The Law Commission’s consultation paper on digital assets including proposal of third category of personal property to cover crypto-tokens and other digital assets - Part 1

The Law Commission for England and Wales has launched a significant and detailed consultation on proposals to ensure that the law recognises and protects digital assets, which include crypto-tokens, cryptoassets and non-fungible tokens (NFTs).

In this article, we provide our readers with a high-level overview of some of these proposals, which include (1) the creation of a third category of personal property, and (2) that the concept of control, rather than the concept of possession, should apply to data objects.

The first of these proposals would be a radical departure from over a century of legal precedent that recognises only two categories of personal property. The Law Commission’s consultation has been prepared after the UK government requested it should review the law on digital assets to ensure they can continue to be protected as they evolve. Digital assets continue to assume a more important role in today’s society, are used for an ever-expanding variety of purposes, and the UK government has recently announced its intention to make the UK a global hub for cryptoassets.

We encourage our readers to read the consultation paper (which can be found in full, here, and in a 20-page summary, here) should they wish to understand all of the Law Commission’s proposals in relation to digital assets.

Data Objects: the third category of personal property

The consultation’s central proposal is for the explicit recognition in law of a third category of personal property to ensure that the law recognises and protects digital assets.

Traditionally, the law of England and Wales has recognised two categories of personal property: things in possession and things in action. The addition of a third category of personal property would therefore be a radical departure from legal precedent which has been adopted since 1885[1].

The Law Commission argues that digital assets often do not fit cleanly into either category as they are neither tangible (in the normal sense) nor are they claimable or enforceable by legal action, although it acknowledges the possibility that digital assets could come within an expanded category of things in action.

The Law Commission therefore proposes a third category of personal property, “data objects”, which, it states, “will better allow the law to focus on attributes or characteristics of the things in question, without being fettered by analysis or principles applicable to other types of personal property.” The consultation also highlights the strong support for this proposal from some academics and market participants and that the proposal would be in keeping with international law reform in this area.

In order to be considered a data object, the Law Commission proposes that a thing must:

1. be composed of data represented in an electronic medium;
2. exist independently of persons and exist independently of the legal system; and
3. be rivalrous (i.e. if use of a thing by one person prevents another’s ability to use that thing at the same time).

Data represented in an electronic medium:

In order to distinguish from things in possession, the Law Commission proposes that, to qualify as a data object, a thing must be composed of data represented in an electronic medium, such as in the form of a computer code, electronic, digital, or analogue signal.

Existence independent of persons and independent of the legal system:

The Law Commission’s second criterion can be split into two parts: (1) the requirement for a thing to exist independent of persons and (2) the requirement for a thing to exist independent of the legal system.

The objective of the first element is to differentiate a data object from those things that which are not separable from persons, such as “(unsevered) body parts, friendships or thoughts”, which are not usually appropriate for property rights.

The aim of the second element is to ensure that things in action (those things which are claimable or enforceable by legal action such as cash balance at a bank) and other types of property created by legislation (for example, intellectual property rights) cannot be classified as a data object. In contrast, the Law Commission state that data objects “exist independently of (and cannot be created nor extinguished by) legal rules. Nor are data objects only enforceable by legal action or proceedings.”

Rivalrous:

Rivalrousness refers to the ability of the possessor of a thing to prevent the use of that item by another. For example, in ordinary situations, your enjoyment of fresh country air would not prevent another from enjoying that same air. However, if you were to eat an ice cream while you enjoyed your country stroll, no one else would be able to eat that same ice cream. The ice cream is rivalrous while the air is not.

The consultation argues that rivalrousness is critical for things to be considered objects that attract property rights.

Divestibility:

Divestibility can, very basically, be referred to as the ability of an asset to be transferred to another and for the transferor to no longer be in possession of that thing.

Interestingly, despite the Law Commission acknowledging objects of property rights as being, in general, necessarily divested on transfer, it concludes that divestibility should not be a requirement for a thing to be recognised as a data object. Rather, the consultation report states that divestibilty is instead “a useful indicator of whether [the object] will meet the other criteria”.

The main reason for this is to ensure the law remains flexible and capable of adapting to the nuances of some digital assets which are not divestible. Mandating divestibility could therefore prevent innovation in the digital asset space. The consultation suggests that this is consistent with the way divestibility is more generally considered as a characteristic of property rights.

Control over possession: further potential area of law reform:

In addition to the creation of a third category of property rights, the Law Commission also discuss other areas in which legal certainty for digital assets may be achieved. To demonstrate this, the Law Commission consider the application of existing practice by reference to crypto-tokens, which it suggests, would be categorised as a data object. Accordingly, for reference, the Law Commission provides a non-exhaustive and non-determinative definition of crypto-tokens and invites comments from consultees, which can be viewed and commented on here.

Law of possession – potential problems with application to data objects:

One often hears it said that possession is nine-tenths of the law. This is certainly true in personal property law, which, for tangible objects, employs the concept of possession.

However, the Law Commission suggest that, for a variety of reasons, the concept of possession does not apply well to digital assets.

Firstly, the consultation outlines that as crypto-tokens generally evolved because of a failure of market practice, the concept of trying to fit crypto-tokens within a legal framework based on maintaining the status quo may seem reductive by its very nature. Also, it highlights that market practice would not apply possession to all data objects in any event, as the notion of possession is applicable only to tangible assets. Accordingly, the Law Commission consider that market practice in relation to data objects such as crypto-tokens has developed without centring on the law of possession and any attempt to fit data objects into that framework “would be highly likely to undermine, confuse and potentially fracture the complex, sophisticated and varied legal structures that the crypto-token markets have developed over the last 13 years”.

Another drawback of the concept of possession in relation to crypto-tokens highlighted by the consultation is the fact that it is also likely to be interventionist, given the development of the law has fundamentally taken place based on dealings with tangible assets.

Amongst other things, the Law Commission also suggests that the extension of the concept of possession to data objects would “further complicate an already complex legal concept” and that the key elements of the concept of possession are less applicable to data objects than they are to tangible assets.

The alternative - control as a factual concept:

As an alternative, the Law Commission proposes the development of a new concept that would be more finely attuned to the complexities of data objects whilst maintaining the positives of the law of possession: the concept of control. Here, the Law Commission explain, “whether a person is in control of a data object should depend on the factual ability to determine use that the person has over that data object, rather than on the legal rights that they may have in relation to it.” Accordingly, the concept of control can be understood as being functionally similar to the concept of possession, without the requirement of intention.

The Law Commission suggest that this proposal “strikes the best balance between creating legal certainty for the market and maintaining the dynamism and flexibility that characterises the law of England and Wales in respect of the facilitation and development of novel technology.”

However, the Law Commission acknowledges that the concept of control alone may not be sufficiently nuanced to adequately deal with complex legal mechanisms and arrangements (including transfers of title of crypto-tokens, custody arrangements, collateral arrangements, and the operation of causes of action and remedies). Instead, it states, the concept of control would be best utilised as forming a part of how these arrangements are structured or considered.

Comment:

The Law Commission’s consultation paper is an extensive piece of work that is seeking to grapple with a multitude of legal issues that affect digital assets. It takes us through a journey from first principles to the day-to-day reality of owning and dealing in digital assets. English courts have been at the forefront of tackling some of these issues as they are approached by parties for remedies over the past few years. (You can find our extensive coverage of these decisions in a number of articles published by the team, below.[2])

However, it is recognised that there are still many questions unanswered, and it would greatly assist the development and adoption of digital assets to have clarity on the applicable legal principles. Whether this clarity comes from creation of a parallel regime for digital assets or the acceptance that digital assets fall within the ambit of already established legal principles, is a debate that is likely to divide opinion. What is clear though that the Law Commission are paving the way for a path to certainty.

Market participants are encouraged to respond to the Law Commission’s consultation by Friday 4 November 2022. A full list of the Law Commission’s consultation questions is at pages 468 to 482 of the consultation paper here.

[1] See Colonial Bank v Whinney (1885) 30 Ch D 261 at 285, by Fry LJ: “all personal things are either in possession or in action. The law knows no tertium quid between the two.”

[2] D’Aloia v Persons Unknown & Others (unreported, 24 June 2022)

Lavinia Deborah Osbourne v Persons Unknown & Ozone [2022] EWHC 1021 (Comm)

Sally Jayne Danisz v Persons Unknown and Huobi Global Ltd (T/A Huobi) [2022] EWHC 280 (QB)

Zi Wang v Graham Darby [2021] EWHC 3054 (Comm)

Fetch.ai Ltd and anr v Persons Unknown Category A and ors [2021] EWHC 2254 (Comm)

ION Science Ltd v Persons Unknown and others (unreported, 21 December 2020)

Toma v Murray [2020] EWHC 2295 (Ch)

Ruscoe v Cryptopia Limited (in liquidation) CIV-2019-409-000544 [2020] NZHC 728

AA v Persons Unknown [2019] EWHC 3556