In our first part, we discussed the technological foundations of NFTs. Next, we turn to the legal issues, most certainly to be raised in any NFT litigation.
NFT’s Intellectual Property Rights
Patent, copyright, trademark ownership, and individual publicity rights are all IP rights that subsist in the underlying asset comprising 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 hands depending upon the way the NFT is structured.
In the United States, the general rule is an intellectual property right is not transferred unless the patentee, copyright owner, or trademark owner clearly states there is a transfer in a signed writing. Various federal laws govern this process. In particular, 35 U.S.C. §261 provides that “[a]pplications for patent, patents, or any interest therein, shall be assignable in law by an instrument in writing.” Further, 17 U.S.C. §204(a) allows for “[a] transfer of copyright ownership … is not valid unless an instrument of conveyance, or a note or memorandum of the transfer, is in writing and signed by the owner of the rights.”
As such, the IP holder will often retain ownership of his or her copyrights in 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 set period time. A copyright license is a simple written contract allowing the IP holder to control how their work images are used, displayed, and monetized by others.
NFTs do not change these fundamental principles. Any image attached to the NFT will require some degree of IP owner/holder approval. Since we are still dealing with “ordinary” IP rights, it is important to acknowledge that NFTs still present substantial infringement risks. Copyright infringement would occur if works are copied, sold, or otherwise publicly displayed without proper authorization from the copyright holder. Since anonymous minting of fraudulent NFTs is on the rise, this is a particular problem. Trademark infringement may occur if customers are confused by the source or sponsorship of the NFT. Similarly, design patents will be infringed if the designs bear substantial similarity, and an individuals’ right of publicity can also be violated if the NFT depicts individuals.
Are NFTs Securities?
NFTs are not definitively deemed securities solely because there is a question as to if they are securities. In fact, to determine if an NFT would fall under that securities rubric, each NFT must undergo a specific fact intensive review.
This review determines if the NFT is an “investment contract,” a type of security under federal law. To begin, we need to focus on not only the NFT, but the NFT transaction as well. Moreover, those selling NFTs — if they are deemed securities — must also register as a broker-dealer or obtain some exemption to the broker-dealer registration requirements.
These issues are determined by a review of case law, in particular, SEC v. W.J. Howey Co., 328 U.S. 293, 301 (1946). In the W.J. Howey Co. case, the United States Supreme Court considered “investment contract” parameters for an instrument pursuant to the Securities Act of 1993, by looking at four criteria: investment of money; in a common enterprise; with an expectation of profits; and to be derived solely from the managerial efforts of others. Essentially, if there is no money, it is a gift. Further, if there is no expectation of profit, it is a product. Similarly, if there is no common enterprise, it is a collectible while if there is no third-party effort, it is a commodity.
As such, NFTs run both regulator risk as well as private securities litigation. Nonetheless, the law is still unsettled, and cases are still germinating 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. Nonetheless, traditional contract law still applies to the transaction. As such, the NFT seller must offer the NFT’s title to the NFT purchaser. Further, title does not pass until the NFT purchaser accepts the contract’s terms. The NFT purchaser must also provide consideration, that is, cause payment to be made and/or executed as required by the seller.
Moreover, since the NFT remains linked to the blockchain and the smart contract. Any subsequent transactions are usually governed by that smart contract, or by code programmed into the NFT.
Arbitrating NFT Disputes
Arbitrating NFT disputes may be the most efficient manner to handle these matters. Parties can select arbitrators with technical and legal credentials. Arbitral institutions and neutrals are adaptable. Arbitration is a private proceeding.
Arbitration may be tailored to meet the unique needs of the parties with speedy resolution. Designation of an independent international arbitral institution avoids the appearance of home-court bias. New York Convention to enforce international arbitration awards, and the dispute resolution provision is critical.
A sample dispute resolution provision follows:
(d) Conducting Arbitration and Arbitration Rules. The arbitration will be conducted by the American Arbitration Association (“AAA”) under its Consumer Arbitration Rules (the “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 who wishes to start arbitration must submit a written Demand for Arbitration to AAA and give notice to the other party as specified in the AAA Rules. The AAA provides a form Demand for Arbitration 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 issues relating to the interpretation, applicability, enforceability and scope of this arbitration agreement.
(e) Arbitration Costs. Payment of all filing, administration and arbitrator fees will be governed by the AAA Rules, and we won’t seek to recover the administration and arbitrator fees we are responsible for paying, unless the arbitrator finds your Dispute frivolous. If we prevail in arbitration, we’ll pay all of our attorneys’ fees and costs and won’t 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 the “bells and whistles” for ensuring coverage in any event in an arbitration. The parties may rely upon to effectively resolve their disputes.
In sum, NFTs presents a myriad of issues that litigations will highlight. Picking an effective and efficient forum for resolution of these matters is critical given the myriad of issues both legal and factual for NFTs.