How UCC Article 12 May Make NFTs More Valuable
This article was originally written and published in a longer form by the American Bar Association on March 22, 2023.
Non-fungible tokens (NFTs) came into the mainstream through celebrity-driven art projects, but there may be other intriguing use cases. Providing accurate and secure registers of ownership with the ability to embed smart contract attributes means that NFTs present a novel and potentially disruptive way to track and distribute certain forms of IP. But mainstream adoption of NFTs as a tool for IP exploitation will require vested interest holders to understand the full breadth of their utility and convenient application of the rapidly evolving law addressing digital asset commerce.
New UCC Article 12 and Its Possible Effects
In July 2022, the Uniform Law Commission and American Law Institute finalized a new Article 12 and other amendments to Article 9 of the UCC, intended to address the law of commercial transactions involving “controllable electronic records” (CERs), as well as “controllable accounts “and “controllable payment intangibles.”
The intent of this legislation was to more directly address ownership and security interests in electronic record assets (a.k.a. digital assets) upon which some level of control can be exercised, including virtual currencies, payment intangibles, accounts evidenced by an electronic record, and certain NFTs. As of this writing, at least four states (Nebraska, Iowa, New Hampshire and Indiana) have now adopted all or portions of these amendments to the UCC. These commercial codes uphold the promise of establishing legal standards for commercial transactions involving various forms of CERs not clearly addressed by earlier versions of the UCC.
The amendments include clarifications to the methods and priorities of security interest perfection, choice of law provisions, and a transitional period for assets previously perfected under an earlier version of the UCC.
Importantly, there are comments to these amendments cautioning that control of an electronic record does not mean that control also exists over property “tethered” to the CER. In other words, having control over the electronic record (e.g., an NFT) does not necessarily mean there is control over (or a perfected security interest in) an underlying IP right from which the NFT derives its value.
One important implication of this clarification is that an interest in an NFT (e.g., a perfected security interest) will not necessarily mean that interest extends to the tethered asset itself, and if an interest is to be secured in the underlying asset (as opposed to the NFT itself and the intrinsic value it may have), perfection of a security interest in the tethered asset itself likely must be made separately from or in tandem with perfection of an interest in the NFT.
What Should Businesses Do to Perfect Their Interest in NFTs?
To perfect a security interest under the existing Article 9 of the UCC in most states, the NFT must first be classified in terms of type of collateral. In many cases, the NFT will be considered a general intangible, which will require filing of a properly prepared UCC financing statement in the relevant jurisdiction to perfect a security interest. But if viewed as “investment property,” control may be the preferred method of perfection, suggesting that in some instances asset type ambiguities could present ambiguities under UCC. Texas has enacted amendments to that state’s Article 9, clarifying that a security interest in virtual currencies can be perfected by either the filing of UCC-1 financing statements or control.
If adopted in the relevant state, the provisions of Article 12 of the UCC allow either control of the CERs/NFT or the filing of a UCC financing statement to perfect a security interest. Importantly, control of the CERs/NFT will take priority over even a previously filed UCC. Given the distinction, however, between the NFT itself and the IP rights that may be tethered to it, if the NFT is intended to convey a title interest in the tethered patent, trademark or copyright, it will be advisable to also record notice of the security interest using existing recordation systems at the U.S. Patent and Trademark Office or the U.S. Copyright Office, as applicable.
Please contact Drew Patty or Andrew Coffman or any member of the Phelps Intellectual Property team if you have questions or need advice or guidance.
Published in Landslide, Vol. 15, No. 3, March/April 2023, by the American Bar Association. Reproduced with permission. All rights reserved. This information or any portion thereof may not be copied or disseminated in any form or by any means or stored in an electronic database or retrieval system without the express written consent of the American Bar Association or the copyright holder.
