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England and Wales Legal Commission Proposes Classification of NFTs as Data Objects | Latham & Watkins LLP

Latham & Watkins LLP

Creators and consumers of NFTs should evaluate the legal and commercial aspects of NFTs related to copyright.

The Law Commission for England and Wales (the “Commission”) is a statutory independent body that enforces the laws of England and Wales and recommends reforms if it believes they are necessary. The Commission recently published a public consultation paper on digital assets, which closed on November 4, 2022. One of the key proposals in the document is the recognition of a third category of personal property, designated as “data objects”.

This category differs from the existing two categories of personal property:

  • Items in possession (any object that can legally be owned, such as a car)
  • Things in action (any personal property that can only be claimed or secured through legal action or legal proceedings, such as the right to sue for breach of contract)

A digital asset falls within the Commission’s proposed definition of a data object if it:

  • consists of data presented on an electronic medium, including in the form of computer code, electronic, digital or analog signals;
  • exists independently of individuals or the legal system; as well as
  • is adversarial, which means that one person’s use of the resource necessarily impairs the ability of others to use it at the same time.

The Commission concludes that crypto tokens (including NFTs) satisfy the proposed criteria for data objects and are objects of ownership. This post does not analyze the proposed criteria for data objects, but rather explores the implications for NFT of classifying data objects as proposed by the Commission.

What does the classification of NFTs as data objects mean?

The Commission notes that NFTs are likely to play an increasingly important role in today’s online interactions. The Commission also notes that, as a starting point, the NFT is a crypto-token that is itself capable of attracting personal property rights, and that NFTs allow exploration of how these rights can coexist with intellectual property interests.

The consultation paper distinguishes between a crypto token as an object of personal property rights and other things external to a crypto token that may be associated with a crypto token. The Commission uses the Bored Ape Yacht Club NFT to illustrate this difference. For example, an NFT contains internally written information that points to information written externally to a crypto token (for example, Bored Ape Yacht Club NFT refers to an image of a cartoon monkey that is stored on a public file system). Against this backdrop, the Commission is investigating some of the common or potential misconceptions about NFTs (namely, copyright and royalties), which are summarized below.

Copyright – Assignment and Licensing

Many NFTs are not copyright related. However, for NFTs that are linked to a copyrighted work, such as the Bored Ape Yacht Club, which links to an image of a cartoon monkey, the link may work in such a way that the transfer of the NFT itself results in the transfer of copyright in the copyrighted work. law (although such translations are relatively rare). Under English law Section 90(3) of the UK Designs and Patents Copyright Act 1988 requires that a copyright assignment be “signed in writing by or on behalf of the assignor”. How an NFT transfer, which is also intended to transfer the copyright of a copyrighted work, works in the blockchain space is unclear. However, the Commission has previously noted that the common law takes a pragmatic approach to the electronic execution of transactions and that digital information presented or displayed on a screen satisfies the broad definition given to “writing” in the 1978 Interpretation Act.

Thus, to the extent that the transfer of an NFT (which is related to any underlying copyrighted work) is also intended to transfer copyright to the purchaser, due regard should be given to the formalities required under English law.

However, what if the intent is for the copyright of a work to remain with the original creator of that work, rather than being transferred to the NFT purchaser? The typical approach is for the content creator to license the use of the copyrighted work to the buyer of the NFT. What form does this license take and where can it be located? The Commission recognizes that this license can be structured in three different ways:

  • By a smart contract – a self-executing program code that may include certain licensing conditions. For more information about smart contracts and smart contracts law contracts, please refer to this Latham blog post
  • Through a license granted entirely separate from the NFT; for example, the license can be published on a website
  • Under license implied by the actions and/or views of the creator. However, with regard to the implied license, the Commission notes that a conservative starting point should be that the NFT does not automatically grant a license.

Regardless of how the license may or may not be granted or implied, the terms of the license remain an important consideration for creators to keep in mind when creating an NFT. Due consideration should be given to the scope of the license. For example, is it global or territorial, are there royalties paid, and what actions are NFT holders allowed to do with the main related content? Are they limited to displaying this content? Are they allowed to commercialize this content? Typically, the license can be broad or narrow, flexible or restrictive, at the choice of the content owner.

Royalty

The Commission also recognizes that the NFT contract may be designed in such a way that the original creator of the copyrighted work (and in some cases, who may also be the creator of the NFT itself) receives not only payment for their work after transfer, but also payment for each subsequent transfer between third parties. The advantage of this mechanism is obvious; it provides a revenue stream and opens up new opportunities for intellectual property monetization.

Typically, a royalty mechanism is built into a smart contract and is accompanied by a set of terms and conditions that secure royalties to the creator.

takeaway food

The NFT market is very innovative with many possible use cases for NFTs. For example, NFTs can represent ownership of digital assets or fractional ownership of an apartment, act as a ticket to a sporting event, and so on. However, while the Commission is not proposing any legislative reforms specific to NFTs (noting that English law currently provides flexibility for the development of law governing NFTs), it is imperative that creators, consumers or other participants operating in this ecosystem:

  • Understand the legal terms that must be included in the terms and conditions of the NFT.
  • Understand the regulatory framework surrounding NFTs
  • Assess the commercial considerations of the NFT that are associated with a copyrighted work, for example, what is the scope of a license for a copyrighted work?

In addition, at the time of writing, the Commission has launched a separate review commissioned by the UK government on how private international law applies to digital assets. Cases involving new technologies such as digital assets combined with distributed ledger technology have raised a number of conflict of law issues. For example, because digital assets are intangible and often distributed, their geographic location can be difficult to determine. This, in turn, can lead to uncertainty as to which courts have jurisdiction to hear the dispute and/or which laws should apply. The Commission intends to publish a consultation paper in the second half of 2023 to set out the current rules of private international law and, if necessary, make recommendations for reform.

This post contains public sector information licensed under the Open Government License v3.0.

Written by khirou

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