In July 2022, the Law Commission published a consultation proposing certain reforms in relation to property rights and digital assets. The main recommendation of the consultation was to create a new category of assets, called data objects, to ensure that cryptocurrency and other forms of digital assets can be legally recognized as property. This approach builds on previous court rulings that crypto-assets could be property and be protected by injunctions, such as freezing orders. The consultation closes on November 4, 2022.
How is ownership currently recognized by law?
The law generally recognizes two types of property. The first relates to items in possession, which covers tangible and physical items. For example, cars and books would be possessions. The second category is things in action, which deals with issues such as contractual rights. This often includes rights such as copyrights and the right to sue another person.
How do crypto-assets fit into all of this?
Crypto-assets do not fit neatly into either ownership category. Crypto-assets are not tangible, which means they cannot be possessions. Crypto-assets are also not contractual rights, which means they are not things in action. Although it is possible for a crypto-asset to confer certain contractual rights (for example, the holder of an NFT can obtain certain copyrights), these contractual rights are distinct from the crypto-asset itself. In other words, the contractual right conferred by the crypto-asset can be protected as a thing in action, but the crypto-asset itself cannot be a thing in action.
This technically means that crypto-assets should not legally be recognized as property. However, courts in England and Wales were more pragmatic than this and realized that holders of crypto-assets would not be adequately protected if the crypto-assets could not be protected as property. As such, Commercial Courts have issued various rulings that crypto-assets should be protected as a third type of asset and be subject to injunctions, such as blocking orders – although this third type of goods has not been defined or specified (for more details on these decisions, please refer to our Blockchain blog posts here and here).
While these decisions were welcome, they are not absolute. These rulings were made only in interim injunction hearings, rather than a full trial. Additionally, the question of whether crypto-assets could and should be recognized as property was not properly debated in these hearings. Therefore, it is technically possible that a later higher court could decide that crypto-assets are not property following full litigation on the issue. As such, these Law Commission recommendations, if they come into effect, would be a welcome chapter in the ongoing saga over whether cryptoassets should be recognized as property.
What does the law commission propose?
The Law Commission has proposed introducing a third category of assets – called “data objects” – to create certainty that the law can protect crypto-assets and other digital items. The Law Commission recommends defining data objects based on the following three criteria:
- Data objects must be composed of data represented in an electronic medium, including in the form of computer code, electronic signals, digital or analog. This criterion is necessary to distinguish a data object from a physical possession. To use the example of a hard drive, the hard drive itself would be a physical item and therefore a thing in possession. However, the underlying data stored on the hard drive would not be a possession thing because this information is not a physical item. This first criterion would capture the underlying data stored on that hard drive and seek to protect it under this new ownership classification (assuming the other two criteria are also met).
- Data objects must exist independently of people and the legal system. This is especially important for differentiating data objects from things in action. An example of a thing in action is the right to sue someone. It does not exist independently of a person because the right will belong to a specific person and only that specific person can exercise that right. Nor does it exist independently of the legal system, because a trial actively requires the legal system. Conversely, a crypto-asset can exist independently of people and legal systems, as they can exist, for example, only on the blockchain. Blockchain theoretically exists outside the scope of any person and outside the scope of any legal system.
- Data objects must be rival. In general, a good is rival if the use of the good by one person necessarily affects the ability of others to make an equivalent use of it at the same time. The Law Commission gives the example of a book. If person A is reading a book, it is possible that person B is reading the same story but in a different copy of the book. As such, the book itself is rival, but the story is not rival. This can apply to crypto-assets because, if Person A holds a crypto-asset token and chooses to spend or redeem that token, Person B cannot use those tokens at the same time. An element being rival is a crucial characteristic for an element to be protected by property rights. It stands to reason that if something is not rival, it can be freely used by almost anyone at the same time and therefore does not warrant strict legal protection.
The Law Commission also considered including surrender as a fourth criterion. This would mean that the data object should be able to be transferred or disposed of. However, the Law Commission found that the second and third criteria made surrender an unnecessary addition because surrender would be a likely consequence of meeting those conditions. It was also noted that some tokens are non-transferable, and while assignment could be a useful indication of the characteristics of ownership, it would mean that non-transferable tokens would not receive proper protection.
How does the Law Commission recommend enforcing data object property rights?
As a general rule, the enforcement of property rights in things in action and things in possession depends on who is able to control the thing concerned. “Control” is a difficult concept in property law, and it’s not always clear who has control over something. Sometimes it might be the owner, but other times it might be the holder (assuming the two are not the same). There has been a very complicated literature and case law on what amounts to control and the process of identifying who has control.
The Law Commission notes that control concepts may not work for data objects. When it comes to crypto-assets, control is often determined by who holds the cryptographic key. This could lead to situations where the true owner of the crypto-asset is unprotected simply because their custodial wallet provider, or another third party, holds their cryptographic key on their behalf. Unfortunately, the Law Commission did not properly develop an alternative recommendation on how control should be treated with respect to data objects, and recommended leaving that to future case law to provide appropriate meanings. This could create a number of problems, including:
- Court decisions are often left to the discretion of the judge in question based on the facts and evidence available to him. It is entirely possible that a judge hearing a case one day may make a different decision than another judge hearing exactly the same facts and evidence on another day;
- It’s unclear when the case would be argued, if ever. As such, this notion of who controls the data object might be a hurdle that may never be resolved; and
- not all cases set a precedent, and the existence of different facts or evidence could lead to different courts and judges making different rulings, meaning that there would still be no certainty about what should be reviewed .
Did the Law Commission make any other recommendations?
The Law Commission made a number of other recommendations in the consultation paper, including:
- Ensure fairness darling defense is available with respect to data object transfers. This defense applies when a bona fide purchaser purchases an asset for bona fide value. The bona fide buyer would be able to retain the asset in the event of an ownership dispute, and the other party to that dispute would have to look to the fraudulent seller for a reward;
- Characterize crypto token custodial agreements as trusts (i.e. the custodian would hold the tokens in trust for the owner). The Law Commission recommends that such a trust operate so that the beneficiaries are equitable tenants in common. This means that each beneficiary would have a proportional right to the crypto-assets held in the trust;
- Allow courts to make monetary rewards in crypto-tokens. The reasoning is that in some crypto-asset cases, a crypto-asset reward would better reflect the loss incurred.
What are the next steps?
The consultation is open until November 4, 2022. After that, the Law Commission would need time to review the responses and develop its policy proposal. Once developed, this would then be reported as advice to the government. The government would have the choice to adopt the policy or not to take further action. As such, it is possible that the Law Commission’s recommendations on data objects will be ignored, and the status of crypto-assets as property remains rather uncertain. However, given that the UK government wants to be seen as a market leader and innovation hub for crypto-assets, we wouldn’t expect to see such proposals completely ignored. If the recommendations were to be adopted, we would not expect to see legislative changes in place until 2024 at the earliest.
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