NFT Licensing: Three Mistakes to Avoid | HUB

Introduction

The non-fungible token, known as “NFT”, has risen to prominence in the digital asset market as a new asset class. NFTs had $17.7 billion in sales in 2021 alone. They have since garnered attention from celebrities, artists, luxury brands, and video game companies as a new way to monetize digital media.

However, successful commercialization of this asset class requires attention to intangible implications of NFT transactions. More importantly, ownership of an NFT does not equate to or necessarily imply ownership of the underlying associated IP assets. Although many in the crypto industry treat NFTs as if the media associated with NFTs are NFTs themselves, this is not always the case. The NFTs we discuss are separate digital assets tracked on blockchains that are associated with digital media assets stored on other computer systems. For this reason, robust IP licensing practices are necessary to ensure that those participating in NFT transactions do not become embroiled in costly litigation surrounding IP ownership and use, or disappointed by misunderstandings about what a buyer receives when purchasing an NFT.

In this notice, we identify three structural licensing errors that are common in the NFT industry. Those who wish to participate in the NFT industry should be aware of these mistakes and try to avoid them in their own NFT ventures.

Absence of license

Many NFT companies have failed to adopt and implement any licensing model. Without an explicit license, in the event of a dispute over the use or ownership of digital media relating to an NFT, the courts will apply common law contract and licensing principles, which can prove disastrous for both the NFT purchaser and the owners of the digital IP assets linked to NFT.

A core principle in contract law is that when a contracting party does not know, or has no reason to know, the contractual intention of the other contracting party, and the second party knows the intention of the first party, the first contracting party’s opinion will control the contract. This legal principle exposes IP owners to the risk of inadvertently losing ownership of the IP assets associated with their NFTs.

In practice, this might look like this: Lillian is a recognized digital artist and creates a collection of NFTs that showcase her digital art. She sells her NFTs online with no license terms attached. She is aware of the widespread misconception among NFT buyers that they are taking ownership of the IP rights in the NFTs they purchase, and she hopes this misconception increases the value of her NFTs. If accused in court, even if Lillian did not explicitly grant or transfer any IP rights, she could still cede them to buyers since she had reason to know that the buyers thought they were buying the IP rights.

This risk associated with confusion regarding ownership of IP is widespread and can also backfire. Just last year, a cryptocurrency-backed decentralized autonomous organization (DAO) bought a rare book for €2.6 million, with hopes of producing an animated series based on the book. The DAO assumed that ownership of the physical copy entitled them to the copyright and the right to produce derivative works. It did not, leaving the DAO in an unfortunate position, having invested heavily in the purchase of the book.

To avoid such confusion, NFT entities must, at a minimum, provide explicit license language in connection with the sale of their NFTs.

Implementation of an unenforceable license

Second, and perhaps the most pervasive licensing failure, is that some NFT firms offer explicit license language in connection with their NFTs, but fail to inform NFT purchasers of the existence or terms of the license. Without clear notice of terms, the license is likely to be ineffective and unenforceable. In other words, even if an NFT venture grants a license, each buyer must be able to accept the license terms, which is a necessary element to create a legally binding contract.

In most major NFT companies, the license terms are tucked away on a company’s website, which may not be where either the primary or secondary sales of the NFTs take place. Instead, such sales of NFTs often occur on NFT marketplaces such as OpenSea, where the inclusion of license terms is not required to buy or sell an NFT. In such cases, buyers may not even know that a license exists or where to find it.

If sued in court, a buyer can successfully argue that they are not subject to any license terms since they were unaware of the license or did not agree to its terms. Accordingly, any licensing restrictions on the use of intangible assets represented by the NFT, such as a restriction on commercialization of the asset, may be unenforceable. Moreover, the absence of a legally binding contract may result in the loss of IP ownership rights altogether.

As such, NFT undertakings must take steps to ensure that every sale of their NFTs is prominently accompanied by their license terms. This can be achieved by including licenses directly in the lists of NFTs, through click-wrap agreements, or perhaps through some mechanism that uses the NFT’s metadata. Some NFT marketplaces embed license terms directly into the listing, greatly reducing the risk of unenforceable licenses.

Lack of enforcement mechanisms in license

Third and finally, even if an NFT entity grants an explicit and conspicuous license, the terms may be implemented in a way that is nevertheless impossible or unenforceable.

Many prominent NFT companies adopt licensing restrictions that attempt to protect against copyright infringement, trademark infringement or other inappropriate use of the digital media content. In particular, an NFT Issuer may impose restrictions on the use of the Licensed NFT IP Assets to depict hatred, intolerance, violence or cruelty, or violate the rights of others; and using the NFT entity’s brand and other trademarks that may accompany the NFT in a manner that is inappropriate, likely to cause confusion or dilute, blur or tarnish the entity.

Such restrictions are essential with the increase in NFT adoption by luxury brands or other companies where protection of brand and public image is essential. However, a company’s NFTs can be purchased by completely unknown entities, perhaps in far-flung jurisdictions, and without codified mechanisms to enforce violations of license terms, violations, such as violations of license restrictions, can be extremely difficult to stop from a practical perspective.

To address these enforcement issues, NFT issuers can grant themselves administrative authority over the NFT smart contract’s code, allowing them to unilaterally change ownership of NFTs. For example, if an owner of an NFT issued by a luxury brand uses it to tarnish the brand’s image, thereby violating the terms of the license, the luxury brand, as contract administrators, can revoke ownership of that NFT, significantly reducing its potentially catastrophic damage to the brand. Such basic administrative authority would also enable the seamless return of stolen NFTs, which could help prevent situations like the one involving a stolen Bored Ape Yacht Club NFT that made headlines in the industry this spring.

Without these hard-coded mechanisms, licenses are only useful to the extent that they are enforced through litigation, provided that NFT holders can be identified. But in many cases the damage has already occurred long before any legal relief can be obtained. NFT firms should seek to avoid this outcome through basic, codified mechanisms that enable effective enforcement of license terms.

Conclusion

These three structural licensing failures are the growing pains of this brand new asset class. While there have yet to be lawsuits targeting these flaws, the law is clear: (1) explicit license terms reduce the risk of losing one’s IP rights, (2) purchasers must consent to conspicuous license terms in order for them to be enforceable, and ( 3) license terms must be practically enforceable to be valuable. As such, participants in the NFT industry and others looking to expand into the space must keep these issues top of mind and ensure that their businesses do not fall victim to such licensing failures.

We are grateful for the contributions to this publication from our summer associate Joshua Durham.