Control is the key: The key is control | Sullivan and Worcester

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Jacqueline Cook, Of Counsel and Luna Owen, intern in the Trade & Export Finance team of Sullivan & Worcester, comment on the document “Digital Assets: Consultation Paper 256” published by the Law Commission.

1. Radical proposal for reform of English property law

Law Commission’s “Digital Assets: Consultation Paper” (Consultation) proposes a radical change in English law by suggesting that there should be a new class of immovable property labeled Data objects for digital assets that do not appear to fit into the existing categories of English personal property law. Currently, digital assets can be recognized as rights, certain intellectual property rights and other intangible contractual rights.

The digital asset workflow is part of a larger examination of the legal landscape and its relationship to the virtual world. The consultation goes hand-in-hand with work on the Electronic Trade Documents Bill, which will be known as the Electronic Trade Documents Act once it receives Royal Assent, expected later this year.[1]

2. Complex legal concepts and the virtual world

Over time, the English courts have defined certain characteristics to help identify a property as an item of property, namely: identifiability; rivalry; excludability; separability; and value. [2] Many of these seem to be different aspects of what we would consider key to asset ownership: control. English law has concepts for tangible assets, and now these are being adapted and tested for a new form of assets, digital assets.

Discussions during the consultation on the complexities of demonstrating ownership, commercial viability, access to rights in digital assets are not unheard of, as similar discussions took place during the consultation on the electronic commercial documents bill, covering the likes of electronic bills of lading and promissory notes.

3. Data Objects

The radical new category, Data Objects, aims to capture assets that do not clearly fall under the categories of ‘thing in possession’ (for tangible property, e.g. land or merchandise) or ‘thing in action'[3] (usually used for intangible assets such as duties imposed by the legal system, for example a debt). English courts have started to relax the meaning of “thing in action” in an effort to accommodate certain digital assets with some success. However, the Law Commission offers three criteria for identifying a digital asset as a data object. The following criteria could be used for existing and future new digital assets:

  • the data object must be represented in an electronic medium (intangibles held either by computer code or by electronic, digital or analog means);
  • the data object must have an independent existence (independent of both people and a particular legal system, (i.e. the data can exist without the need for someone who could apply the data object); and
  • the data object must be rival (that is, it must be under the control of one person to the exclusivity of others).

Assignment would be an indicator of whether a digital asset might be a data object, but it would not be a hard requirement. The consultation examines some of the following assets and whether they should constitute data objects; databases, crypto-tokens, crypto-currencies, non-fungible tokens, (NFT), stablecoins, central bank digital currencies, digital finance and blockchain. Other examples studied include milk quotas, EU carbon emission quotas, export quotas and certain licenses. However, in setting out its own analysis in relation to this latest list of assets, the Law Commission actually found that many of them not meet all three criteria to qualify as data objects.

Indeed, Data Objects would mainly cover crypto-tokens. The term “crypto-tokens,” according to the Consultation, encompasses cryptocurrencies, central bank digital currencies, and NFTs. So, is it worth establishing a new class of personal property in law for a narrow class of assets? The proposal supports the UK government’s goal of making the UK an international hub for digital assets. It is also supported by the Law Society, the City of London Law Society and the Financial Market Law Committee of the Bank of England, as it would provide a principles-based approach consistent with the ripple effect that regulation, capital rules and tax provisions could follow recognizing that an increasing part of the UK economy is made up of virtual assets.

4. The key is control

Throughout the Consultation, the Law Commission flirted with the idea of ​​adapting existing legal principles to cover ownership of a Data Object, with possession being the key principle. However, given the existing complexities related to the principle of possession, and to avoid that possession is “master of all assets and master of nothing”, the Consultation encourages the development of a new concept on how a person can hold or have a data object. Therefore, it turns out that the key to ownership of digital assets is indeed control.

Although control is an important characteristic of ownership, it will be key when it comes to data objects. According to the Consultation, in order to illustrate control over a Data Object, the asset must be capable of being sufficiently concentrated in a single person (or group) and must be rivalry. This means in practice that the controlling person can (i) exclude other people from the data subject; (ii) use the Data Objects, and (iii) identify itself as the person having the capabilities in (i) and (ii).

How one excludes others from the data object is likely to be a digital solution in itself, for example using a private key. Each electronic platform or system will have its own rules for how a private key is issued and whether it is actually transferred or reissued, very similar to whether a data object is transferred or reissued to a new owner or person in control. Basically, this will take the form of a code or an access code via a portal.

5. What about warranties?

Traditional lending and new decentralized finance (DeFi) could examine how NFTs, crypto-tokens and cryptocurrencies could be mined as collateral to back borrowing, which the Law Commission acknowledges could be done under the law current up to a certain point. What is crucial, in our opinion, is whether or not these assets would be a financial guarantee. If so, the Law Commission asks whether data subjects would fall under the current regime (meaning such security interests do not need to be registered with Companies House), or whether agreements would need to be changed. financial guarantee (no 2) Regulations 2003 to clarify the law.

Again, the key will be control: not control as the courts see it in relation to a fixed or floating charge, but practical and identifiable control in relation to Data Objects. Control from the secured creditor’s perspective may depend on the operation of the platform used or may depend on access to the private key. Here, although title cannot be transferred to the secured creditor upon taking security, control of the Data Subject should be vested in the secured creditor as the private key holder to prevent any assignment of any kind. whatsoever or any other security granted thereon. The control must therefore exclude even the loader from accessing the data object.

6. How will this be part of the future of trade finance?

It appears that the category of Data Subjects does not include receivables or receivables that would arise from a contract, even if they are to be transferred or paid by electronic means. Receivables will always be classified in the category of “things in action” arising from a commercial agreement between the debtor and the creditor. So no change there.

But what if a cryptocurrency was offered as a means of payment? What if NFTs are offered as collateral for short-term borrowing? What if a variety of crypto-tokens, e.g. central bank digital currencies, start to become an acceptable means of payment for commodities or are offered as collateral? Will English law provide the security needed to support trade and the trade finance market and help it grow?

In our view, English law already has the flexibility to allow the development of new digital products, some will be protected as intellectual property rights and others as intangible rights. Nevertheless, the proposals in the consultation would certainly redefine English law by introducing a new category, data objects, and with it certainty and protection under the financial security regime.

seven. Have your say!

Responses are expected by November 4, 2022, after which the Law Commission will produce a report and any relevant draft legislation. You can access the online consultation to submit your responses here.

[1] Read the alert from the Sullivan & Worcester Trade & Export Finance team The Electronic Trade Documents Bill is on the agenda!

[2] See CP 256 for a summary of the current position in English law on how to identify an object of property.

[3] Previously known as “chosen in possession” and “chosen in action”.

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