In July 2022, the Law Commission published a consultation proposing certain reforms in respect of property rights and digital assets. The consultation’s primary recommendation was to create a new category of property, referred to as data objects, to ensure that cryptocurrency and other forms of digital assets could be legally recognised as property. This approach builds upon previous court rulings which held that cryptoassets could be property and be protected by injunctions, such as freezing orders. The consultation closes on 4 November 2022.
How is Property Currently Recognised Under the Law?
The law generally recognises two types of property. The first is things in possession, which covers tangible and physical objects. For example, cars and books would be things in possession. 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 Cryptoassets fit Within this?
Cryptoassets do not fit neatly into either category of property. Cryptoassets are not tangible, which means that they cannot be things in possession. Cryptoassets are also not contractual rights, which means that they are not things in action. While it is possible for a cryptoasset to confer certain contractual rights (e.g., the holder of an NFT may obtain certain copyrights), these contractual rights are separate to the cryptoasset itself. In other words, the contractual right conferred by the cryptoasset can be protected as a thing in action, but the cryptoasset itself cannot be a thing in action.
This technically means that cryptoassets should not legally be recognised as property. However, the Courts of England and Wales have been more pragmatic than this and have realised that cryptoasset holders would not be suitably protected if cryptoassets could not be protected as property. As such, the Commercial Courts have issued various rulings that cryptoassets should be protected as a third type of property and be the subject of injunctions, such as freezing orders – though this third type of property was not defined or specified (for further details of these rulings, please refer to our Blockchain blog posts here and here).
While these decisions have been welcome, they are not absolute. These rulings were made at interim injunction hearings only, rather than at a full trial. Additionally, the issue of whether cryptoassets could and should be recognised as property was not properly litigated during these hearings. Therefore, it is technically possible that a subsequent higher court could rule that cryptoassets are not property following a full litigation of the issue. As such, these recommendations from the Law Commission, if they come into force, would be a welcome chapter in the ongoing saga of whether cryptoassets should be recognised as property.
What does the Law Commission Propose?
The Law Commission has proposed introducing a third category of property — to be known as “data objects” — in order to create certainty that the law can protect cryptoassets and other digital items. The Law Commission recommends defining data objects on the basis of the following three criteria:
- Data objects must be composed of data represented in an electronic medium, including in the form of computer code, electronic, digital or analogue signals. 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 thing in possession as 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 classification of property (assuming the other two criteria were also satisfied).
- Data objects must exist independently of both persons and the legal system. This is particularly important to differentiate data objects from things in action. An example of a thing in action is a right to sue someone. This does not exist independently of a person because the right will belong to a specific person and only that specific person could exercise that right. It also does not exist independently of the legal system, because a lawsuit actively requires the legal system. Conversely, a cryptoasset can exist independently of both persons and legal systems, as they can exist, for example, solely on the blockchain. The blockchain theoretically exists outside of the scope of any person and outside of the scope of any legal system.
- Data objects must be rivalrous. Broadly speaking, an item is rivalrous if the use of the item by one person necessarily prejudices the ability of others to make equivalent use of this at the same time. The Law Commission gives the example of a book. If Person A is reading a book, it is possible for Person B to read the same story but in a different copy of the book. As such, the book itself is rivalrous, but the story is not rivalrous. This can apply to cryptoassets because, if Person A holds a cryptoasset token and chooses to spend or redeem that token, Person B cannot use those tokens at the same time. An item being rivalrous is a crucial feature for an item to be protected by property rights. It stands to reason that if something is not rivalrous, it can be freely used by almost anyone at the same time and, therefore, does not warrant stringent legal protection.
The Law Commission also considered including divestibility as a fourth criterion. This would mean that the data object would need to be capable of being transferred or disposed of. However, the Law Commission considered that the second and third criteria rendered divestibility an unnecessary addition as divestibility would be a likely consequence of satisfying those conditions. It was also noted that some tokens are non-transferable and, while divestibility can be a useful indication of property characteristics, it would mean that non-transferable tokens would lack suitable protection.
How does the Law Commission Recommend Enforcing the Property Rights of Data Objects?
Generally, the enforcement of property rights over things in action and things in possession relies on who is able to control the relevant thing. “Control” is a difficult concept in property law, and it is not always clear who has control over a thing. Sometimes it may be the owner, but other times it may be the holder (assuming the two are not one and the same). There has been some very complicated literature and case-law on what amounts to control and what the process is for identifying who has control.
The Law Commission notes that concepts of control may not work for data objects. In respect of cryptoassets, control is often determined by the individual who holds the cryptographic key. This could lead to situations where the true owner of the cryptoasset is not protected simply because their custodian wallet provider, or another third party, is holding their cryptographic key on their behalf. Unfortunately, the Law Commission did not properly develop an alternative recommendation for how control should be dealt with in respect of data objects, and recommended leaving this to future case law to deliver appropriate meanings. This could create a number of problems, among others:
- Court decisions are often at the discretion of the judge in question based on the facts and evidence before them. It is entirely possible that one judge hearing a case on one day could make a different decision to another judge hearing the exact same facts and evidence on other day;
- It is not clear when the matter would be litigated, if ever. As such, this notion of who controls the data object could be a cliff-hanger that may never be resolved; and
- not every case sets a precedent, and the existence of different facts or evidence could result in various courts and judges reaching varying decisions, which means that there would still be no certainty on what amounts to control.
Did the Law Commission make any other Recommendations?
The Law Commission made a number of other recommendations within the consultation paper, including, among others:
- Ensuring that the defence of equity’s darling is available in respect of transfers of data objects. This defence applies where a bona fide purchaser purchases an asset for value in good of faith. The bona fide purchaser would be able to keep the asset if an ownership dispute arose, and the other party to that dispute would need to look to the fraudulent seller for recompense;
- Characterising crypto-token custody arrangements as trusts (i.e., the custodian would hold the tokens in trust for the owner). The Law Commission recommends that such trust should operate in such a way that the beneficiaries are equitable tenants in common. This means that each beneficiary would have a proportional entitlement to the cryptoassets held in the trust;
- Enabling the courts to make monetary awards in crypto-tokens. The reasoning for this is that in certain cryptoasset cases, a reward of cryptoassets would better reflect the loss suffered.
What are the next steps?
The consultation is open until 4 November 2022. After that, the Law Commission would require 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 as to whether it chooses to enact the policy or take no further action. As such, it is possible that the Law Commission’s recommendations on data objects are ignored, and the status of cryptoassets as property remains rather uncertain. However, on the basis that the UK Government wants to be seen as a market leader and innovation-hub for cryptoassets, we would not expect to see such proposals completely ignored. If the recommendations were to be adopted, we would not expect to see any legislative changes in place before 2024 at the earliest.