Change is Coming! Understanding the New Rules of NFT Sales and Secured Financing with Jeff Karas

Transcript

My name is Jeff Carris. Uh I am attorney in the web3 space. Uh I work for uh the law firm Brown and Rednick. And I am here today to talk about some actual updates in um the positive way about uh crypto laws which might be shocking uh to some people given headlines and everything else we hear about some negative things in the legal space related to to NFTTS and um and our crypto space. Uh so this is primarily related to um the sales and transfer of uh crypto and NFTTS and also secured financing and secured lending in that

space. Uh so before I get started, I do have a trigger warning. The word security is going to pop up uh in this speech a few times. Um but it is not about a Howie test or Gary Gendler or the SEC or any of that. uh it is about secured lending, but I just I know there might be some emotional reactions to that word and I just want to let you know. All right. So, uh to anyone unfamiliar with what the UCCC is, uh which is probably most people that are not attorneys and took a very specific class in law school, uh it's the uniform commercial code. Uh and that in general governs the rules of commercial

transactions, um including the sale of goods and secured lending. Uh it was primarily written in either the 1950s or 1990s um depending on which articles you're looking at. Um, it is a more or less uniform code, but I will say that it is enacted on a state-by-state basis, and there are some tweaks in certain states, but in general, you can uh if you know the UCCC rules, um you're you're in a very very good spot to to uh deal with each state and their rules because they generally enact it uh in its entirety, including amendments, which we will talk about in a second. Um so again this was primarily written in

the 1950s and 1990s which um I don't know if any of you are familiar with uh with when crypto was invented but uh that was much later than these dates. So it is also slightly outdated for our concerns. Now uh most of this space uh as far as lawyers and attorneys go we know it's outdated and have been kind of trying to work within the rules that have been given to us. Um but a committee was formed in 2019 uh to create some amendments to solve this problem of it being outdated. Uh that was approved in 2022. Uh it went through several rounds of revisions.

There's a giant committee and comments and all this kind of stuff. Uh so it was a very thorough process to to get to the finalized um amendments. And what it does is it essentially uh creates an entirely new article uh article 12. Uh so previously there were 11 articles, now there will be 12 once it's enacted. Uh and that deals with um crypto for lack of a better buzzword. And um so it creates slashclarifies an entirely new asset class uh so that we know kind of how to deal with um both crypto and NFTs and digital tokens in

general. Uh they call that a controllable electronic record. Uh which we'll just call CERS for the rest of this and um that's pretty much what we've been calling it in the space so far. um that deals specifically with the rights of transfer and negotiability in a in a sale or transfer of uh CERS um and like I mentioned secured lending and also some unique choice of law what jurisdictions are going to govern these transactions um I will say that the committee was done finalizing article 12 but like I said it's up to the states if they want to actually enact this stuff uh but it has been uh enacted or is at

least introduced as a bill to be enacted in 21 states so far. And I would generally expect most states to to follow soon. Uh so we'll go through um some of what these buzzwords that I talked about are and some of the de definitions and how to deal with them. Uh the biggest one obviously is the new new asset class called controllable electronic records. Uh this is a record of information in electronic form that is susceptible to control. Uh I will I'll trust me I'll go into that more and and what all that means but uh I will point out here that electronic form is intentionally vague. Uh they didn't want to say you know distributed ledger technology or something like that so

that we would then have to amend this again when we have a new smart contract situation coming out uh which seems to happen every week in our space. So uh have a little bit of foresight to hopefully pick up all of the other progressions in this type of technology in our space. Um so this includes um you know non-fiat virtual currencies your your bitcoins and your ethereums and everything like that and also digital tokens such as NFTts and um there are some other nuances about um like controlled accounts and things like that but we won't get into that in a 20-minute talk about all this. Um so what does control mean? This is kind of the most important aspect here and the biggest change and probably was the most

debated topic in all these committee meetings. Um, so in order to have control of this record of information in electronic form, a person must have the power to enjoy substantially all the benefit of the CER, the exclusive power to prevent others from enjoying substantially all the benefit of the CER. and and the end is important because it means we have to have all three uh the exclusive power to transfer control or to cause another person to obtain control of the CR. So pretty much that means anything hanging out in your MetaMask is is going to count here. You have um you know you have the power to enjoy all the benefits of that let's

call it a dead call it a dead fella if you will. um that dead fella sitting in your MetaMask, you have uh essentially all the benefits of it. You have the power to prevent other people from using it. Uh and you also have the power to con transfer to control to someone else. Uh I will point out that that in this language just presented here, it does um appear that you have to be an individual that uh has all of these. uh but there are some nuances written into article 12 that allow for multi-IG uh accounts to to exist in this space and it's still considered control.

Um so I this is a little bit of a legal nuance but this also control here also includes control agreements uh with respect to a digital token or a CER by way of uh smart contracts. So in order to or the smart contract if it's it's designed to execute on you know predetermined actions upon completion of of of predetermined conditions uh that is uh also control. Um so in the traditional legal space they're they're called account control agreements that you would sign with like a bank or some third party that says if this person over here doesn't pay their loans. So um as an example then I will take control

of their account with the bank here. This allows for the smart contracts to actually be that sort of third party component which is very interesting and was definitely a problem in the space when it came to um defining control in that smart contract concept. Um all right so we've defined what a CER is. So what does that mean and what uh new rules apply to CERS? Uh specifically there's a concept of negotiability which is transfer. Um so if the CER is purchased in a voluntary transaction highlighted that because that means no theft uh the purchaser acquires an interest in all the rights that the CR and the transfer had and or had the

power to transfer. Uh that's a basic way of saying you get what the person was telling you. uh and that's pretty standard. But what is important here is that they've applied what uh is commonly called the take-free rule or the shelter rule. And that means that if a good faith purchaser without notice of a competing interest acquires a digital token, NFT, anything here, it will obtain the rights free of any competing complaints. So that means that uh a stolen NFT that is sold downstream to a good faith purchaser that did not know that it was stolen and

had no reason to believe uh that it was stolen. Uh that purchaser is going to take that NFT downstream free of any rights of the victim of the theft. Uh, which is interesting because I don't know if anybody's paying attention to to kind of what's going on with the the flagged assets in the NFT space, but um that flag would definitely be notice in this case. U but without the flag, there might be uh an argument that, you know, I bought it without notice in good faith. So, uh it's mine now. Uh I'm sure the concept of without notice uh will be litigated at some point. Um but given the uh vagueness a little bit of this uh

and what's happening in the space right now, it's definitely an interesting concept. Um, I will say that when we say that the rights of the transfer are are transferred to the purchaser, this does not apply to what the article 12 calls tethered rights, which is uh like IP rights or if you're, you know, selling title to a good, a physical good via NFT. The UCCC is basically saying that IP laws are going to govern the transfer of IP rights and real estate laws are going to um you know govern the transfer of any real estate title that's that's attached to that NFT. So you're really just getting um the NFT itself and and any sort of rights that that good has,

not necessarily rights that have been tethered to that in some way. um which again is probably going to be a very interesting concept as we move forward because I know IP rights are are getting kind of coded into some NFTts and um transferability of that kind of stuff is a very interesting topic but as far as the UCCC article 12 is concerned those are a completely separate area of the law so they're not going to worry about it more or less uh I will say that there is a small exception to this and that's if there's a right to payment attached to that NFT uh it's they treat the article 12 is treating that more like an account. Uh and you can transfer that, right? Um but that's again a a very nuance situation here. Uh all right. So

that's negotiability and transfer. Um then the next thing is secured lending. And this is actually my background. So I won't spend the remainder of my time talking about this, but I'm sure many of you here or listening are familiar with with the NFT lending space and and um also a and things like that. Um, in the past you we weren't sure what asset class according to the UCCC uh that an NFT or a token would fall into. So by creating this new asset class, the CER, we now know for sure what the rules are of what's called perfection. Uh, and perfection just means that you've put the world on notice that um you have a

security interest, again, trigger warning, sorry. uh security interest in that asset and you have a right to it uh as a lender. Uh similar to you know a used car uh if you got a loan to buy that used car, the bank is going to have a right to that car if you don't pay back your loan. Uh so perfection is how you put the rest of the world on notice that that used car uh has an a lean or a security interest on it. Uh so article 9 typically uh with these things the CR now that we've defined them and they made some amendments to article 9 which covers secured lending uh you can uh perfect your security interest by filing what's called the UCCC1 with secretary

of states of of jurisdictions um that are applicable and that's basically just a onepage form that says I have a security interest and here's a short description of it. Um, but the problem with that in our space is, uh, you have to know where the borrower is. Uh, you also have to know their name and address and everything like that. Um, again, it's a simple form in in in normie space, if you will, but, uh, you know, you're not filing a UCCc1 for a random stranger that's, you know, moonboy 69 on your UCCc1. So, probably a little bit problematic for our space. Um but thankfully the the new um amendments add the concept of control. Um and if you

have control which we've previously defined um you can put the world on notice more or less that uh you have a security interest in that. So again, if you have that sort of either a smart contract or a third party agreement that says if the borrower does not do what they're supposed to do under the loan agreement or the security agreement, uh then it's mine now. Uh and so now that we've defined control when it comes to the CERS, uh we can be a little bit more impactful with our security agreements in the legal space and how to deal with these, which is awesome, uh because it was a little bit ambiguous before.

Um, so it does still require a written security agreement to kind of govern the terms, which is still problematic if you're in the code is law crowd and and don't want to sign an agreement next to these things. Um, if you want to argue about whether or not code is law, I'll be here all day and I absolutely hate that phrase, but that's not the topic of this conversation. Um, so we you still do need some sort of security agreement. Uh, and I will bring up the the the choice of law concept here. Um, because it would be where you file the UCCc1 or just sort of what uh state and laws govern your perfection because again only 21 states are even enacting this right now. So, it might not even be applicable in the state that you're

trying to do this in. Uh, it's a little bit complicated and definitely going to be something that I think will be argued about. um the choice of law and the jurisdiction if you don't explicitly state it in your agreement is wherever the um the CER is located and located means where the system is recorded uh which I'm sure all of you here are familiar with that could be literally anywhere in the world especially for something like Ethereum. So that is a very open concept. I'm not sure how that's going to shake out but that's how they've defined it so far. Um yeah, I've got two and a half minutes left. I know that was a very very quick crash course on a very complicated piece of law, but uh I just thought it was some good news

that um we are actually creating laws that are going to be helpful for us moving forward. Uh and so I thought I'd let everyone know about it. Um, if there's any questions, um, I'll be around and obviously I'm I'm here and on Twitter and also, um, Brown Rudnik if you want to find me there. Um, is there any questions that you want to ask in the next two minutes? Sure. Go ahead. Yeah. Yeah.

Yeah. Yeah, like I said, um the the question was about um the take-free rule, the shelter rule. Uh the I think the without notice is going to be the most interesting thing here. I think there's a lot of um the the other prongs of that is a good faith purchaser, which is a legal term, but pretty easy to to check that prong. Um and for value, which is also easy to check that prong, but the without notice is going to be um I think heavily litigated. Uh, nobody's really litigating um stolen NFTTS yet. Uh, there's some things in the process and and trying to figure that out, but even like where to serve notice and all that kind of stuff is a little complicated right now, but I am very confident that we will see stolen NFT uh

cases at some point. Um, it's just kind of a matter of when the price and and concern and what you might get back in that situation is worth more than the legal fees to litigate it. that's when uh we'll see it. Until that point, uh we'll probably just keep arguing about it on Twitter. So, okay, I think my time is up, but uh thank you