The Law Commission of England and Wales proposes to classify NFTs as data objects | Latham & Watkins LLP

NFT creators and consumers should consider the legal and commercial considerations of NFTs associated with copyrighted work.

The Law Commission of England and Wales (the Commission) is a statutory independent body which keeps the law in England and Wales under review and recommends reform where it determines that it is necessary. The commission recently published a public consultation document on digital assets that closed on 4 November 2022. One of the key proposals in the paper is the recognition of a third category of personal property, labeled “data objects”.

This category is distinct from the current two categories of personal property:

• Things in possession (any object that the law considers capable of being owned, for example a car)
• Thing in action (any personal property that can only be claimed or enforced through legal action or procedure, such as a right to sue for breach of contract)

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

• is composed of data represented in an electronic medium, including in the form of computer code, electronic, digital or analog signals;
• exists independently of persons or the legal system; and
• is rivalrous, which means that one person’s use of the resource necessarily exceeds the ability of others to make similar use of it at the same time.

The Commission concludes that crypto tokens (including NFTs) satisfy the proposed criteria for data objects, and are subject to property rights. This post does not analyze the proposed criteria for data subjects, but rather examines the implications for NFTs of being classified as data subjects under the Commission’s proposal.

What does it mean for NFTs to be classified as data objects?

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

The hearing note draws a distinction between a crypto token as the subject of personal property rights and other things outside of a crypto token that can be attached to the crypto token. The Commission uses the Bored Ape Yacht Club NFT to illustrate this distinction. For example, an NFT contains internally registered information that points to information registered externally to the crypto token (eg, the Bored Ape Yacht Club NFT links to an image of a cartoon monkey stored in a publicly accessible file system). Given this background, the Commission explores certain common or possible misconceptions in relation to NFTs (namely in relation to copyright and royalties), which are summarized below.

Copyright — Assignment and Licensing

Many NFTs are not linked to copyrighted work. For NFTs that are linked to copyrighted work, e.g. Bored Ape Yacht Club linking to an image of a cartoon monkey, however, the link may work so that a transfer of the NFT itself causes a transfer of copyright in the copyrighted work (although such transfers are relatively rare). Under English law, section 90(3) of the UK Copyright Designs and Patents Act 1988 requires an assignment of copyright to be “in writing signed by or on behalf of the assignor”. How transfers of NFTs that are intended to also transfer copyright to the copyrighted work work in the blockchain space is uncertain. However, the Commission has previously noted that the common law takes a pragmatic approach to electronic execution of transactions, and that digital information represented or displayed on a screen satisfies the broad definition given to “in writing” in the Interpretation Act 1978.

As such, to the extent that a transfer of an NFT (which relates to any underlying copyrighted work) is intended to also transfer the copyright to the purchaser, regard should be had to the formalities required under English law.

But what if the intention is that the copyright of the work remains with the original creator of that work, and is not transferred to a purchaser of the NFT? A typical approach is for the content creator to license the use of the copyrighted work to a purchaser 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 smart contract – self-executing software code – which may contain specific license terms. For further information on smart contracts and smart lawful contracts, see this Latham blog post
• Through a license granted entirely separate from NFT; for example, the license may be published on a website
• With a license implied by the actions and/or representations of the creator. However, with regard to the implied licence, the Commission notes that the conservative starting point should be that an NFT does not automatically grant a licence.

Despite how a license may or may not be granted or implied, the terms of the license remain an important consideration that creators should take into account when creating an NFT. Due consideration should be given to the scope of the license. For example, is it worldwide or territorial, are royalties payable, and what actions are NFT holders allowed to take with the underlying linked content? Are they limited to showing that content? Are they allowed to commercialize that content? In general, a license can be as broad or narrow, flexible or restrictive, as the content owner chooses.

Royalties

The Commission also recognizes that an NFT contract can be designed so that the original creator of the copyrighted work (and in some cases, who may also be the creator of the NFT himself) receives not only a payment for his work after a transfer, but also a payment for each subsequent transfer between third parties. The advantage of this mechanism is self-evident; it provides a revenue stream and opens new avenues for intellectual property monetization.

Typically, the royalty mechanism is built into the smart contract, and is accompanied by a set of terms and conditions, which contractualize the royalty payments to the creator.

Remove

The NFT marketplace is highly innovative with a myriad of possible NFT use cases. For example, NFTs can represent ownership of digital assets, or shared ownership of an apartment, or act as a ticket to attend a sporting event, and so on. While the Commission does not propose any legislative reforms specifically dealing with NFTs (noting that English law currently provides flexibility for the development of the law governing NFTs), it is imperative that creators, consumers or other participants operating in this ecosystem:

• Understand the legal terms that should be incorporated into the NFT terms
• Understand the legal and regulatory framework surrounding NFTs
• Consider the commercial considerations of NFTs associated with copyrighted work, for example what is the scope of the license to the copyrighted work?

Furthermore, at the time of writing, the commission has launched a separate review, commissioned by the British government, into how private international law applies to digital assets. Cases involving new technology, such as digital assets combined with distributed ledger technology, have generated 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 about which courts have jurisdiction to hear a dispute, and/or which laws will apply. The Commission aims to publish a consultation note in the second half of 2023 to set out the current rules of private international law and, if appropriate, make recommendations for reforms.

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