in a letter of credit transaction. A letter of credit is issued bya bank at the request of the applicant-buyer and is transmitted to thebeneficiary-seller (Stage 1). In its simplest form, the seller then presents to theissuing bank the documents called for by the credit (Stage 2). The bankexamines the documents to see whether they are in conformity with the termsof the credit (Stage 3) and, if satisfied, makes the promised payment to the seller(Stage 4). The following subsections will examine those four stages in turn toconsider whether the blockchain technology will offer any advantages over thecurrent practice.
Issuance and Transmission to the Beneficiary (Stage 1)
Current PracticeAt the stage of issuance and transmission to the beneficiary, the dematerialization of a letter of credit is a well-established practice. By the end of
the 19th century, letters of credit were transmitted by telegraph. Today, the vast
majority of letters of credit are issued and transmitted by electronic means.5
A letter of credit is conducive to paperless issuance and transmission since it
is not a document of title. The UCP 6006 is also supportive of de-materialized
transmission. In Article 11(a) it provides that “[a]n authenticated teletransmission of a credit . . . will be deemed to be the operative credit . . . , and any
subsequent mail confirmation shall be disregarded.”
Advantages of Using Blockchain
Then, are there any advantages of using the blockchain technology in thecontext of issuance and transmission? One of the pilot projects for thede-materialization of a letter of credit gives an explanation in the following
terms:
It will take several days to arrive at the exporter . . . even if you use
4
In fact, some enterprises offering distributed ledgers as a supply chain solution are alreadyup and running. These include Everledger and Provenance.
5

James Barnes & James Byrne, “E-Commerce and Letter of Credit Law and Practice” (2001)
International Lawyer 23, 24.
6International Chamber of Commerce, Uniform Customs and Practice for Documentary
Credits: 2007 Revision (2006).

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electronic notification. However, by sharing the information across theblockchain network, you will be able to browse the information
immediately.7
One wonders, however, whether the more expeditious notification throughthe blockchain network as asserted in this passage is real since communication
by other electronic means can be equally instant.
Presentation of Documents under a Letter of Credit (Stage 2)
The Current PracticeIn the context of the presentation of documents, unlike in the context ofissuance and transmission, de-materialization is not well established in thecurrent practice.
Electronic presentations occasionally take place, using the platforms of thecentral registry model.8 Overall, however, paper presentations are still prevalent.
This is also reflected in the low rate of adoption9 of eUCP.10 The laggard
de-materialization seems largely due to the uncertainty over whether electronic
bills of lading are treated as the legal equivalent of paper bills of lading. A billof lading is a document of title embodying the right to claim the delivery of
goods from the carrier. However, unless the applicable law treats electronic bills
7
IBM Blockchain, “How Mizuho Bank Leverages IBM Blockchain for Supply finance,”
available at https://www.youtube.com/watch?v=FmhB83dCYzg (August 2, 2017) (Last accessedon October 25, 2017). NTT Data, too, makes a similar statement: “We have confirmed theusefulness of blockchain in trade finance by a demonstration which was the first ever in Japan.”(A translation by the present author from the original in Japanese.) Available at http://www.
nttdata.com/jp/ja/services/sp/blockchain/initiatives/ (Last accessed on October 25, 2017).
8

One of the organizations providing such a platform is Bolero (Bill of Lading Electronic
Registry Organization). It states on its website, “Bolero solutions offer a safer, smarter and fasterway to centrally manage letters of credit and electronic presentations. Buyers, sellers, banks andcarriers can electronically exchange letters of credit, electronic bills of lading, insurance certificatesand other trade documentation over a common digital network.” Available at http://www.bolero.
net/home/letters-credit-management/ (Last accessed on November 11, 2017). For the actual useof the Bolero platform, see e.g. “Bank of China and RBS move forward with Bolero” Trade
Finance (September 5, 2013).
9
See James Byrne, “The Four Stages in the Electrification of Letters of Credit” 3 (2012) Geo.
Mason J. Int’l Com. L. 253, 270; William Patrick Cronican, “Buyer Beware: Electronic Lettersof Credit and the Need for Default Rules” 45 (2013) McGeorge L. Rev. 383, 391. See also “KEB
issues first paperless LC under eUCP,” Trade Finance (December 1, 2010).
10International Chamber of Commerce, Supplement to the Uniform Customs and Practice forDocumentary Credits for Electronic Presentation (version 1.1 (2007)). It applies where a credit
indicates that it is subject to eUCP (Article e1(b)) and seeks to accommodate the presentation ofelectronic records alone or in combination with paper documents (Article e1(a)).

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of lading as equivalent to paper bills of lading, the buyer and the banks cannot
feel safe to rely on them. The past and present projects of electronic bills of
lading have been plagued by the absence of supporting legal environment.11 If
the legislators of many states adopt the UNCITRAL Model Law on Electronic
Transferable Records (2017), it would help create a favorable environment.12
Advantages of Using Blockchain
In the context of the presentation of documents, the DLT aspect of theblockchain technology seems to offer some advantages over the central registrymodel. As noted in the first section of this article, above, the use of distributed
ledgers enhances the security and integrity of data. Apart from the saving of costwhich it entails, the tamper resistance of the ledgers will be helpful to fulfil therequirement under the UCP 600 that “[a]t least one original of each document
stipulated in the credit must be presented.”13 The eUCP provides that thisrequirement is satisfied simply by presenting one electronic record,14 which
seems to add nothing. On a better interpretation, this requirement is met where
there exists a reliable assurance as to the integrity of the information it
contains.15 Distributed ledgers, due to their tamper resistance, are more suitableto provide a reliable assurance than a central registry.
The advantages of the blockchain technology seem, however, limited. As
noted above, the technology does not prevent false information from being fed
into the ledger. It should be noted that the most serious form of fraud in lettersof credit relates to the issuance of false documents16 rather than to tamperingwith documents after they have been issued.
11
For details, see Koji Takahashi, “Blockchain Technology and Electronic Bills of Lading”(2016) 22 Journal of International Maritime Law, pp. 202, 206. Its focus is on public blockchain
platforms (p. 204). After its publication, efforts to develop private blockchain platforms haveintensified on the part of financial industry. In fact, the points made in that article, including
those on legal issues but excluding those made in section 6 of that article, are also relevant to
private blockchain platforms.
12

For details, see Koji Takahashi, “Implications of the Blockchain Technology for the
UNCITRAL Works,” forthcoming from the UNCITRAL Secretariat, Modernizing International
Trade Law to Support Innovation and Sustainable Development.
13

Article 17(a).

14Article e8.

15

See Article 9(4)(a) of the United Nations Convention on the Use of Electronic
Communications in International Contracts (2005).
16

See e.g., Sztejn v. J. Henry Schroder Banking Corp., 177 Misc. 719, 31 N.Y.S.2d 631 (Sup.
Ct. 1941). In this case, the seller tendered a bill of lading and invoices describing the bristles as
called for by the letter of credit when in fact it had shipped cow hair and other rubbish.

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Most significantly, the legal hurdle to using electronic bills of lading cannot
be sidestepped by using blockchain.17 Until and unless a favorable legal
environment emerges, this problem will continue to plague both the central
registry model and the blockchain model.
Payment under a Letter of Credit (Stage 4)
Before turning to consider the examination of documents (Stage 3), it isanalytically convenient to consider payment under a letter of credit (Stage 4).
If, as is usually the case today, the parties to a sales contract choose a fiat
currency as the currency of payment for their contract, payment under a letterof credit is commonly effected by an electronic transfer. The use of theblockchain technology will add nothing in this context.
Where, on the other hand, the parties to a sales contract choose acryptocurrency as the currency of payment for their contract, the blockchain
network must be used to effect payment. If they opt to use a letter of credit, thepayment cannot be effected directly from the buyer to the seller since itnecessarily involves the issuing bank as an intermediary. All the same, it is worth
considering whether it is possible to render the letter of credit transaction atrustless method of payment by means of any ancillary function of theblockchain technology. The answer would be yes if, and this is a big if, it werepossible to automate the examination of documents since a computer code on
a blockchain, which may be called “smart contract,”18 could then be set to work
to trigger payment without any manual authorization by the bank. In the next
subsection, we will go back to Stage 3 and consider whether it is possible toautomate the examination of documents.
Examination of Documents (Stage 3)
The purpose of examining documents presented under a letter of credit is tosee whether they are in conformity with the terms of the credit. To consider
whether the examination can be automated, it is necessary to consult theprovisions of the UCP 600, which articulate the standard and tests for
examination. Some of the provisions lay down concrete tests for ambiguous
terms in a credit. Thus, Article 3 provides in the relevant part:17

The same point is made by John Sze “Blockchain: the next wave in trade finance,” available
at http://www.jtjb.com/all/2017/blockchain/ (Last accessed on October 26, 2017).
18
The expression “smart contract” is a misnomer. It is in fact a computer code stored on a
blockchain, triggered by transactions on it and reads and writes data in it: Gideon Greenspan,“Beware the impossible smart contract” (2016), available at http://www.multichain.com/blog/
2016/04/beware-impossible-smart-contract/ (Last accessed on November 14, 2017). Its relevanceto a “contract” (in the legal sense) only lies in the fact that it can automate the online executionof the part of a contract which says “if A happens, then do B.”

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For the purpose of these rules:. . .
Terms such as “first class”, “well known”, “qualified”, “independent”,“official”, “competent” or “local” used to describe the issuer of adocument allow any issuer except the beneficiary to issue that
document. Unless required to be used in a document, words such as“prompt”, “immediately” or “as soon as possible” will be disregarded.
The expression “on or about” or similar will be interpreted as a
stipulation that an event is to occur during a period of five calendar
days before until five calendar days after the specified date, both startand end dates included.
These provisions would facilitate the automation of document examination.
There are, however, provisions that would necessitate human interventions.
Thus, another part of Article 3 provides:
For the purpose of these rules:. . .
A requirement for a document to be legalized, visaed, certified orsimilar will be satisfied by any signature, mark, stamp or label on the
document which appears to satisfy that requirement.
The examination under this test could require the exercise of value judgment
and, therefore, cannot be automated. In addition, the provision in Article 14(e)is in the following terms:
In documents other than the commercial invoice, the description of
the goods, services or performance, if stated, may be in general terms
not conflicting with their description in the credit.
In contrast with the test for commercial invoice (Article 18(c)) which uses
the words “must correspond with,” this test calls for great flexibility. To
automate examination under Article 14(e), unless and until there are considerable advances in artificial intelligence, one would need to anticipate every
possible description of all possible goods. It must, therefore, be concluded thatthe examination of documents under a letter of credit cannot at present
realistically be automated.
Summary of This Section
Some pilot projects for the de-materialization of the letter of credit
transactions seek to tap into the DLT aspect of blockchain. However,advantages over the central registry model seem limited. Most importantly, thebiggest obstacle to de-materialization, namely the legal hurdle to electronic billsof lading, cannot be sidestepped by the mere use of blockchain.
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Even where the parties to a sales contract choose a cryptocurrency as thecurrency of payment for their contract, as long as they opt to use a letter ofcredit, the payment process necessarily involves a bank as an intermediary. An
ancillary function of blockchain, called “smart contract,” cannot be set to work
to render the letter of credit transaction a trustless method of payment since theexamination of documents cannot be automated.
BLOCKCHAIN FOR THE ESCROW ARRANGEMENT
Having examined the implications of the blockchain technology for the letterof credit transaction in the preceding section of this article, our analysis will
now turn to the escrow arrangement.
Escrow Arrangement
In general, escrow is an arrangement whereby, instead of sending money
directly to the payee, the payer temporarily deposits funds in the hands of athird party called an “escrow agent.” After confirming that the payee has
performed its side of the deal, the payer allows the escrow agent to release theescrowed funds to the payee. It is a method of payment used in a variety ofdealings such as real estate transactions and mergers and acquisitions.
In the context of a sale of goods, the arrangement usually works as follows.
The seller and the buyer first appoint an escrow agent whom they can trust. The
buyer deposits the purchase price in the account of an escrow agent. After
receiving the goods from the seller and inspecting them, the buyer authorizes
the escrow agent to release the escrowed funds to the seller. If the buyer rejects
goods for non-compliance with the sales contract, the escrow agent will act inaccordance with the terms of appointment. Thus, depending on the terms, heor she may return the escrowed funds to the buyer, or may hold the funds until
the dispute is resolved by arbitration or litigation and then follow theresolution, or also may act as an arbitrator to resolve the dispute.
The escrow service, namely the service provided by an escrow agent, has been
available to make payment in fiat currencies. Recently, some providers started
the service for the payment of cryptocurrencies. In fact, there is a reference toescrow in the Bitcoin’s foundation paper which states, “routine escrowmechanisms could easily be implemented to protect buyers.”19 For the paymentof a cryptocurrency, an address on the blockchain serves as an escrow account.
Risks of the Escrow Arrangement
The escrow arrangement requires the buyer to deposit funds with an escrowagent in advance of the seller’s performance. This leads to some risks. The
19

Satoshi Nakamoto, “Bitcoin: a peer-to-peer electronic cash system,” supra note 1 at p. 1.

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escrow agent may misappropriate the escrowed funds or a third party may steal
them. If an escrow agent becomes bankrupt, the escrowed funds may constituteproperty of the bankruptcy estate, unless they are deemed to be held in trust
under the applicable law.20 Furthermore, the seller may collude with an escrowagent to defraud the buyer, and vice versa.21
Those risks are real and may be the reason why the escrow arrangement is notas prominent a method of payment as the letter of credit in trade involving alarge sum of money. To guard against those risks, licensing and other regulatory
requirements are imposed on the providers of escrow services by some legal
systems,22 and include compliance costs. The analysis in the following
subsection will consider whether those risks can be removed or reduced with theuse of the blockchain technology.
The 2-of-3 Multisig
In 2011, a new addition was made to the scripting capabilities of the Bitcoin’s
blockchain, which enabled an ancillary function called “multisig” (or “multisignature”). The function is a species of “smart contract.” It is now also
implemented on the blockchains of other cryptocurrencies. While there arevarious permutations to multisig addresses, where a 2-of-3 multisig address iscreated, two digital signatures of the three associated public keys are needed tosend units of the cryptocurrency from that address to another address. This
makes it possible for three persons to have joint control over the same address
instead of one person having total control. Then, units of the cryptocurrency inthat address can only be sent if the transaction is signed by two of the three
20

In the United States, the bankruptcy estate is comprised of “all legal or equitable interestsof the debtor in property as of the commencement of the case” (11 U.S. Code § 541(a)(1)). The
existence of property interests is a matter for the applicable state property law. Under New Yorklaw, an escrow agent has neither legal title nor an equitable interest in the escrowed funds since
the latter are deemed to be held in trust: See In re Dreier LLP, 527 B.R. 126, 133 (S.D.N.Y.
2014). The upshot is that in the event of an escrow agent’s bankruptcy, the escrowed funds do
not constitute property of the bankruptcy estate. The same outcome cannot, however, beguaranteed under all legal systems.
21

Thus, in collusion with the seller, an escrow agent may release the escrowed funds to theseller without waiting for the buyer’s authorization. If, on the other hand, an escrow agent
colludes with the buyer, he or she may never release the escrowed funds to the seller.
22

See e.g., Division 6 of the California Financial Code; Ch. 7 of Title 6 of the Arizona
Revised Statutes. Such regulations may be interpreted as applicable also where the escrow accountaccepts a cryptocurrency. For example, s. 17003(a) of the California Financial Code mentions thedelivery of “money . . . or other thing of value” in defining the term “escrow.” See also
paragraphs (4) and (7) of s. 6-801 of the Arizona Revised Statutes which likewise mention thedelivery of “money . . . or any other thing of value.”98

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parties with control. Thus, where the parties to a sales contract choose acryptocurrency as the currency of payment for their contract and opt for theescrow arrangement as the method of payment, they may appoint an escrowagent and create a 2-of-3 multisig address, which they control jointly with theescrow agent.23
In a majority of cases where no dispute arises between the seller and thebuyer, they can both sign a transaction to send the escrowed funds either to theseller or to the buyer without any help from the escrow agent. Thus, they canboth sign a transaction to release the funds to the seller when the goods havearrived to the satisfaction of the buyer. On the other hand, where the sales
contract is amicably cancelled or terminated, they can both sign a transaction
to return the funds to the buyer.
Should a dispute arise between the seller and the buyer, there will be astalemate between them. But the escrow agent can break it by adding his or her
signature to a transaction to release the escrowed funds. Thus, depending on theterms of appointment, the escrow agent may add his or her signature to returnthe escrowed funds to the buyer, or may wait until the dispute is resolved byarbitration or litigation and then follow the resolution, or also may act as anarbitrator to resolve the dispute.
The fortification of an escrow account with the 2-of-3 multisig would reduceor remove the risks of the escrow arrangement outlined above. Thus, since
signatures of multiple parties are needed to release the escrowed funds, the riskof theft by a third party will be reduced. The risk of misappropriation by theescrow agent is removed since he or she cannot single-handedly release thefunds. In the event of the escrow agent’s bankruptcy, the likelihood of theescrowed funds constituting property of the bankruptcy estate will be no higher
than would be the case where the escrow account is unfortified with themultisig. The multisig fortification does not, however, remove the risk ofcollusion by the escrow agent with the seller or the buyer. Accordingly, the needfor a trusted intermediary is not eliminated. However, the reduction andremoval of the other risks associated with the escrow arrangement should justify
easing the regulatory requirements for the provision of an escrow service.24
Summary of This Section
Where the parties to a sales contract choose a cryptocurrency as the currencyof payment for their contract and opt for the escrow arrangement as the method
23

An escrow account fortified with the 2-of-3 multisig is actually used in some online market
places such as OpenBazaar.
24

For more about such regulatory requirements, see supra note 22.

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of payment, they may create an escrow account fortified with the 2-of-3
multisig. The multisig does not dispense with an intermediary because an
escrow agent needs to get involved to break a stalemate between the seller andthe buyer in the event of a dispute. The parties will need to find an escrow agent
whom both can trust because the risk of collusion is not eliminated by themultisig fortification.
The required level of trust in an escrow agent is, however, lower than would
be the case where an escrow arrangement is not fortified with the multisig
because the use of multisig reduces or removes other risks associated with theescrow arrangement. The reduction and removal of such risks should justify
easing the regulatory requirements for the provision of an escrow service.
THE POTENTIAL OF THE MULTISIG-FORTIFIED ESCROWSERVICE FOR MAKING AN INROAD INTO THE MARKET OF
THE LETTER OF CREDIT
The fortification of an escrow account with multisig will, by reducing andremoving risks, enhance the attractiveness of the escrow service. Moreover, if theregulatory requirements for providing escrow services are eased commensurately
with the reduced risks, the cost of compliance will be lowered, which willfurther enhance the attractiveness of the escrow service. This begs the question
whether the multisig-fortified escrow service has the potential of making an
inroad into the market of letters of credit and other methods of payment,
though this question will only surface if and when it becomes a widespreadpractice to choose a cryptocurrency as the currency of payment for the sale ofgoods.25 The following analysis will seek to answer this question by comparing
the escrow arrangement (with or without the multisig fortification) with othermethods of payment.
Comparison with the Direct Advance Payment and the Open AccountTransaction
The escrow arrangement purports to reconcile the conflicting needs of theparties to a sale: the seller wants to receive payment as early as possible whereas
the buyer wants to make payment as late as possible. As a method of payment,
it sits somewhere in the middle between the two ends of the spectrum, namely
the direct advance payment and the open account transaction.
25

It is beyond the scope of the present article to consider whether and when such a practicewill be established. But the stabilization of the value of cryptocurrencies will surely be aprerequisite.

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Compared to the direct advance payment, the escrow arrangement is amethod of payment more favorable to the buyer since the deposited purchaseprice is not released until the buyer approves the goods.
Compared to the open account transaction, the escrow arrangement is amethod of payment more favorable to the seller since the buyer has to deposit
the purchase price, which will not constitute property of the bankruptcy estatein the event of the buyer’s bankruptcy.26 In addition, the funds deposited are inthe (usually safe) custody of a trusted third party, namely an escrow agent.
Comparison with the Letter of Credit Transaction
Like the escrow arrangement, the letter of credit transaction sits somewherein the middle of the spectrum between the direct advance payment and theopen account transaction. Its rationale is the same as that of the escrowarrangement: it purports to reconcile the conflicting needs of the parties to asale. However, it strikes a balance between the conflicting needs differently fromthe escrow arrangement, as detailed below.
A letter of credit is subject to the well-established principle of independence.
It is reflected in Article 4(a) of the UCP 600, which stipulates, “A credit by its
nature is a separate transaction from the sale or other contract on which it may
be based.” The opposite is true with the escrow arrangement. Only after
inspecting and approving the goods, does the buyer authorize the escrow agent
release the escrowed funds.
By virtue of the principle of independence, a letter of credit is almost
equivalent to “cash in hand” for the seller and may be pledged as security forloan. It has earned the reputation as “the life blood of international commerce.”27
A side effect of the principle of independence is that it creates an opportunity
for perpetrating fraud on the underlying sale contract.28 On the other hand, theescrow arrangement allows the buyer to release the purchase price after
26
In the United States, it has generally been held under state laws that the debtor who hasplaced funds in an escrow account does not retain an unqualified interest in the funds, with theresult that in the event of the bankruptcy of the debtor, the funds do not constitute property ofthe bankruptcy estate under the federal law (11 U.S. Code § 541(a)(1). See supra note 20. For
a recent case, see LTF Real Estate Co. Inc. v. Expert S. Tulsa LLC, 619 Fed. App’x. 779 (10th Cir.
2015) (under Oklahoma law). For other cases, see Alan Resnick & Henry Sommer (eds) 5 Collier
on Bankruptcy ¶ 541.09[2] (16th ed.)).
27
As described in a number of cases, including United City Merchants v. Royal Bank of
Canada [1982] Q.B. 208, 250 per Griffiths L.J. (English Court of Appeal).
28

See supra note 16 for the facts of a seminal case, which established a parameter of theprinciple of independence.

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inspecting the goods and, therefore, leaves no room for this type of fraud,
though it is vulnerable to a different kind of fraud noted above.29
In terms of the nature of tasks undertaken, the issuing bank of a letter ofcredit acts as a reliable paymaster who skillfully performs the difficult task ofchecking the conformity of documents with the terms of the credit. An escrowagent, on the other hand, acts as a custodian of the purchase price who istrusted to release the escrowed funds in accordance with the terms of
appointment. Where an escrow account is fortified with the 2-of-3 multisig, theterm “custodian” is no longer apt to describe the role of the escrow agent. Thisis because the escrow agent can only release the escrowed funds with the helpof another person and because the other two persons can act together to release
the funds without the help of the escrow agent. An escrow agent’s role may,therefore, be better described as “moderator.” Unless he or she is asked toperform the role of an arbitrator, an escrow agent’s task is much simpler than
the task of the issuing bank of a letter of credit. Because the complexity of a task
is factored into the costs of services, an escrow service transaction can besignificantly less expensive than a letter of credit transaction.
The letter of credit transaction does not necessarily require the buyer to put
the purchase funds in the issuing bank in advance. The necessity depends on thecreditworthiness of the buyer and other circumstances. The escrow arrangement, on the other hand, invariably requires an outlay of deposit, which entails
various risks. As seen above, some of the risks are reduced or removed by thefortification of an escrow account with the 2-of-3 multisig.
Summary of This Section
The foregoing analysis reveals that as between the conflicting needs of theparties to a sales contract, the escrow arrangement strikes a balance in a way
different from other methods of payment such as the letter of credit, the open
account transaction, and the direct advance payment. Accordingly, it appeals to
the needs of traders different from those catered to by other methods of
payment. Although the multisig fortification would enhance the attractivenessof the escrow service, the basic practice remains the same. It follows that should
it ever become a widespread practice for the parties to a sales contract choose
a cryptocurrency as the currency of payment, an escrow service might gain someprominence with the use of multisig fortification, but is unlikely to makesignificant inroads into the market of the letter of credit and other methods of
payment.
29

See supra note 21.

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RECAPITULATION
Aside from the conclusions stated in the summary sections above, thefollowing observations may be offered in terms of the two aspects of theblockchain technology highlighted in the first section of this article.
The DLT Aspect of Blockchain
Some pilot projects for the de-materialization of the letter of credit
transaction envision the use of the blockchain technology. They seek to tap into
the DLT aspect of blockchain. The advantages of distributed ledgers, though
they come with significant caveats, might be big enough to warrant introducing
blockchain as a tool for supply chain management. In the more specific context
of the letter of credit transaction, however, the advantages of distributed ledgers
over the central registry model seem limited. Most significantly, the biggest
obstacle to de-materialization, namely the legal hurdle to electronic bills of
lading, cannot be sidestepped by the mere use of blockchain.
Blockchain for Trustless P2P Trading
The blockchain technology creates an online platform, which enables thetrustless P2P trading of cryptocurrencies and other tokens. Thus, if the parties
to a sales contract choose a cryptocurrency as the currency of payment for theircontract, they can send and receive payment on a P2P basis without the
involvement of any intermediary. However, even the payment of a cryptocurrency necessarily involves an intermediary if the parties wish to avail themselvesof services provided by a third party (such as the issuing bank of a letter of credit
and an escrow agent). Furthermore, even an ancillary function of theblockchain technology, which may be called a “smart contract,” cannot render
the letter of credit a trustless method of payment since the examination of
documents cannot be automated. Neither is the escrow arrangement rendered
trustless by the multisig fortification, a species of “smart contract,” since there
remains the risk of an escrow agent acting in collusion with either the seller orthe buyer. However, the multisig fortification lowers the required level of trust
in an escrow agent since it reduces or removes the risks associated with theescrow arrangement.

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