In February 2024, the Law Commission published – by way of a short consultation – its draft Property (Digital Assets etc) Bill (the Bill).
The Bill is the product of important and extensive work undertaken by the Law Commission on the status and nature of digital assets as "property", including its final report on digital assets (published in June 2023). Clause 1 of the Bill is the central provision. Establishing legal certainty around the treatment of digital assets as "property" will pave the way for the increased issuance, trading, clearing and settlement of such assets in the financial markets, and support their use as collateral.
"Objects of personal property rights A thing (including a thing that is digital or electronic in nature) is capable of being the object of personal property rights even though it is neither—
(a) a thing in possession, nor
(b) a thing in action."
The intention of the Bill, as explained in paragraph 3.10 of the short consultation, is to confirm that things that are not things in possession or things in action (including digital assets) are capable of being personal property as a matter of the laws of England and Wales – and that it should be left to the courts to determine: (1) what things (including what types of digital assets) fall within this separate category; and (2) what personal property rights attach to such things.
Historically, the common law has recognised only two types of "things" that could be the objects of personal property rights:
What is clear is that digital assets – not taking tangible form – cannot be "possessed". They "exist" in a distributed ledger system independently of the legal system and may not constitute a "claim" on another person.
Since 2021, the Law Commission has been undertaking a ground-breaking and essential project to explore potential legal reforms necessary to support the development of crypto-tokens, other digital assets and the use of DLT-based technologies. This important work has been wide-ranging – covering the law of personal property, trusts, contract, tort, collateral and private international law. The supporting analysis is always thorough and well-presented, responsive to key issues identified by consultees and prepared with the objective of enhancing the attractiveness of English law to support the issuance, holding and transfer of digital assets. The output of the Law Commission's work is already proving highly influential in the development of the law and is often cited before the courts of England and Wales (and other common law jurisdictions).
We have been actively engaged in assisting the Law Commission to develop its proposals, the majority of which we warmly welcome.
It remains important, however, to carefully scrutinise each element of the Law Commission's recommendations to ensure that it achieves the desired and stated outcome – in particular, the common objective of enhancing legal certainty for the UK financial industry – and to suggest improvements, where possible and practicable. In this piece, we carry out that exercise in relation to the Bill.
We highlight below some pitfalls to avoid and suggest a drafting solution which, if implemented, will further enhance legal certainty for the digital assets community, encourage innovation and the increased use of digital assets in the financial markets, and promote international harmonisation with other common law jurisdictions.
Although the Law Commission states that the intention of the Bill is not to determine which "things" fall into the third category of personal property, the likely implicit effect of the Bill will be to require the courts of England and Wales to interpret "things in action" narrowly – and to include crypto-tokens and similar digital assets in the Bill's new, "third category" of personal property.
There are a number of English cases of high authority that support a flexible, dynamic and expansive interpretative approach to the concept of a "thing in action" as covering all intangible things (and not just intangible things that can only be claimed or enforced by legal action or proceedings). This is underscored by the Law Commission in its short consultation, where it repeatedly uses the expression "in the narrow sense" when referring to its conception of "things in action" at the basis of its proposals for the Bill.
There are, broadly speaking, two schools of thought as to how the courts might ultimately interpret and apply the concept of a "thing in action":
1. narrowly, so as to exclude crypto-tokens and similar digital assets; and
2. widely, as including such digital assets.
The wide interpretation has been adopted in other common law jurisdictions – like Singapore. See ByBit Fintech Ltd v Ho Kai Xin and others [2023] SGHC 199.
If the Bill supported the common law development of a wide definition of a "thing in action" (i.e. as capable of including crypto-tokens and similar digital assets) then there would be no need for the additional category of personal property that is supported by clause 1: it would be sufficient for the Bill to confirm that a digital asset is capable of being the object of personal property rights even though it is not a right that may only be claimed or enforced by legal action or proceedings against another person or persons.
Due to the way the Bill has been drafted, it risks going further than its stated aim. It reaches for a conclusion about how crypto-tokens and similar digital assets should be categorised under the common law and potentially prevents or inhibits the courts of England and Wales from determining that they may be properly characterised as "things in action" under a wide, inclusive and expansive interpretative approach to that class of personal property. A middle ground would be to amend the drafting of clause 1 as follows:
"A thing (including a thing that is digital in nature) is capable of being an the object of personal property rights even though it is neither –
a. a thing in capable of possession, nor
b. a thing in action right that may only be claimed or enforced by legal action or proceedings against another person or persons."
This would achieve the desired purpose of the Law Commission (i.e. to clarify that a thing may be the object of personal property rights, even though – to use the language of the consultation accompanying the Bill – it is not a thing in action "in the narrow sense"), while avoiding "forcing the hand" of the courts of England and Wales to interpret "things in action" narrowly so that digital assets can only be characterised as falling within the Bill's new "third category" of personal property.
By creating a third category of personal property for crypto-tokens and similar digital assets, the Bill (if enacted in the form proposed by the Law Commission) would represent a potentially decisive step in encouraging the common law development of title, perfection, priority, innocent acquirer and other proprietary rules for such digital assets. That is vitally important – it is those rules that support the proper functioning of the financial and other markets. For intangible assets today, there are existing rules of English law and equity for "things in action" which are certain, well-founded and produce predictable effects for participants in the UK's financial and other markets, which in turn underpins confidence in those markets.
However, as identified in (1) above, the current drafting of the Bill could have the unintended effect of forcing digital assets to fall within the Bill's new "third category" of personal property for which there are (currently) no similar rules of English law and equity. In addition, even when such rules do begin to take shape, they may develop in a way that does not align with the corresponding rules applicable to "things in action" (or sub-categories of "things in action"), which are familiar to participants in the UK's financial and other markets and benefit from a wealth of prior consideration and analysis by those participants (and their legal advisers). This means that there will be a (potentially material and unnecessary) period of legal uncertainty while the courts develop the relevant common law proprietary rules to support this new category of personal property as applying to crypto-tokens and similar digital assets.
One of the advantages of leaving the courts of England and Wales to develop a wide interpretative approach to the category of "things in action" to include crypto-tokens and similar digital assets is that, once the courts have done so, the industry would have immediate (much greater) certainty as to the likely rules that would apply to digital assets – they can look to the existing proprietary rules (or an incremental development of such rules) that apply today to "things in action" (or relevant sub-categories of "things in action"). Our suggested amendments to clause 1 of the Bill would also help to ensure this remains a possibility.
Building upon the pitfall we identified in (2) above, as the courts look to develop the common law applicable to any new, third category of personal property founded upon the provisions of the Bill, they are likely to find the Law Commission's earlier work and analysis, which culminated in the Bill, highly influential. In particular, in its final report, the Law Commission proposed a concept of factual "control" as the foundation to determine title and related issues affecting crypto-tokens and similar digital assets.
Although the premise of "control" as the foundation of legal ownership of a crypto-token or similar digital asset makes sense, the Law Commission goes on to take inspiration from concepts found in the law of possession as applicable to tangible assets. Some of these ideas would, in our view, create material legal uncertainty for the holding and transfer of crypto-tokens and similar digital assets. They may create significant "traps for the unwary" who deal in or with such digital assets, and be problematic for the digital assets industry and the viability of digital assets for use in the financial sector.
To take an example in the context of collateral: imagine a collateral-taker wants to take security by way of a fixed equitable charge over digital assets. To take the fixed charge, the collateral-taker has to take an appropriate level of control over the digital assets – just as it would in relation to financial instruments today, like shares.
However, if (by taking that level of control) the collateral-taker is vested with the proposed "control-based legal proprietary interest" (see Box: What are the Law Commission's possession-inspired ideas?), does it also accept wider (potentially non-derogable) obligations (equivalent or similar to those of a pledgee or other bailee) which are not currently accepted or expected by collateral-takers of intangible assets today? That would make taking digital assets as collateral much less attractive for collateral-takers who may then, by analogy with the law of bailment, be under a duty to take reasonable care to ensure that the digital assets are not lost, damaged or destroyed.
There are various. For example, in its final report, the Law Commission proposes that the common law could be separated from, and be inferior to, a "superior" legal title. This could support both intermediated (custody) relationships and security arrangements, as well as founding a new cause of action by analogy with the tort of conversion.
The Law Commission goes on, drawing from possessory concepts like bailment, to suggest that the holder of the control-bases legal proprietary interest might also be subject to certain obligations to protect or vindicate the assets under its control.
The practical problem is that taking security over digital assets might then become more burdensome for the collateral-taker than taking security over other intangible assets (like shares). Collateral-takers might not accept crypto-tokens or similar digital assets as security, or they might "price in" the risks arising from any additional legal uncertainties or duties associated with the new "control-based legal proprietary interest" to financings.
The potential to introduce additional duties on the holders of "control-based legal proprietary interests" raises serious questions in other contexts as well. Can a custodian of digital assets, subject to the duties that attach to the "control-based legal proprietary interest", define its legal obligations in the same way that it can under a trust deed or custody agreement today? In relation to a pool of digital assets, is it legally possible for a custodian to hold part of the pool as trustee for some clients, while holding part of the same pool under the "control-based legal proprietary interest" for other clients?
More fundamentally, the Law Commission's ideas essentially introduce relative legal title (i.e. different levels of "legal" title, in addition to any equitable title) into the world of digital assets and other "third category things". While such a concept of legal title is appropriate to deal with issues arising in relation to tangible assets, there is no sound policy basis for its inclusion and application to crypto-tokens and other intangible assets. Its development for such assets is, in our view, unnecessary, unhelpful and likely to introduce real risks and uncertainty to the use of digital assets in our financial and other markets.
As outlined above, the concept of a "thing in action" is flexible, dynamic and potentially open-ended. The Law Commission's short consultation, its final report and its earlier work all recognise that the exact scope of a "thing in action" is uncertain as a matter of the current common law. However, clause 1 of the Bill nonetheless uses the term "thing in action" without definition as a core element in defining (by exclusion) the potential scope of the new "third category" of personal property.
This inevitably introduces (on the face of the Bill) a material element of interpretative uncertainty into an instrument which is intended to remove any residual legal uncertainty as to the eligibility of crypto-tokens and similar digital assets to qualify as personal property under the laws of England and Wales. Again, our suggested amendments to clause 1 of the Bill seek to address this issue.
Finally, as outlined above, the likely intention and effect of clause 1 of the Bill is to require the courts of England and Wales to categorise crypto-tokens and similar digital assets as being outside the category of "things in action".
This raises retroactivity concerns: if a charge-taker has taken a charge over a borrower's "things in action", reasonably concluding that (as a matter of existing English law) "things in action" exhaustively cover all of the borrower's intangible personal property (including the borrower's crypto-tokens and other digital assets), then the Bill (if given retroactive effect) would effectively remove digital assets from the scope of the relevant charge. This result could fundamentally change the risk profile associated with the arrangements between the charge-taker and the borrower.
The courts, then, with regard to such potential "unfair" impacts, would be likely to apply the principle against retroactivity and interpret the Bill as only applying in relation to digital assets (or interests in relation to digital assets) that were "created" after the Bill came into force.
This result would have the opposite effect of the stated intention of the Bill: rather than introducing a single, uniform and clear taxonomy determining how crypto-tokens and other digital assets are to be characterised as a matter of the English law of personal property, it would create "tiers" of personal property rights, interests and duties in relation to digital assets. This would raise material legal uncertainty and potentially introduce a number of difficult practical issues for the application of proprietary rules in relation to digital assets.
As with any new legal development, it is vital to always have an eye on the horizon and consider the implications of a change in law for those most closely affected by it. In the case of digital assets in particular, this includes market participants holding and transferring digital assets (including in the traditional financial markets) and persons seeking to take collateral over digital assets.
We are very supportive of the vital and extensive work being undertaken by the Law Commission to bring much-needed legal certainty to the status of digital assets as personal property. The pitfalls we outline in this paper, and the drafting solution we propose to address these, are aimed at ensuring that this strive towards legal certainty is not impeded by the law of personal property (as it applies to digital assets) developing in unpredictable or unhelpful ways, which could act as a barrier to innovation.
