The Role of the NFTS in the Metaverse: Litigating Nft Disputes – Part II | Fox Rothschild LLP

In our first part, we discussed the technological basis of NFTs. Next, we turn to the legal issues, which are sure to be raised in any NFT lawsuit.

NFT’s intellectual property rights

Patents, copyrights, trademark ownership and individual publicity rights are all IP rights that exist in the underlying asset that comprises the NFT. These underlying IP rights exist “off-chain”, that is, the IP rights are separate from the NFTs. The IP rights may or may not be transferred when an NFT changes ownership, depending on the way the NFT is structured.

In the United States, the general rule is that an intellectual property right is not transferred unless the patentee, copyright owner, or trademark owner clearly states that it is a transfer in a signed writing. Various federal laws govern this process. Specifically, 35 USC §261 provides that “[a]Applications for patents, patents, or any interest therein, shall be transferable by operation of law by instrument in writing.” Furthermore, 17 USC §204(a) allows “[a] transfer of copyright … is not valid unless a document of transfer, or a note or memorandum of the transfer, is in writing and signed by the owner of the rights.”

As such, the IP owner will often retain ownership of their copyrights to the underlying asset, and only grant a license to allow others to use or display the image of their original work for a limited purpose and over a specified period of time. A copyright license is a simple written contract that allows the IP owner to control how their work images are used, displayed and monetized by others.

NFTs do not change these basic principles. Any image linked to NFT will require a certain degree of IP owner/holder approval. Since we are still dealing with “regular” IP rights, it is important to recognize that NFTs still pose a significant infringement risk. Copyright infringement will occur if works are copied, sold or otherwise displayed publicly without the proper permission of the copyright holder. Since anonymous minting of fake NFTs is on the rise, this is a particular problem. Trademark infringement may occur if customers are confused about the source or sponsorship of NFT. Similarly, design patents will be infringed if the designs are substantially similar, and an individual’s right to publicity can also be infringed if the NFT depicts individuals.

Are NFTs securities?

NFTs are not definitively considered securities simply because there is a question of whether they are securities. In fact, to determine whether an NFT would fall under this securities rubric, each NFT must undergo a specific fact-intensive review.

This review determines whether the NFT is an “investment contract,” a type of security under federal law. To begin with, we need to focus on not only NFT, but also the NFT transaction. Also, those who sell NFTs – if they are considered securities – must also register as a broker-dealer or obtain some exemption from the broker-dealer registration requirements.

These questions are decided by a review of case law, particularly SEC v. WJ Howey Co., 328 US 293, 301 (1946). In the WJ Howey Co. case, the US Supreme Court considered the “investment contract” parameters of an instrument under the Securities Act of 1993, looking at four criteria: investment of money; in a joint enterprise; with an expectation of profit; and to be derived solely from the management efforts of others. Essentially, if it’s not money, it’s a gift. Furthermore, if there is no expectation of profit, it is a product. Likewise, if there is no joint venture, it is a collectible, while if there is no third-party effort, it is a commodity.
As such, NFTs run both regulatory risk as well as private securities litigation. Yet the law remains unsettled, and cases continue to fester through both arbitration and federal and state courts.

NFTs and contract law

As described above, the NFT rights are defined in a smart contract on the blockchain platform. Traditional contract law still applies to the transaction. As such, the NFT seller must offer the NFT’s title to the NFT buyer. Furthermore, ownership does not pass until the NFT buyer accepts the terms of the contract. The NFT buyer must also provide consideration, i.e. ensure that payment is made and/or carried out as required by the seller.

Also, since NFT remains tied to the blockchain and the smart contract. Any subsequent transactions are usually controlled by the smart contract, or by code programmed into the NFT.

Arbitration of NFT disputes

Arbitration of NFT disputes may be the most effective way to deal with these matters. The parties can choose arbitrators with technical and legal credentials. Arbitral institutions and neutrals are adaptable. Arbitration is a private matter.

Arbitration can be tailored to meet the unique needs of the parties with speedy resolution. Designation of an independent international arbitration institution avoids the impression of bias in domestic law. The New York Convention for the Enforcement of International Arbitral Awards and the dispute settlement provision are critical.

An example of a dispute resolution provision follows:

(d) Conduct of Arbitration and Arbitration Rules. The arbitration will be conducted by the American Arbitration Association (“AAA”) in accordance with its Consumer Arbitration Rules (“AAA Rules”) then in effect, except as modified by this Agreement. The AAA Rules are available at www.adr.org or by calling 1-800-778-7879. A party wishing to initiate arbitration must submit a written demand for arbitration to the AAA and provide notice to the other party as specified in the AAA Rules. The AAA provides a Demand for Arbitration form at www.adr.org. Any arbitration hearings will take place in the county (or parish) where you live, unless we both agree to a different location. The parties agree that the arbitrator shall have exclusive authority to decide all questions relating to the interpretation, applicability, enforceability and scope of this arbitration agreement.

(e) Arbitration Costs. Payment of all filing, administrative and arbitration fees will be governed by the AAA Rules, and we will not seek to recover the administrative and arbitration fees we are responsible for paying, unless the arbitrator finds your dispute frivolous. If we win arbitration, we will pay all of our attorneys’ fees and costs and will not seek to recover them from you. If you prevail in arbitration, you will be entitled to an award of attorneys’ fees and expenses to the extent provided under applicable law.

This provision fits all “bells and whistles” to ensure coverage in all cases in an arbitration. The parties can be relied upon to effectively resolve their disputes.

Conclusion

In sum, NFTs present a myriad of questions that court cases will shed light on. Choosing an efficient and effective forum to resolve these matters is critical given the myriad of issues both legal and factual for NFTs.

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