Crypto – UK Law Commission

Recommendations for reform and development of law relating to digital assets by the Law Commission of England and Wales

Introduction

The Law Commission of England and Wales (Law Commission) called for evidence on the legal status of digital assets in April 2021 and issued an interim report in November 2021. In July 2022, it issued a consultation paper. On 28 June 2023, the Law Commission published a 304-page final report on digital assets. The report explains the existing legal structure, and contains limited recommendations for reform and development of the law relating to digital assets.

Set out below is our highlights of the report:

The Law Commission concludes that the common law of England and Wales is, in general, sufficiently flexible, and already able, to accommodate digital assets. The Law Commission proposes a tripartite approach to law reform, i.e., (i) reform through further common law development where possible; (ii) targeted statutory law reform only to confirm and support the existing common law position or where common law development is not realistically possible; and (iii) provision of further guidance from industry-specific technical experts which would support both common law and statute.

The major recommendations and conclusion in the report are:

A third category of property.

The Law Commission concludes that some digital assets are neither things in possession nor things in action, but the law of England and Wales treats them as capable of being things to which persona property rights can relate.
There should be statutory confirmation of the existing position at common law, which would facilitate the law’s continued development on the point, and lay to rest that such 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.

Control

The Law Commission discussed the legal significance of the concept of control over third category The Law Commission concluded that factual concept of control (i.e., ability to exclude or to permit access to a third category thing, and put the third category thing to the uses of which it is capable of); and the legal consequences of control would work differently for different digital assets (e.g., due to the inherent features and functions of different digital assets, the control relate to transfers, holding arrangements, collateral arrangements and remedies would be different).
The Law Commission recommended that a panel of industry-specific technical experts, legal practitioners, academics and judges to provide non-binding guidance on the complex and evolving factual and legal issues relating to control involving third category things such as digital objects (and other issues relating to digital asset systems and markets more broadly).

Transfers

The Law Commission explored two opposing views as to the legal characterisation of transfer operation within a crypto-token system (which typically involves replacement, modification, destruction, cancellation, or elimination of a pre-transfer crypto-token and the resulting and corresponding causal creation of a new, modified or causally-related crypto-token).
The Law Commission concluded that it is possible to effect a legal transfer of a crypto-token offchain, by a ‘change of control” (along with the requisite intention).

Innocent acquisition rule – good faith purchaser for value without notice

The Law Commission concluded that a special defence of good faith purchaser for value without notice applicable to crypto tokens can be recognised and developed by the courts through incremental development of the common law.

Intermediated holding arrangement

The Law Commission conclude that crypto-token intermediated holding arrangements can be characterised and structured as trusts, including where the underlying entitlements are (1) held on a consolidated unallocated basis for the benefit of multiple users, and (2) potentially even commingled with unallocated entitlements held for the benefit of the holding intermediary itself. And the best way to understand the interests of beneficiaries under such trusts are as rights of co-ownership in an equitable tenancy in common.
Recognition of a control-based legal proprietary interest could provide the basis for an alternative legal structure for custodial intermediated holding arrangements in addition to trusts. This could take the form of holding intermediaries being recognised as acquiring a control-based proprietary interest in held crypto-token entitlements that is subject to a superior legal title retained by users.
The Law Commission does not at this stage recommend, a general pro-rata shortfall allocation rule in respect of commingled unallocated holdings of crypto-tokens or crypto-token entitlements held on trust by a custodial holding intermediary that enters insolvency proceedings. A more extensive, in-depth assessment of the merits of potential insolvency law reform applicable to specific custodial holding intermediaries is necessary.

Collaterals

The Law Commission concluded the establishment of multidisciplinary project to formulate and put in place a statutory legal framework that clearly facilitates the entering into, operation and enforcement of (certain) crypto-token and (certain) crypto-asset collateral arrangements.

Causes of action and associated remedies

The Law Commission concluded that:
- causes of action and associated remedies in the context of third category things. The Law Commission concludes that much of the current law concerning causes of action and remedies can be applied to third category things without law reform;
- the legal principles relating to void contracts can apply to third category things, in the same was as they do to other objects of personal property rights, without law reform;
- claims in proprietary restitution and restitution for unjust enrichment likely will be available in the context of third category things, whereas a claim in conversion will not be available. However, such claims are unlikely to succeed where a claimant’s crypto-token is burned by a defendant;
- it would be better for the courts to develop specific and discrete principles of tortious liability by analogy with, or which draw on some elements of, the tort of conversion to deal with unlawful interferences with digital objects.

The report will now be considered by the UK Government, which will consider whether and how to move forward with the Law Commission’s recommendations.

To learn more about our services and how we can assist you in this ever-changing space (in particular, structuring, tokenisation, collaterals, and/or litigation), please contact us.

Alfred Leung, Partner (alfredleung@hkytl.com; 852 3468 7202)