New Digital World, Old Legal Rules

It’s time for me, as one of the only lawyers in the NFT Twitter room, to once again let everyone know they are making huge mistakes by treating NFTs as the lawless wild west.

I regularly see people brag about doing deals in the NFT space without any formal written agreements. As an NFT collector and member of the community, these tweets are great to see. Our rapidly expanding digital tribe is full of primarily good/trustworthy people. But as an attorney, I shudder. Whether you are starting a new venture, pooling money for a large purchase, joining a DAO, or doing a simple private deal, you need to be using actual written contracts or you need to be prepared to lose everything with no recourse.

In this article I will explain the basics of contract law and important terms for NFT deals.

Photo by Matthias Zomer on Pexels.com

Contract Basics

Contracts come in many shapes and sizes. They can be extensive and try to plan for every possible contingency, or be simple one page documents with just the necessary terms to meet the relevant state/country legal requirements. For people buying NFTs as a group, I often suggest forming a holding LLC for that asset. In that case, the LLC’s operating agreement can act as a contract between the co-investors. What you want is simply (1) something in writing; (2) with all the key terms in one place; (3) signed by all parties. Many jurisdictions accept digital signatures, but it is usually best to go old-school and put pen to paper when dealing with contracts.

I already covered some contract basics in my article explaining the difference between a smart contract and a formal contract. What is not mentioned in that article, is that jurisdictions often have a “statute of frauds” which determine what must be in formal written contracts to be enforceable. The Uniform Commercial Code has a model statute of frauds of which many states have enacted some version of. If you do not have a formal written contract, signed by all parties, then you run the risk that a court will refuse to enforce any verbal or informal agreement you may have. A simple contract eliminates this unnecessary risk.

Additionally, people need to understand the contracts are often cost saving devices. A well-written contract turns the uncertain into the certain, and creates a clear winner or loser to many potential disputes before those disputes ever arise. What happens when one person wants to sell the joint-purchased NFT but the other wants to hodl (hold)? Who gets control of the project when the developers have irreconcilable differences? What are the rights that come with your DAO participation? If there is a split, who has to buy who out and at what price?

Rather than spending tens of thousands of dollars litigating the above issues in the event of a dispute, a contract sets out answers to these questions with little-to-no need for court intervention. The only time a judge is needed is when one party is refusing to play by the established rules. If that is the case, you want a formal written contract to place in front of the judge, not a bunch of discord messages or DMs for the judge to try to piece together an agreement post hoc (if the case isn’t thrown out entirely for violation of the relevant statute of frauds).

Key NFT Contract Terms

When putting together a contract on NFT matters, here are a few provisions you should certainly consider:

Governing Law/Jurisdiction– Web3 does not have jurisdictional boundaries. You may be doing deals with somebody in New York City one day, and Hong Kong the next. This creates a problem: in the event of a dispute what jurisdiction’s laws should apply, and what court should adjudicate those issues? Rather than trying to later convince a court what laws to apply or that it has jurisdiction over the party in breach, have those things established beforehand. The last thing you want to do is fly 8,000 miles, dozens of times, because some foreign court is only court with jurisdiction over your business partner.

Bonding (if either party is anonymous)– Contracts can certainly be made with anonymous people. Anonymity contracts are not unusual. However, an anonymous person can’t have their assets seized if they breach an agreement or be called into court in the event of a dispute. Nor can you guarantee that anonymous person is solvent in the event of a dispute. Contracts are no good if there is no person or assets to enforce the contract against. If the person you are contracting with is anonymous, there should be a provision which either provides a bond which covers that person’s liability in the event of a dispute, or the non-anonymous person should have control over the relevant assets to prevent an unknown individual from absconding with the venture’s assets.

Dispute Resolution Provision- Litigation is expensive. Luckily (or unluckily depending on who you ask) the United States has the Federal Arbitration Act which gives parties almost unfettered discretion on agreements to solve disputes outside of formal court proceedings. I’ve already written about what alterative dispute resolution could look like in the Web3 world. It doesn’t necessarily need to be done by an established arbitrator such as those provided by the American Arbitration Association. It could be an individual, or a group of individuals, in the community you both trust. If you want to name me as the arbitrator, have at it! If you can figure out a way to solve disputes without costly and formal court proceedings, that is usually preferred.

Note: virtually all contract terms can be standardized. I often create “form” contracts for my clients, which cover all the major issues for their particular needs and can be easily/cheaply edited to add or remove provisions based on the individual circumstances of a deal. If you are doing frequent partnerships, or lots of off-market deals, you can hire an attorney to create a form contract which you can later edit for hundreds of similar deals without any additional expense simply by filling in the blanks.

Conclusion

We as a community put a ton of emphasis on how people should protect their assets from digital theft. We don’t put enough emphasis on how people should be legally protecting themselves from other forms of theft such as embezzlement or failing to abide by agreements. This was fine in 2020 when NFTs were a $300 million dollar industry but less acceptable when it turned into a $40 billion dollar industry in 2021 with expected growth beyond that in 2022.

Get a lawyer who knows NFTs. Listen to that lawyer. Code is not law. Law is law. Use written contracts. Form legal entities. Work within the law or be prepared to be beaten by the long arm of the law.

If you have any questions, or would like me to cover anything in particular, reach out to me on either of my twitter pages. As always, I am an attorney, I am not your attorney. For legal advice, you should always consult (and pay for) an attorney.

3 thoughts on “New Digital World, Old Legal Rules

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

%d bloggers like this: