Law commission

The Law Commission’s consultation paper on digital assets, including the proposal for a third category of personal property to cover crypto-tokens and other digital assets

The Law Commission for England and Wales has launched a major and detailed consultation on proposals to ensure the law recognizes and protects digital assets, which include crypto-tokens, cryptoassets and non-fungible tokens (NFTs).

In this article, we provide our readers with a high-level overview of some of these proposals, which include (1) the creation of a third category of personal property, and (2) that the concept of control, rather than the concept of possession, should apply to data objects.

The first of these proposals would be a radical departure from more than a century of case law which recognizes only two categories of personal property. The Law Commission’s consultation was prepared after the UK government asked it to review the law on digital assets to ensure they can continue to be protected as they evolve. Digital assets continue to take on a more important role in today’s society, are used for more and more purposes, and the UK government has recently announced its intention to make the UK a global hub for cryptoassets.

We encourage our readers to read the consultation paper (which can be viewed in its entirety, here, and in a 20-page summary, here) if they wish to understand all of the Law Commission’s proposals relating to digital assets.

Data objects: the third category of personal property

The central proposal of the consultation is the explicit recognition in law of a third category of personal property to ensure that the law recognizes and protects digital assets.

Traditionally, the law of England and Wales has recognized two categories of personal property: things in possession and things in action. The addition of a third category of movable property would therefore be a radical break with the case law adopted since 1885.[1].

The Law Commission argues that digital assets often do not fit neatly into either category because they are neither tangible (in the normal sense) nor claimable or enforceable through legal action, although it recognizes the possibility that digital assets may fit into a broader category. things in action.

The Law Commission therefore proposes a third category of personal property, “data objects”, which, it specifies, “will better allow the law to focus on the attributes or characteristics of the things in question, without being stymied by analysis or principles applicable to other types of movable property.” The consultation also highlights the strong support for this proposal from some academics and market players and the fact that the proposal would be in line with international law reform in this area.

To qualify as a data object, the Law Commission proposes that a thing must:

  1. be composed of data represented on an electronic medium;

  2. to exist independently of people and to exist independently of the legal system; and

  3. be rival (that is, if one person’s use of a thing prevents another person from using that thing at the same time).

Data represented on an electronic medium:

In order to distinguish between things in possession, the Law Commission proposes that, to qualify as a data object, a thing must consist of data represented in an electronic medium, such as in the form of computer code, electronic, digital or analog signal.

Existence independent of people and independent of the legal system:

The Law Commission’s second criterion can be divided into two parts: (1) the requirement that a thing exists independently of people and (2) the requirement that a thing exists independently of the legal system.

The purpose of the first element is to differentiate a data object from those things that are not separable from people, such as “body parts (not separated), friendships or thoughtswhich are generally not suitable for property rights.

The purpose of the second element is to ensure that actionable things (things that can be claimed or enforced by legal action, such as a bank’s cash balance) and other types of property created by legislation (eg intellectual property rights) cannot be classified as a data object. In contrast, the Law Commission states that data objects “exist independently of (and cannot be created or extinguished by) legal rules. Nor are data objects solely enforceable by legal action or proceeding.

Rival :

Rivalry refers to the ability of the possessor of a thing to prevent the use of that item by another. For example, in ordinary situations, your enjoyment of the fresh country air would not prevent another from enjoying that same air. However, if you were to eat an ice cream while walking around the countryside, no one else could eat that same ice cream. Ice is rival while air is not.

The consultation argues that rivalry is essential for things to be seen as objects that attract property rights.

Transferability:

Assignment can, very fundamentally, be referred to as the ability of an asset to be transferred to another and for the assignor to no longer be in possession of that thing.

Interestingly, although the Law Commission recognizes that objects of property rights are, in general, necessarily assigned upon transfer, it concludes that assignment should not be a requirement for a thing to be recognized as an object of data. On the contrary, the consultation report indicates that the assignment is rather “a useful indicator to know if [the object] will meet the other criteria”.

The main reason for this is to ensure that the law remains flexible and able to adapt to the nuances of certain digital assets that cannot be transferred. Mandating divestiture could therefore inhibit innovation in the digital asset space. The consultation suggests that this is consistent with how assignment is more generally seen as a feature of property rights.

Control of possession: another potential area for law reform:

Besides creating a third category of property rights, the Law Commission is also discussing other areas where legal certainty of digital assets can be achieved. To demonstrate this, the Law Commission considers the application of existing practice by reference to crypto-tokens, which it says would be classified as a data object. Accordingly, for reference, the Law Commission provides a non-exhaustive and non-determinative definition of crypto-tokens and invites comments from those consulted, who may be consulted and commented on. here.

Law of possession – potential problems applying to data objects:

We often hear that possession is nine-tenths of the law. This is certainly true in movable property law which, for material objects, employs the concept of possession.

However, the Law Commission suggests that, for a variety of reasons, the concept of possession does not apply well to digital assets.

Firstly, the consultation points out that since crypto-tokens have generally evolved due to a failure of market practices, the idea of ​​trying to enshrine crypto-tokens in a legal framework based on maintaining the status quo may seem reductive by its very nature. Further, he points out that market practice would by no means apply possession to all data objects, as the notion of possession only applies to tangible assets. Accordingly, the Law Commission considers that market practice with respect to data objects such as crypto-tokens has developed without focusing on the right of possession and any attempt to integrate data objects. in this context”would be very likely to undermine, confuse and potentially fracture the complex, sophisticated and varied legal structures that crypto token markets have developed over the past 13 years”.

Another disadvantage of the notion of possession in relation to crypto-tokens highlighted by the consultation is the fact that it is also likely to be interventionist, given that the evolution of the law has fundamentally been made on the basis of transactions with tangible assets.

Among other things, the Law Commission also suggests that extending the concept of possession to data objects “further complicate an already complex legal conceptand that the key elements of the concept of possession apply less to data objects than to tangible assets.

The alternative – control as a factual concept:

As an alternative, the Law Commission proposes the development of a new concept that would be more finely tuned to the complexities of data objects while retaining the positive aspects of the right of possession: the concept of control. Here, the Law Commission explains: “whether a person controls a data object should depend on the factual ability to determine the person’s use of that data object, rather than the legal rights that person may have in relation to that data object.” Accordingly, the concept of control can be understood to be functionally similar to the concept of possession, without the requirement of intent.

The Law Commission suggests that this proposal “strikes the best balance between creating legal certainty for the market and maintaining the dynamism and flexibility that characterizes English and Welsh law in relation to the facilitation and development of new technologies.”

However, the Law Commission recognizes that the concept of control alone may not be sufficiently nuanced to adequately address complex legal mechanisms and arrangements (including transfers of crypto-token ownership, custodial agreements, Warranty and Operation Causes of Action and Remedies). Instead, he says, the concept of control would be best used as part of how these arrangements are structured or envisioned.

Comment:

The Law Commission’s consultation paper is an in-depth work that seeks to tackle a host of legal issues that affect digital assets. It takes us through a journey from first principles to the day-to-day reality of owning and trading digital assets. The English courts have been at the forefront of addressing some of these issues, as they have been approached by parties seeking remedies over recent years. (You can find our extensive coverage of these decisions in a number of articles published by the team, below.[2])

However, it is recognized that there are still many unanswered questions, and it would greatly assist the development and adoption of digital assets to have clarity on the applicable legal principles. Whether this clarity comes from creating a parallel regime for digital assets, or from accepting that digital assets fall under already established legal principles, is a debate that is likely to divide opinion. What is clear, however, is that the Law Commission is leading the way to certainty.

Market participants are encouraged to respond to the Law Commission consultation by Friday 4 November 2022. A full list of Law Commission consultation questions can be found on pages 468 to 482 of the consultation document here.