Discussion Post: A Stable Legal Framework for Digital Uniqueness

CTA: “In these threads, we attempt to further the discussion of a key problem in this category and evolve our understanding of the domain space where research work has not yet answered the specific problem or question being considered. These posts are living documents, and it is our hope that the community will continue to contribute to their structure and content.”

Fairfield, Joshua, Tokenized: The Law of Non-Fungible Tokens and Unique Digital Property (April 6, 2021). Indiana Law Journal, Forthcoming, Available at SSRN: https://ssrn.com/abstract=3821102

Key Problem / Topic Area

The author identifies existing legal frameworks through which NFTs can be adjudicated as personal property instead of intellectual property.

Specific Question or Problem Statement

Do the expectations of NFT buyers align with the legal conditions outlined in Terms of Service agreements associated with centralized NFT merchants?

Approach / Methodology

The author is establishing the legal frameworks in which NFTs can be adjudicated as sales of personal property instead of licensing of Intellectual Property.

Background

Check out our previous discussions of Tokenized: The Law of Non-Fungible Tokens and Unique Digital Property.

Part one covering Creating Digital Uniqueness, described the technological components of an NFT and gave an introduction to the different treatment of personal and intellectual property under the United States Uniform Commercial Code.

Part two, Existing Legal Frameworks and Problems, delved deeper into the legal frameworks governing various types of assets, and gave a history of how digital assets became entwined with intellectual property. Consumers cede many of their rights under an intellectual property framework, often without realizing it, so NFT consumers may be better served by a more familiar property-oriented definition of their rights.

The author refers to the following recent cases in Part Three:

Rensel v. Centra Tech - A case in which the Southern District of Florida was attempting to determine if a buyer who had purchased a cryptocurrency by paying Ether into a smart contract was bound by the terms of agreement in arbitration that appeared on the seller’s website. The court ruled that since the buyer interacted with the smart contract directly, the terms of arbitration on the website did not apply to the agreement between buyer and seller since the smart contract was the point of sale.

Capitol Records v ReDigi - A case in which a website attempted to create an aftermarket for used digital audio files under the condition that the original user gave up ownership of the original copy. The court ruled that the website did not have the license to resell the audio files and were thus violating the IP rights of the license owners. The court ruled that the destruction of the original copy did not negate the process of copying and transmitting the file, which violated the copyright agreement associated with the original IP.

The court affirmed the holding that Redigi’s service created a new copy of a sound recording, and the reproduction right is not subject to the first sale doctrine, which applies solely to a particular phonorecord. The court declined to weigh in on whether Redigi engaged in a distribution of a phonorecord through its service. The court rejected Redigi’s argument that its technical process of deleting the original copy of the file in the course of reselling a sound recording does not constitute a reproduction, holding that the deletion does not nullify the fact that a reproduction has been made. The court rejected ReDigi’s fair use argument, finding:

(1) under the first fair use factor, the reproduction is not transformative or add nothing new, and that, given the total absence of transformative purpose, the commercial motivation weighs against a finding of fair use under this factor;

(2) the second fair use factor plays no role here;

(3) the copying of the entire digital file disfavors fair use under the third factor; and

(4) “Factor Four weighs powerfully against fair use”, in particular, because, unlike used physical copies, “used” digital files are identical to “new” digital files, and thus Redigi’s marketplace directly competes with Plaintiff’s primary market.

Weighing the factors together, and relying heavily on the Second Circuit’s TVEyes decision, the court concluded there was no justification for fair use here, saying “Even if ReDigi is credited with some faint showing of a transformative purpose, that purpose is overwhelmed by the substantial harm ReDigi inflicts on the value of Plaintiff’s copyrights through its direct competition in the rights holders’ legitimate market, offering consumers a substitute for purchasing from the rights holders.”

Finally, the court rejected the policy-based arguments made by copyright law professors in an amicus brief supporting ReDigi that the first sale doctrine should be applied broadly to protect ReDigi “to vindicate purchasers’ ability to alienate digital copyrighted works under the first sale doctrine—emphasizing that §109(a) is styled as an entitlement rather than a defense to infringement—without regard to technological medium.” The court concluded, “If ReDigi and its champions have persuasive arguments in support of the change of law they advocate, it is Congress they should persuade. We reject the invitation to substitute our judgment for that of Congress.”

The following sections of the Uniform Commercial Code are also pertinent to the discussion of NFTs as personal property:

Uniform Commercial Code (UCC) § Article 2: Sales - The set of codes outlining the standards for the regulation of sales, warranties, and how exchanges of goods and services in the United States are regulated.

UCC § 2 - 204: Uniform Commercial Code Article 2 - Section 204. Formation in General

(1) A contract for the sale of goods may be made in any manner sufficient to show agreement, including conduct by both parties which recognizes the existence of such a contract.

(2) An agreement sufficient to constitute a contract for sale may be found even though the moment of its making is undetermined.

(3) Even though one or more terms are left open a contract for sale does not fail for indefiniteness if the parties have intended to make a contract and there is a reasonably certain basis for giving an appropriate remedy.

UCC § Section 2-207: Battle of Forms - This occurs when a buyer and seller have different terms of agreement during the process of an executed transaction. Legal precedent nullifies any terms that are not found in both contracts as being unagreed upon terms. In this case, if no terms are agreed upon then the standard rules surrounding exchange of goods under UCC apply. If the deal involves anything other than goods, then common law rules apply. If the deal is between merchants, then once an offer has been made, any new or additional terms included in the acceptance of that offer become part of the final agreement unless: The offer limits acceptance to only its own terms, the responding party objects to the additional or different terms within a reasonable time, or the additional or different terms materially alter the terms of the offer. If neither party is a merchant, then any differing conditions of the offer are incorporated into the contract unless there is a condition of the other party’s agreement to all terms, in this case constituting a rejection of the offer and a counter-offer taking its place.

UCC § 2-206(3) Common Law Mirror Image Rule - In contract law, a doctrine requiring any acceptance to be an unconditional assent to the terms of the offer. Thus, at least historically, any acceptance had to embrace the pricing and other information included in an offer, or there would be no binding contract. In modern commercial settings, a binding contract is often recognized despite minor discrepancies between the offer and acceptance. For instance, under the Uniform Commercial Code, a clearly expressed acceptance can create a binding sales contract even if the acceptance contains added or different terms when compared to the offer.

UCC § 2 - 207: Uniform Commercial Code, Article 2. Section 207: Additional Terms in Acceptance or Confirmation (2)

Additional Terms in Acceptance or Confirmation -

(1) A definite and seasonable expression of acceptance or a written confirmation which is sent within a reasonable time operates as an acceptance even though it states terms additional to or different from those offered or agreed upon unless acceptance is expressly made conditional on assent to the additional or different terms.

(2) The additional terms are to be construed as proposals for addition to the contract. Between merchants, such terms become part of the contract unless:

(a) the offer expressly limits acceptance to the terms of the offer;

(b) they materially alter it; or

(c) notification of objection to them has already been given or is given within a reasonable time after notice of them is received.

(3) Conduct by both parties which recognizes the existence of a contract is sufficient to establish a contract for sale although the writings of the parties do not otherwise establish a contract. In such a case the terms of the particular contract consist of those terms on which the writings of the parties agree, together with any supplementary terms incorporated under any other provisions of this Act.

UCC § 2 - 314 Uniform Commercial Code, Article 2 - Section 314 Implied Warranty: Merchantability; Usage of Trade -

(1) Unless excluded or modified (Section 2-316), a warranty that the goods shall be merchantable is implied in a contract for their sale if the seller is a merchant with respect to goods of that kind. Under this section, the serving for value of food or drink to be consumed either on the premises or elsewhere is a sale.

(2) Good To be merchantable must be at least such as

(a) pass without objection in the trade under the contract description; and

(b) in the case of fungible goods, are of fair average quality within the description; and

(c) are fit for the ordinary purposes for which such goods are used; and

(d) run, within the variations permitted by the agreement, of even kind, quality, and quantity within each unit and among all units involved; and

(e) are adequately contained, packaged, and labeled as the agreement may require; and

(f) conform to the promise or affirmations of fact made on the container or label if any.

(3) Unless excluded or modified (Section 2-316) other implied warranties may arise from the course of dealing or usage of trade.

UCC § 2 - 315 Implied Warranty: Fitness for Particular Purpose -

Where the seller at the time of contracting has reason to know any particular purpose for which the goods are required and that the buyer is relying on the seller’s skill or judgment to select or furnish suitable goods, there is unless excluded or modified under the next section an implied warranty that the goods shall be fit for such purpose.

UCC § 2 - 403 - Power to Transfer; Good Faith Purchase of Goods; “Entrusting”.

(1) A purchaser of goods acquires all title which his transferor had or had power to transfer except that a purchaser of a limited interest acquires rights only to the extent of the interest purchased. A person with voidable title has the power to transfer a good title to a good faith purchaser for value. When goods have been delivered under a transaction of purchase the purchaser has such power even though

(a) the transferor was deceived as to the identity of the purchaser, or

(b) the delivery was in exchange for a check which is later dishonored, or

(c) it was agreed that the transaction was to be a “cash sale”, or

(d) the delivery was procured through fraud punishable as larcenous under the criminal law.

(2) Any entrusting of possession of goods to a merchant who deals in goods of that kind gives him power to transfer all rights of the entruster to a buyer in ordinary course of business.

(3) “Entrusting” includes any delivery and any acquiescence in retention of possession regardless of any condition expressed between the parties to the delivery or acquiescence and regardless of whether the procurement of the entrusting or the possessor’s disposition of the goods have been such as to be larcenous under the criminal law.

[Note: If a state adopts the repealer of Article 6-Bulk Transfers (Alternative A), subsec. (4) should read as follows:]

(4) The rights of other purchasers of goods and of lien creditors are governed by the Articles on Secured Transactions (Article 9) and Documents of Title (Article 7).

[Note: If a state adopts Revised Article 6-Bulk Sales (Alternative B), subsec. (4) should read as follows:]

(4) The rights of other purchasers of goods and of lien creditors are governed by the Articles on Secured Transactions (Article 9), Bulk Sales (Article 6) and Documents of Title (Article 7).

[Note: As amended in 1988.]

Conclusions / Key Takeaways

The researcher suggests that regulations associated with sales of personal property should be applied to NFTs to create a digital personal property class. This new class would complement intellectual property and physical property as a means of aligning sales in collecting markets with buyers’ expectations.

CTA: Future Work / RFP

The researcher suggests that a more stringent assessment of End User License Agreements would make it more likely to push platforms to align their recognition of NFTs as personal property to ensure that NFTs achieve their potential in creating a new digital personal property asset class, instead of falling into licensing terminology, regulations, and practices.

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What are the potential drawbacks of defining NFTs as personal property? To me, it would seem like it might restrict some of the benefits of them such as paying artists a share of each sale. What about connecting more complex types of contract to an NFT, like real estate – would you be able to put a mortgage on an NFT deed?

@Benton what do you think?

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I am not sure royalty payments to artists are any more protected by NFTs and blockchain sales than they are by a specialized organization like BMG or ASCAP. The current structure of royalty payments come from accumulated sales and listens which are reported by centralized entities. While the notion of decentralizing this system seems to be beneficial for artists, decentralizing the process opens up even more room for exploitation through copying and counterfeiting so while there is a decentralized network on which artists can sell their own works, there is no real enforcement agency to prevent counterfeiting and theft resulting in the artist not benefitting anyway.

Artists currently have a better legal framework for protecting their royalties going through traditional channels than through NFTs. While the promise for NFTs and getting artist royalties is there, the practical application for deploying the technology to ensure protection for artists works simply isn’t there. NFT sites usually leave the due diligence to the seller, and thus the sites are NOT guaranteeing they will protect the artists’ ownership.

Honestly, an NFT for a piece of property sounds like a terrible idea. For one, property is divisible. The notion of an “indivisible” and “non-fungible” digital tracker for a plot of land sounds terribly incongruous with how mortgages and land titles function. If I owned an acre or hectare of land, and a single NFT represented that land, would I have to create two NFTs if I wanted to split the land into two plots and sell one? There are some contracts and structures that would be made unnecessarily complex by NFTs being added, which would likely induce what is known as “Braess’ Paradox”. In Braess’ Paradox, adding more complexity to a system can cause it to slow down. In the case of mortgages and land title exchanges, NFTs might actually make the process take much longer due to the nature of what occurs when land title ownership is exchanged.

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Paul Ennis at UCD has a nice article about the artist Damien Hirst (of $10mm diamond-studded platinum skull fame) and his $2000 microdot NFTs. The author is selling an option to either destroy the physical or NFT component of the work within a year. Damien Hirst's 'The Currency': what we'll discover when this NFT art project is over

For some added context: https://www.damienhirst.com/texts1/series/spots (his spot paintings)

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I am looking at the Damien Hirst NFT printing and wondering how this will affect the market. On the one hand, having an artist with a big name will likely draw attention. On the other hand, this feels like a Warhol-esque exploitation of art collectors in which Hirst is taking the ridiculous notion of paying $2000 for a “unique item” and creating thousands of “unique items” with no real individual character. In effect, he is “mass producing uniqueness”. This is a paradox. I am not sure the result of Hirst’s experiment will have the desired effects, unless he is trying to expose the paradox that uniqueness cannot be mass-produced without undermining said uniqueness.

Honestly, the whole Hirst thing feels like “Exit Through the Gift Shop” but the crypto version.

How long before we see Dadaist NFTs that are created with the explicit intention to be burned?

I believe until we see the first Dadaist NFT “art” work, we won’t know if this is a genuine “art” movement or another coy attempt at exploiting art collectors.

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