NFTs – five legal things to consider

Wherever you are in the NFT ecosystem (artist creator, gallery creator, collector buyer, gallery buyer, investor buyer, art advisor or just curious), you may be scratching your head about at least one element of the NFT life-cycle. On the legal side, there is a lack of judicial consideration of some key aspects, and the regulators and consumer protection authorities are still catching up.

That said, there are several key legal considerations that we recommend thinking about in the context of an NFT venture governed by English law. Being clear on these from the outset could pay dividends in the long run (acknowledging that, however good your preparedness, the market is young and volatile). We are focusing here specifically on copyright, contract and consumer law considerations and the list is non-exhaustive (for example, anti-money laundering and financial regulatory considerations may well be relevant too). We refer here to NFTs that point to digital art while acknowledging that NFTs can, in theory, point to any asset.

1. Whose copyright is it anyway?

When you sell an NFT, unless there is an agreement to the contrary, the buyer takes ownership of the NFT but not any copyright in the underlying digital artwork. Issues can arise when the owner of the NFT thinks that they can use the digital artwork in any way they want but they do not, in fact, own the copyright in it or have permission from the copyright owner to use it. In that scenario, the owner of the NFT cannot do much with the NFT other than view the digital artwork in a domestic setting without being in breach of copyright.

So if you are buying an NFT make sure that you review the associated terms document in advance to check that you will be receiving all of the rights you need or expect to receive in the underlying digital artwork.

Issues can also arise when NFT creators link the NFT to a digital artwork that itself reproduces a third-party work without permission and therefore infringes copyright. The Financial Times recently reported that a group of artists including Anish Kapoor were considering taking legal action against a curator who had minted NFTs pointing to digital photographs of their real-world artworks without the artists’ permission - the curator’s project, called “Art Wars”, was taken down from OpenSea, the NFT marketplace. Where the NFT-linked digital work reproduces a third party’s copyright, a creator or seller of an NFT may be liable for "authorising" infringements of the copyright which occur when third parties make or disseminate copies of the underlying artwork.

If you are selling an NFT, either include a disclaimer making clear that you are not transferring the copyright or granting permission to use the digital artwork or, if you include a transfer of the copyright or grant a licence under it in the NFT terms document, make sure that you have all necessary rights to do this, including the rights needed to support the creation of the artwork and its subsequent use by buyers of the NFT. Think about whether you want to sell ownership of those rights to the buyer of the NFT (less common) or whether you want to grant the buyer and any future owner of the NFT a limited licence instead (more common). If you choose to grant a copyright licence consider whether the licence is exclusive or not, perpetual or time-limited, for commercial or non-commercial use and whether you want to expressly reserve any rights for yourself, such as merchandising rights.

2. The importance of a contract

The degree of contractual complexity required when selling an NFT is likely to be impossible to code into the underlying smart contract so a natural language terms document is highly advisable. If copyright ownership is to be transferred, it will need to be signed by the seller of the rights (an electronic signature would normally be acceptable).

It might be theoretically possible for a purely code-based contract to meet the requirements for a binding contract under English law, but it would be prudent to include a natural language contract that complements and is consistent with any code-based terms. An order of precedence clause can be included to resolve any inconsistency between the two (and is, indeed, advisable). Given the often cross-border nature of NFT sales and the challenge of determining the “location” of a digital asset, we would always recommend including a clear applicable law and jurisdiction clause in the natural language contract.

It is also important to check the interaction of your sales terms with the terms of the marketplace that you are selling on. If you are the buyer, checking this is also important in case of any critical inconsistencies.

3. Consumer law obligations

Most NFTs pointing to digital artworks will be sold on marketplaces directed at consumer buyers (rather than business buyers). Under English law, specific consumer protections apply to contracts between traders and consumers. A digital artist or cultural institution selling an NFT is likely to be a trader under the Consumer Rights Act 2015 and will therefore need to comply with consumer protection legislation.

Traders must ensure that the terms of consumer contracts are transparent – in other words that the terms are expressed in plain and intelligible language. A purely code-based contract is highly unlikely to meet the transparency standards imposed by English law so clear natural language contractual terms should therefore be used.

Consumers are normally provided with a statutory right to cancel a contract for goods or services within 14 days of the purchase. On the basis that NFTs are digital content, it may be necessary to obtain the consumer buyer’s express acknowledgement that by going ahead with the purchase of the NFT they are waiving their 14-day right to cancel.

4. Advertising standards

The Advertising Standards Authority (ASA) has deemed the advertising of NFTs to be a “red alert” priority – link. Ensure that your advertising of NFTs is responsible and in accordance with the ASA’s expectations.

5. What happens on resale?

Artists are entitled to a royalty on the proceeds of any resale of their artworks, under the artist’s resale right regime. It remains unclear, however, whether digital artworks fall within artist’s resale right. The point is untested but given the clear language of the EU Directive on which the UK regulations are based, the general view is that artist’s resale right only applies to works in physical form and cannot apply to NFTs.

This does not prevent the creator of an NFT from seeking to impose a contractual requirement to pay a resale royalty. You may be able to code an instruction into the NFT code for a percentage of any resale proceeds to go back to you or even to a third party. This is a potentially exciting method for digital artists and cultural institutions to generate future income. It is yet to be seen how robust and enduring such mechanisms will be though.

For greater legal protection, any coded resale royalty should be backed up by a written natural language contractual term setting out the resale royalty obligation on the first buyer of the NFT plus an obligation that requires the first buyer to impose the same obligation on the second buyer and so on. A contractual obligation on the buyer not to run any part of a resale transaction outside of the blockchain should also be included, as well as an obligation to resell on the original NFT platform (if it is technically necessary for the resale transaction to be run through the original platform for the coded resale royalty instruction to operate). These measures are intended to provide you with contractual protection of the resale royalty that, arguably, the code alone may not and to stop the resale royalty being circumvented by a buyer and seller negotiating a sale price and exchanging funds off-chain, with only a nominal sum being paid on-chain. Policing and enforcing these contractual terms may be another potentially significant challenge. 

If you are buying an NFT, check the related code and the terms document to understand any resale royalty obligations before completing your purchase.

If you require further information about anything covered in this briefing, please contact Natalie Rimmer or your usual contact at the firm on +44 (0)20 3375 7000.

This publication is a general summary of the law. It should not replace legal advice tailored to your specific circumstances.

© Farrer & Co LLP, March 2022