NFT Projects – Essential Legal Advice

Greater sophistication is now required when approaching and undertaking NFT projects; if you fail to plan, you plan to fail. An increasing number of NFT project creators are being caught out by failing to undertake the basic due diligence at the outset of project planning. Common problems include NFTs that infringe existing intellectual property rights, fall foul of financial regulations, or are mis-sold.

If you fail to treat the launch of an NFT project like the launch of any other business (obtaining necessary legal advice and undertaking due diligence) you could easily expose yourself to unnecessary personal risk, which could result in not only the failure of the project but also in direct personal liability.

ESSENTIAL LEGAL ELEMENTS TO AN NFT PROJECT

There are several essential legal elements to an NFT project:

1. Regulation
2. Intellectual Property
3. Smart Contracts
4. Corporate Structure
5. Terms of Business
6. Branding

We discuss each of the above issues below, and if you would like to discuss them in further detail, as to how they apply to your project, please do get in touch with us.

We have substantial experience in supporting a wide range of individuals and organisations and are well-known for our high-profile work and for providing robust representation for our clients. We provide practical advice on handling NFT matters, as well as advising in general NFT law and legislation.

Speak to our NFT lawyers in London

For expert assistance with the legal aspects of NFTs, contact Saunders Law today for a free, no obligation initial discussion about how we may be able to help.

Call us on 020 7315 4810 or make an enquiry online.

LEGAL ELEMENTS TO CONSIDER IN AN NFT PROJECT

1. REGULATION

Although NFTs are not (yet) specifically regulated, if they exhibit characteristics of other regulated investments, they may trigger legal obligations around their promotion, marketing and sale.

For example, where an NFT grants entitlement to commission on resale, this can be construed as a 'right akin to a secured investment' meaning that it may be subject to regulation. Further, if an NFT is a ‘security token’, it may be a specified investment for the purpose of the Financial Services and Market Act 2000 (Regulated Activities) Order 2001. Alternatively, if the NFT can be classified as e-money, it will be subject to the Electronic Money Regulations 2011.

It’s important to assess whether the NFTs sold in the project can be classed as regulated investments, securities or payment instruments. Further, it should be considered whether the offer for sale, or the provision of related services, such as an exchange platform, constitutes a regulated activity for the purposes of financial regulation.

NFTs commonly contain provisions for enhanced rights, rights to future remuneration, guarantees as to value, connections with tangible goods etc. and these can influence an NFT’s classification.

There are also anti-money laundering regulations to consider, as determined by the Financial Conduct Authority (FCA).

Liability for compliance will sit with the regulated entity and is difficult to pass on. As well as any financial penalties, the reputational risk of non-compliance can be severe.

Therefore, it is recommended that a detailed analysis is undertaken of the project NFTs at the outset, and legal advice is obtained from counsel experienced in this area before any NFTs are marketed, promoted or sold.

2. INTELLECTUAL PROPERTY RIGHTS
   • Copyright
     IP rights principally focus, in respect of an NFT, on copyright.
     Copyright arises upon creation of a work: for example, the creation of a digital image, and the first owner will be the artist (subject to any employment contract, in which case the employer will own the copyright). Unless copyright is assigned (transferred) to another party under a signed, written contract (an assignment), it remains with the original holder. An artist can sell their digital illustration (the digital file) but retain the valuable copyright in the illustration.
     A Copyright owner has the right to protect their work by stopping others from using it (copying, displaying, exploiting it) without permission; it is a right that can be licensed or sold.
     Copyright infringement occurs when someone uses the whole, or a substantial part, of a work without the copyright owner’s permission.It is therefore important to ensure that the NFT project has the right to licence the use of, or assign ownership of, copyright in the artwork the subject of the NFT.
     Where the party selling the NFTs is a separate legal entity (a limited company, for example) from the owner of copyright in the artwork, it will be necessary to grant that entity the right to deal in the relevant IP rights. It may be that IP rights are assigned to a holding company which then licences the use of the IP rights, or a licence is put in place between the copyright owner and the corporate entity.
     The smart contract within the NFT will then contain a sub-licence to the NFT holder granting certain IP rights which may be either limited (the right to display only, for example) or may be more extensive (the right to commercially exploit the artwork).However, the rights of the NFT holder should be clearly defined in the NFT smart contract (which we discuss below).If copyright is infringed, it can lead to not only the removal of the NFT from the hosting platform but can also trigger a claim for damages and an injunction against the infringer.
   • Moral Rights
     Moral rights sit alongside copyright, protecting the integrity and ownership of the work, and include:
     • the right to be recognised as the author of the work (paternity right);
     • the right to object to the derogatory treatment of the work (this would broadly include any unauthorised editing and adaptation of the work); and
     • the right to object to false attribution of the work; and
     • the right not to be identified or named as the author of a work which they did not create.

     Like copyright, moral rights arise on creation of a work (and belong to the author of an original work), however unlike copyright, moral rights cannot be transferred. Importantly, they remain with the creator of the works even if the copyright does not.
     In the UK, moral rights may be waived – i.e., given up – but cannot be assigned or sold to a third party. In agreeing to waive moral rights, an author would no longer obtain the benefits moral rights provide.
     Under UK law, remedies for infringement of moral rights could include damages, which is a financial reward, or an injunction preventing further infringing uses depending on the circumstances.
     It is vital therefore to consider moral rights along with copyright at this early stage.

   • Trade Marks and Registered Designs
     It is not only copyright and moral rights of which you need to be aware: trade mark and registered design rights may also be infringed in the creation of an NFT. It can be tempting to include trade marks for example, in NFTs to make them more appealing or by way of social commentary, for example. However, if without permission, the NFT reproduces, and/or takes unfair advantage of, or is detrimental to, a trade mark, then it may infringe those trade mark rights.
     The infringement of design and/or trade mark rights can lead to expensive litigation.
     It is recommended therefore that an IP audit is carried out in respect of the artwork the subject of the NFT, to verify and ensure appropriate rights and permissions are obtained before an NFT is created and promoted.
     You may also wish to register a trade mark or design before the launch of the project, to protect your branding, and the advice of a lawyer is recommended as to this also.

3. SMART CONTRACTS

A smart contract is a self-executing contract with the terms of the agreement between buyer and seller being directly written into lines of code. The code and the agreements contained within the contract exist across a distributed, decentralized blockchain network. The code controls the contract’s execution and with an NFT, it governs the interplay between the underlying asset and the NFT.

A smart contract will define the thing the NFT represents so for example, an artist might decide that they want to tokenise their physical sculpture and also transfer the actual sculpture to the token holder. The smart contract will stipulate the terms for this transfer.

The smart contract must detail the rights being transferred or owed to other parties – for example: a licence for personal use only of a digital artwork or royalty payable to the creator.

1. • Self-Executing
     As we have seen, smart contracts are self-executing, and so when it comes to the transfer of the NFT, the smart contract will, much like a domino effect, provide for an ‘executing event’ – such as the payment of cryptocurrency into the NFT holder’s crypto wallet, prompting the smart contract to carry out the transaction and move the NFT to another crypto wallet, nearly instantaneously without any further human intervention.

1. • Legal Status
     It was established in the leading case of AA v Persons Unknown, that smart contracts are legally enforceable contracts under the laws of England and Wales.

1. • Liability and Risk
     Many ‘standard-form’ smart contracts fail to adequately provide for, or set out sufficiently a provision for, IP rights, and they can be overlooked. If there is any ambiguity or lack of clarity in the rights accompanying the NFT, it can lead to dispute.If an NFT is misrepresented, you also risk falling foul of advertising and other ‘sale of goods’ regulations.

It is recommended therefore that there is a careful consideration and legal advice obtained in respect of the terms included in the NFT smart contract. Whilst a programmer will code the NFT metadata, underlying the NFT is a contract for sale of the NFT asset to the purchaser, and so it is recommended that legal advice is obtained.

4. CORPORATE STRUCTURE

As we commented above, a smart contract will set out the terms of the relationship between the buyer and the seller of an NFT: with the initial sale of NFT tokens in a drop it’s important to define the seller.

Who is the seller? There are often multiple parties involved in an NFT project - the artist(s), marketing and PR, the programmer, a funder, and others. It is unlikely that all (or even any) of those parties would want to be classed as the ‘seller’, individually contractually bound and liable to each and every buyer of the NFTs.

Being contractually bound means owing liabilities to the other party to the contract: it is the party sued if what is promised with the NFT is not delivered; there may be a fault in the smart contract, a failure of drafting which exposes the seller to liability, for example. Further, outside of contractual rights, consumer rights trump other contractual exclusions, it is not sufficient to simply plaster a ‘we exclude all liability’ notice to the project and its smart contracts.

1. • Limited Liability
     Therefore, it’s necessary to consider ways in which to limit liability for the NFT sellers.The normal way in which the persons behind a business will seek to limit their liability, is to put a corporate entity in place, such as a limited company, through which they trade. As the name suggests (absent fraud) liability to other parties will stop with the company.It is important to note however that a limited company may not be appropriate for all businesses and an LLP (limited liability partnership), or other corporate structure may be more appropriate, so it is always advised that legal advice is sought on this well in advance of the NFT drop. There will also be issues of jurisdiction (geographic location) and tax to consider, again by speaking with an expert.

1. • Advantages of Limited Liability
     Having a separate legal entity in place through which the business of the NFT project is conducted has several advantages:
     Shareholding can be allocated to the parties contributing to the project (PR, marketing, programming etc.) and a shareholders’ agreement can regulate their relationships within the company. Whilst all parties in an NFT project may be ‘friends’ with a ‘common interest’ at the outset, when issues such as money (large sums are often generated by NFT sales) and the direction of the brand are raised, cracks can quickly develop (as a litigator, I have seen many of these).
     It is recommended that you obtain expert advice as to a shareholder’s agreement and other documentation when establishing a trading entity, to balance competing and sometimes conflicting interests of the various parties and ensure the business is run as intended.
     If future investment is sought for the NFT project (for another drop or merchandising or other collaborations for example) then it is easier to invest in an existing company with clearly defined legal parameters, reporting profit/loss accounts and where further shareholding can be allocated in return for an injection of funds.
     When contracting with third parties for merchandising or licensing rights (to use the name/logo/artwork from the NFTs) a contract can be put in place with the company, again limiting liability for those in the business.
     It is not only contracting with third parties which will be necessary, if we take the example of an artist, who is creating artwork for the NFT project, it is recommended a licence agreement (or assignment) of intellectual property rights is put in place, and it is normal to licence rights to the company creating the NFTs.
     Conclusion
     Informed legal advice is recommended on this element to determine the most appropriate legal entity for the business and put in place appropriate/necessary paperwork including agreements setting out the relationships, rights and obligations of the parties.

5. TERMS OF BUSINESS

“Read the T&Cs” is an oft used phrase, but as a litigator, I can tell you it’s very true; the Terms and Conditions of business are first place we look if there is any dispute or question as to the responsibilities and rights owed by the parties to each other.

In respect of an NFT project, you need clear Terms and Conditions in place when selling NFTs. Those T&Cs define the relationship, the rights and obligations owed between the project’s corporate entity (whatever corporate entity you decided upon) and the purchaser.

The T&Cs will typically echo the Smart Contract (as we have discussed above) however they will also appear on the website before the minting/sale.

Why is this important? The relationship is a business to consumer (the purchaser) sale. As a ‘consumer’, the NFT purchaser will enjoy consumer protections: certain liabilities cannot be excluded when dealing with them, all terms must be clear and brought to the consumer’s attention before purchase (to name but a few).

In other words, an NFT project cannot rely on ‘caveat emptor’ being plastered in large font text all over its website. Great care must be taken at this stage, as any court battle will likely side with the consumer.

1. • Whitepaper
     On these lines, you’ll also need to ensure your whitepaper (the document describing and promoting the project), is up to date, clearly set out and is brought to the purchaser’s attention before purchase, to avoid (or better protect against) any future allegations of mis-selling.

1. • Privacy Policy
     As the project will be handling personal data, it is vital to consider a privacy policy for the website, which clearly sets out the rights of individuals as to their personal data, and how that data is controlled and processed. It may also be necessary to register the business with the Information Commissioner’s Office (ICO).It is recommended that legal advice is sought in respect of the above, particularly as the above terms and policies will be NFT and crypto-specific so as to limit liability and clearly define the relationship with the NFT purchaser.

6. BRANDING

If your project is intended to be the first of many, or even if this is the only project you plan, you may wish to commercialise and promote it.

Branding is an essential element of business promotion; it incorporates and protects the goodwill and reputation in a name, logo, and other aspects of a business.

Protecting the brand through registering trademarks and designs and enforcing copyright has clear value to an NFT project.

We can assist in the registration of such intellectual property rights and facilitate advice as to commercial agreements and other licensing issues.

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EXAMPLES OF NFT PROJECTS FAILING TO PREPARE

A failure to undertake due diligence in planning a project can lead to failure, as seen in these high-profile examples:

• Copyright: a successful copyright claim made in respect of an NFT featuring, and purporting to assign rights in, the artist Jean-Michel Basquiat’s 1986 mixed media work on paper, ‘Free Comb with Pagoda’. The NFT was created without the permission of the copyright owner (the late artist’s estate) and was removed from its hosting forum.
  See the article here.
• Trade Mark Rights: the Premier League’s enforcement of its trade mark rights in respect of NFTs created by former footballer John Terry, which featured (without permission) protected trademarks, such as images of the Premier League’s trophy.
  See the article here.

Frequently asked questions about NFT Projects

How does regulation affect NFTs?

Although NFTs are not (yet) specifically regulated, if they exhibit characteristics of other regulated investments, they may trigger legal obligations around their promotion, marketing and sale. There are also anti-money laundering regulations to consider, as determined by the Financial Conduct Authority (FCA). Each case turns on its facts, so it is recommended that legal advice is obtained.

What is there to consider outside of NFT regulation?

There are many other aspects to consider outside of regulation of NFTs, including Intellectual Property rights (protecting your own, and seeking authorisation to use third parties’), the appropriate corporate structure to limit liability and commercial contracts, smart contracts and privacy law. Whether you are launching 10 or 10,000 NFTs these requirements are likely to apply to your project.

Can I not just create NFTs outside of the UK to avoid regulation?

Whilst there are other jurisdictions which are ‘friendly’ to NFTs, which may be their tax regime, or lack of financial regulation, however we would always advise that specialist advice is taken on this. There are not only tax considerations, but also the assignment or licensing of IP rights, and consumer considerations when launching an NFT project, whether here or abroad.

How do I use someone else’s art for my NFT project?

Someone else’s IP is their property, and in order to use it, you must seek and obtain their permission. Permission can be granted by a licence or rights can be transferred by way of a licence. It’s important to cover off all aspects, including moral rights in order to protect and add value to the NFT project and reduce the risk of rights’ infringement.

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Speak to our NFT lawyers in London

If you wish to discuss any of the above issues, we recommend that you do not delay in contacting our specialist IP Team.