The Law Commission's 'data objects': Digital assets as a new property class

Those who have forgotten to choose a thriller for their summer holiday reading can breathe a sigh of relief; the Law Commission has come to the rescue by publishing its 549-page consultation paper on the future of digital assets. Spoiler alert: the Law Commission suggests that, while English law has demonstrated a degree of flexibility in accommodating the use (and regulating the misuse) of digital assets, now is the time to develop a coherent legal framework capable of dealing with all manner of digital assets, instead of relying on the iterative development of the common law. Such a framework would entail new legal fictions, and while the Law Commission’s proposals do not amount to an overhaul of English property law, they would, if implemented, result in fundamental changes.

A new category of property

Property rights are enforceable against the world, rather than against an individual. The Law Commission explains at length why this approach has allowed the global economy to develop processes that deploy capital as productively as possible. Under English law, two categories of property rights are currently recognised:

• Things in possession – rights in “any object which the law considers capable of possession” (e.g. a bag of gold)
• Things in action – rights “asserted by taking legal action or proceedings” (e.g, debts, shares in companies, rights to sue)

The Law Commission concludes that digital assets do not fit “neatly into either of the existing common law categories of personal property”. The value of certain digital assets relies on novel concepts which are not analogous to either existing category. Its proposal is to recognise a third category of personal property – data objects – that would not be constrained by the requirements of the existing categories.

What is a data object?

After considering various potential criteria for determining when a digital asset should be considered a ‘data object’, the Law Commission ultimately proposes a three-limb test.

Limb 1: “it is composed of data represented in an electronic medium, including in the form of computer code, electronic, digital or analogue signals”

The first limb serves two purposes. First, it differentiates data objects from things in possession, meaning that tangible assets cannot be considered data objects. Secondly, it recognises that a data structure may be functionally reliant for its existence upon a tangible structure, such as a network system.

Limb 2: “it exists independently of persons and exists independently of the legal system”

The second limb excludes things in action, which are “wholly reliant on the legal system for their continued existence and enforceability”. The requirement that an object can exist independently of a person ensures that only items that can be identified as distinct objects can be data objects. For example, a unit of a given cryptocurrency can exist regardless of its ownership by a person or recognition by a legal system.

The Law Commission’s example of where an object might exist independently of the legal system, but not independently of the person, was taken from R v Bentham [2005] UKHL 18, in which the House of Lords determined that a man who had placed his hand inside his jacket, with the intention of making it appear as though he was holding a gun, could not be charged with possession of an imitation firearm because “one cannot possess something which is not separate and distinct from oneself”.

Limb 3: “it is rivalrous”

The third and final limb requires the thing in question to be “rivalrous” in the sense that its use is not unlimited. A person reading a physical copy of a book prevents another person from reading that book at the same time. In the context of a thing in action, the obtaining of a patent, prevents another person from obtaining an identical patent. This requirement excludes pure information from becoming a data object.

Rivalrousness is readily comprehensible in the context of tangible objects, but as the Law Commission acknowledges, it is a concept that exists on a spectrum and may be “less familiar at its edges”. The paper’s reliance on tangible analogies, along with its analysis of why alternative criteria are less suitable, suggests that this limb may be the most contentious when it comes to determining whether or not an item is a ‘data object’.

Crypto-tokens

The Law Commission proposes that, of those digital assets which satisfy the requirements for recognition as a ‘data object’, a subset should be considered ‘crypto-tokens’ – data objects which are constituted and recognised as part of a software code that generates, authenticates, sends and validates the changes to a distributed ledger and effects any such changes itself.

The consultation process, which remains open until 4 November 2022, will allow for these proposals to be stress-tested and worked through before a final recommendation is published.

Is a distributed ledger automatically a definitive record of ownership?

Just as the UK Jurisdiction Taskforce before it, the Law Commission considers that a distributed ledger does not represent a definitive record of the legal title of the assets. Rather it represents a record of the links between discrete transactions. While noting that participants could contractually agree that the distributed ledger should act as the definitive record, the Law Commission considered it inadvisable for participants on open, permissionless blockchains to do so. Please see an earlier post, published in the International Journal of Blockchain Law, for an in-depth discussion of the potential litigation risks associated with such an approach: Spotting and managing litigation risk in DeFi

The Law Commission’s view is that in certain circumstances (e.g. a registry system for land ownership), it may be that closed, permissioned blockchains are suitable for determining legal title.

How are crypto-tokens transferred?

The Law Commission’s interpretation is that the act of transferring a crypto-token effects a change in that crypto-token’s data, effectively cancelling the “pre-transfer crypto-token and the resulting and corresponding causal creation of a new, modified or causally-related crypto-token”. The existing methods of creating new legal interests might not easily apply to the transfer of crypto-tokens, and the Law Commission concludes a new mechanism might be needed to recognise this.

Despite its interpretation that the state of a crypto-token is changed by the act of transferring it, the Law Commission still considered that such an act could amount to a derivative transfer (i.e. the recipient’s rights over the property are derived from the rights of the transferee), rather than the creation of a new and original legal interest (such as when a painter applies paint to canvas, creating a legal interest in a painting that previously did not exist).

The view that the existing rights are transferred will be of particular interest to litigators grappling with the question of the transfer of legal title of crypto-tokens in circumstances where the contract under which the transfer was made was void (or voidable) due to a vitiating factor.

What does this mean for disputes?

The recognition of a new legal category of property would have significant ramifications for the finance litigation landscape. All of a sudden, individuals and corporate entities alike would find themselves possessing, as a matter of law, a recognised bundle of assets known as data objects. What is bound to accompany such recognition is litigation: litigation over who owns what, on what terms, and for how long; litigation about the securitisation of such objects, and the enforcement of rights against them. The Law Commission is no doubt mindful of these litigation risks, and those in the financial markets will need to be as well.

Norton Rose Fulbright LLP is one of only three law firms that responded to the call for evidence that led to the consultation paper and welcomes the approach taken by the Law Commission. Their criteria for recognising digital assets as property include those advocated for by Norton Rose Fulbright LLP.

The digital assets consultation is one of a number of related projects by the Law Commission. Our three-part series earlier this year considered Law Commission’s final recommendations on smart legal contracts: Smart legal contracts under English law