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

My name is Jeff Carris. I am a lawyer in the web3 space. I work for the law firm Brown and Rednick. And I'm here today to talk about some real updates in a positive way regarding cryptocurrency laws, which might surprise some people given the headlines and everything else we hear about negative aspects in the legal realm related to NFTs and our crypto space. This relates primarily to the sale and transfer of cryptocurrencies and NFTs and transfer of cryptocurrencies and NFTs , as well as financing and secured loans in that space.

Before we begin, I have a warning. The word "security" will appear in this speech a couple of times. But this isn't about the Howey test, or Gary Gensler, or the SEC Howey test, or Gary Gensler, or the SEC , or anything like that. These are secured loans, but I know there may be some emotional reactions to that word and I just wanted to warn you. Very good.

For anyone unfamiliar with what the UCC is, which is probably most people who aren't lawyers or didn't take that specific class in law school, it's the Uniform Commercial Code. In general, this governs the rules of commercial transactions, including the sale of goods and secured loans. It was written mainly in the 1950s or 1990s, depending on which articles are consulted. It's a more or less uniform code, but I must say that it's enacted state by state, and there are some adjustments in certain states. But, in general, if you know the UCC rules, you're in a very, very good position to deal with each state and its rules, because they generally enact it in full, including the amendments, which we'll talk about in a second.

Again, this was mostly written in the 1950s and 1990s; I don't know if any of you know when cryptocurrencies were invented, but it was long after those dates. Therefore, it is also slightly outdated for our concerns. Most of us in this field, as far as lawyers and litigators are concerned, know that it's outdated and we've been trying to work within the rules we've been given. However rules we've been given. However , in 2019 a committee was formed to create some amendments and resolve this problem of obsolescence.

That was approved in 2022. It went through several rounds of reviews. There was a giant committee, comments, and all that kind of stuff. It was a very thorough process to arrive at the final amendments. What it does is essentially create a completely new article, Article 12.

Previously there were 11 articles, now there will be 12 once it is enacted. And that's about, for lack of a better buzzword, cryptocurrencies. Create or clarify a completely new asset class, to know how to handle cryptocurrencies, NFTs, and digital tokens in general. This is called a controllable electronic record. We'll call it CER for the rest of the talk, which is what we've called it in the industry so far.

It deals specifically with transferability and negotiability rights in a sale or transfer of CERs, and as I mentioned, secured loans and also unique applicable laws: which jurisdictions will govern these transactions. The committee finished finalizing Article 12, but it depends on the states whether they want to enact it; So far it has been enacted or at least introduced as a bill in 21 states. I would generally expect most states to follow suit soon. We'll review some of these buzzwords I mentioned, as well as some definitions and how to handle them. The most important, obviously, is the new asset class called controllable electronic records .

It is an electronic record of information that is subject to control. Trust me, I'll delve into what this means, but I will point out that the term "electronic format" is intentionally vague. They declined to mention distributed ledger technology or anything similar, to avoid having to amend this again when a new smart contract situation arises, something that seems to happen every week. So they had some foresight to try to cover all future advances in this type of technology. This includes non-fiat virtual currencies , such as bitcoins, ethereums and all that, plus digital tokens like NFTs; There are other nuances regarding controlled accounts, but we won't get into that in a 20-minute talk.

So, what does control mean? This is possibly the most important aspect here, the biggest change, and probably the most debated topic in all these committee meetings. To have control of this record of information in electronic format, a person must have the power to substantially enjoy all the benefits of the CER, the exclusive power to prevent others from enjoying those benefits, and that "and" is important because it means we must have all three: the exclusive power to transfer control or cause someone else to gain control of the CER. Basically, this means that anything in your MetaMask will count here. You have, you know, the power to enjoy all the benefits of that, let's call it a digital asset, if you will.

That digital asset stored in your MetaMask essentially gives you all its benefits. You have the power to prevent other people from using it. And you also have the power to transfer control to someone else. I will point out that, in this newly presented language, it seems that you must be an individual who possesses all these faculties. But there are some nuances written in article 12 that allow multi-IG accounts to exist in this space and still be considered control.

This is a legal nuance, but control here also includes control agreements regarding a digital token or a CER through smart contracts. So, if the smart contract is designed to execute predetermined actions after certain conditions are met, that is also control. In the traditional legal field, these are called account control agreements that you would sign with a bank or a third party, indicating what happens if someone fails to repay their loans. As an example, I would then take control of your account with the bank. This allows smart contracts to act as that external component, which is very interesting and was certainly a problem when it came to defining control in the concept of smart contracts.

Okay, we've now defined what a CER is. So defined what a CER is. So what does this mean, and what new rules apply to CERs? Specifically, there is the concept of negotiability, which is the transfer negotiability, which is the transfer . If the CER is acquired in a voluntary transaction—I emphasize this because it means there was no theft—, the buyer acquires an interest in all the rights that the CER and the transferor had or had the power to transfer.

That's a basic way of saying you understand what the person was telling you. And that's pretty standard. But the important thing here is that they have applied what is commonly called the free acquisition rule or the protection rule. And that means that if a bona fide purchaser, unaware of a conflict of interest, acquires a digital token, an NFT, or anything here, they will obtain the rights free from any claims against them. That means a stolen NFT being sold to a bona fide buyer who didn't know it was stolen and had no reason to believe it was.

That buyer will obtain the NFT free of any rights of the theft victim. Which is interesting because I don't know if anyone is paying attention to what happens with marked assets in the NFT space, but that mark would definitely be a warning in this case. But without the brand, there could be an argument that I bought it in good faith and without knowledge. So now it's mine. I am sure that the concept of "without knowledge" will be subject to litigation at some point.

But given the somewhat vague nature of this and what's happening in the sector right now, it's definitely an interesting concept definitely an interesting concept . I will say that when we say that the transferor's rights are transferred to the buyer, this does not apply to what Article 12 calls tied rights, such as intellectual property rights or the sale of a title to a physical asset through an NFT. The UCCC basically says that intellectual property laws will govern the transfer of such rights and real estate laws will govern the transfer of any title to that NFT. So you really only get the NFT itself and any rights inherent in the asset, not necessarily the rights that have been attached to it in some way. Which, again, will probably be a very interesting concept as we move forward, because I know that intellectual property rights are being encoded in some NFTs, and the transferability of that kind of thing is a very interesting topic.

But as far as Article 12 of the UCCC is concerned, those are completely separate areas of law , so they're not going to worry about it much. I will say that there is one small exception to this, and that is if there is a payment right attached to that NFT; Article 12 treats it more like an account. And that can be transferred, right? But that is can be transferred, right? But that is , again, a very nuanced situation , again, a very nuanced situation .

Alright. That's about negotiability and transferability. Next up are secured loans. And this is, in fact, my field of expertise. So I won't spend the rest of my time talking about this, but I'm sure many of you here or listening are familiar with the NFT lending space and things like that .

In the past, we weren't sure what asset class, according to the UCCC, an NFT or a token would fall under. So, by creating this new asset class, the CER, we now know for sure what the rules of what is called perfection are. Perfection simply means that you have signaled to the world that you have a security interest; Again, activation warning, sorry. You have a security interest in that asset and you have a claim on it as a lender. Similar to a used car; If you took out a loan to buy that car, the bank will have a right to that vehicle if you don't pay off the loan.

Perfection is how you notify the rest of the world that that used car has a lien or security interest on it. Article 9, typically on it. Article 9, typically , with these things, now that we have defined them and made some amendments to Article 9, which covers secured loans, you can perfect your security interest by filing what is called a UCCC1 with the Secretaries of State of the applicable jurisdictions. Basically applicable jurisdictions. Basically , it's just a one-page form that says, "I have a security interest, and here is a brief description."

But the problem with that in our space is that you have to know where the borrower is. You also need to know their name, address, and all that. It's a simple form in the traditional sense, so to speak, but you're not going to submit a UCCC1 for a random stranger, like "moonboy 69", on your UCCC1. So it's probably going to be a bit of a problem for our space. But, fortunately, the new amendments add the concept of control.

Well, and if you have control, which we have already defined above, you can notify the world, more or less, that you have a guaranteed interest in it. So again, if you have that kind of smart contract or agreement with a third party that states that if the borrower fails to comply with the terms of the loan or guarantee agreement, then it's now mine. And now that we've defined the control regarding CERs, we can be a bit more effective with our warranty agreements in the legal sphere and how to handle them, which is great, because before it was a bit ambiguous. A written warranty agreement is still necessary to regulate the terms, which is problematic for those who believe that "the code is law" and do not want to sign an agreement alongside these things. If you want to discuss whether the code is law or not, I could be here all day and I really hate that phrase, but that's not the topic of this conversation.

So, indeed, some kind of warranty agreement is still needed. I will mention the concept of choice of applicable law here. Because it would indicate where to file the UCC-1 form or which state and laws govern its completion, since only 21 states are currently implementing this . So it might not even be applicable in the state where you're trying to do it. It's a bit complicated and it will definitely be a topic that I think will be debated quite a bit.

The choice of law and jurisdiction, if not explicitly set out in the agreement, is wherever the CER is located, and "located" means wherever the system is registered. Which, I'm sure everyone here knows, could literally be anywhere in the world, especially for something like Ethereum. So that's a very open concept So that's a very open concept . I'm not sure how it will turn out, but that's how they've defined it so far . Yes, I have two and a half minutes left.

I know it was a very fast-paced crash course on a very complicated law, but I thought it was good news that we are creating laws that will be useful to us in the future. And that's why I thought I'd tell everyone. If you have any questions, I'll be around; Obviously, I'm present and on Twitter Obviously, I'm present and on Twitter , and also on Brown Rudnick if you wish to find me there. Hmm, do you have any questions you'd like to ask in the next two minutes? Clear.

Forward. Yes. Yes, as I said, the question was about the transfer rule, the refuge rule. I think the "without prior notice" will be the most interesting thing in this case. I think there are other aspects, such as the bona fide purchaser aspects, such as the bona fide purchaser , which is a legal term, but it's easy to verify that point.

And the " easy to verify that point. And the " by value" part is also easy to verify, but I think the "without prior notice" part will be the subject of many lawsuits. The truth is, nobody is litigating yet over stolen NFTs. There are processes underway trying to resolve it, but even knowing where to report and all that is a bit complicated right now, but I'm sure we'll see cases of stolen NFTs at some point. It's simply a matter of whether the price and the interest you can recover in that situation is worth more than the legal costs of litigation.

That's when we'll see it. Until then, we'll probably continue discussing it on Twitter. So, well, I guess my time's up, but thanks.