knowledge 14 August 2023 |

UK Law Commission publishes Final Report on Digital Assets

In addition to providing an overview of the UK Law Commission’s recommendations, our briefing sets out the approach adopted by Irish courts with respect to digital assets.

Background

With the proliferation of digital assets, and with financial services becoming increasingly digitalised, there comes the risk of legal uncertainty, as well as a danger that technological innovation will outpace legislation and governmental policy. In this context, in March 2020, the UK Government commissioned the UK Law Commission (the “Commission”) to undertake a review of the law in England and Wales relating to crypto-tokens and other digital assets, and a consideration of whether reform would be needed to ensure that the law can accommodate those assets.

What are “Digital Assets”?

The term “digital asset” is extremely broad. It captures a host of technologies, including digital files, email accounts, digital carbon credits, crypto-tokens, and non-fungible tokens (“NFTs”). In recent years, certain types of digital assets have become increasingly relevant to financial markets and are now used for an expanding variety of purposes, including payments, investments, and linking to, or embodying, debt and equity securities.

Emphasis on Common Law Development

Overall, the Commission’s report recommends a relatively non-interventionist approach, and emphasises that the common law has, thus far, generally proven to be sufficiently flexible to accommodate digital assets. Courts in England and Wales have recognised certain types of digital assets as things to which personal property rights¹ can relate, and have been able to accommodate those assets within the existing boundaries of the common law without the need for statutory intervention.

While suggesting that areas of residual legal uncertainty are largely best left to be addressed by the common law, which provides the flexibility and agility required to address such highly nuanced and complex areas, the Commission recommends targeted statutory intervention in two specific areas, the most significant of which relates to the use of digital assets as collateral.  On that topic, the Commission recommends the creation of a bespoke statutory framework.

Recommendations for Statutory Reform

According to the Commission, law reform should focus on either affirming the existing common law position or be targeted towards residual areas of uncertainty. The Commission submits that statutory intervention is only desirable if it bolsters the existing legal position or if it addresses problems not easily solved through incremental development of the common law. With that as an overarching principle, the Commission makes the following recommendations:

• Statutory Confirmation of the Existing Common Law Position 
  
  The Commission recommends statutory confirmation that a thing will not be deprived of legal status as an object of personal property rights merely by reason of the fact that it is neither a “thing in action” nor a “thing in possession” (being the two traditional categories of personal property).  The Commission emphasises that legislating to this effect would merely confirm what it considers to be the existing common law position and, while not strictly necessary, would have the benefit of avoiding further (arguably academic) arguments about the classification of digital assets. Moreover, according to the Commission, it would provide courts with a clear conceptual foundation for the further development of the common law, including as regards identifying the assets and things that can and should attract personal property rights on a particular set of facts.

• Industry Guidance 
  
  Recognising that it is unrealistic to expect the judiciary to remain aware of all market and technological developments, the Commission recommends the creation of a panel of technical experts, legal practitioners, academics and judges in relation to the new “third category” of personal property (i.e. things that are not “things is action” or “things in possession”).  The panel should provide non-binding guidance on matters including the complex and evolving factual and legal issues relating to the “control”² of such third-category property.

• Targeted Statutory Measures regarding the Regulation of Crypto-Assets 
  
  As mentioned above, the Commission concluded that the laws of England and Wales present problems for the use of digital assets as collateral that cannot be solved or improved by common law development.  This is not only because of the complexity of the issues to which collateral arrangements give rise but also because the treatment of collateral involves complex policy considerations (e.g. priorities on insolvency) that are most appropriately left to the legislature to determine and requires statutory intervention to provide the level of certainty needed by the market.  With that in mind, the Commission makes two final recommendations.   
  
  First, that as a matter of priority, the UK Government should set up a multi-disciplinary project to implement a bespoke statutory legal framework that more clearly facilitates the entry into, operation, and enforcement of certain crypto-token and certain crypto-asset collateral arrangements.     
  
  Second, noting that many crypto-tokens and crypto-assets are likely to fall outside of the scope of the UK’s Financial Collateral Arrangements Regulations (“FCAR”)³, while others arguably do come within its scope, the Commission recommends statutory intervention to clarify the extent to which crypto-assets fit within the UK’s existing FCAR regime.  The Commission emphasises, however, that it does not make a recommendation as to whether any particular type of property should come within the scope of FCAR as this is a question of policy for the legislature.  As a related point, the Commission also recommends a review of existing company law to assess the merit of reform to clarify the validity of crypto-token networks for the issuance and transfer of equity and other registered corporate securities (including through public permissionless ledgers).

Irish Case Law on Digital Assets

As mentioned above, the courts of England and Wales have considered the validity of certain types of digital assets as personal property in some detail, including decisions on how such assets relate to the traditional categories of personal property.⁴

By contrast, Irish courts have yet to make a clear statement as to whether digital assets fall within the common law’s traditional definition of “property”. Cryptocurrencies have, however, provided the factual backdrop to Irish case law, wherein the Irish courts have shown a willingness to adopt a practical approach with respect to the granting of remedies and orders.  Details of those cases are available in earlier briefings here and here.⁵  Given those decisions and the similarities between the common law systems, it seems very likely that the Irish courts would adopt a similar approach to that taken by the courts of England and Wales.

Conclusion

The Commission’s report is an important and useful discussion of the legal principles involved in the use of a broad range of digital assets.  As is made clear by the report, common law systems are generally well-placed to quickly and effectively adapt to the development and use of new types of assets and systems.  There is still, however, an important need for legislation in relation to certain issues (especially where assets are intended to be used as collateral to secure obligations), and it will be interesting to see if the UK legislature adopts the Commission’s recommendations in that regard.

In the global trend towards addressing the legal issues presented by digital assets, it will be interesting to see if any significant divergence of approach arises between jurisdictions.  The Commission’s strong recommendation that statutory intervention be as limited as possible (so as not to unintentionally constrain the flexibility of the common law) may not be followed in all jurisdictions.  For example, EU legislators have shown a willingness to legislate in respect of digital assets, in particular through the recently enacted Markets in Crypto-Assets (“MiCA”) Regulation⁶ (for more information on MiCA see our earlier briefing here).  Ultimately, there is unlikely to be a single “right way” to try to accommodate the opportunities and challenges of digital assets, but it will certainly be important for all market participants to understand the legal and policy positions being adopted in jurisdictions where any business is being undertaken.

As an EU Member State with a common law legal system, Ireland is well placed to become a leading jurisdiction in Europe for the development of the digital assets market. Irish law has the same common law agility and flexibility that has been identified by the Commission as an advantage under the laws of England and Wales. In addition, Ireland will be able to capitalise on the legislative certainty of the EU legal regime, notably including the advantage of pan-EU market access through the cross-border passporting of regulatory authorisations pursuant to MiCA.

Also contributed to by David O’Keeffe Ioiart