Legal Aspects of Non-Fungible Token (NFTs)

Meaning: Non-Fungible Token (NFTs) is a form of Digital Art and entertainment which is mostly based on the Blockchain Technology. It is a type of virtual digital asset. It is often linked to an underlying tangible asset like a music video, a painting, a shoe etc. Non-Fungible means anything which is unique and which cannot be replaced with anything alike. For example, we can exchange 1 Ethereum and get another Ethereum. Thus, Ethereum is Fungible but the NFT of 1st painting of Monalisa is unique, we cannot replace it and get other Monalisa token, thus it is Non-Fungible.

NFTs are smart contract based Intellectual Properties. It operates on blockchain based technologies. Since NFTs include Intellectual Property, it is very important to have a clear demarcation of rights and liabilities of the buyer and seller of NFT and the legal implications of the same.

Whether NFTs are covered under Trademark Law or other Intellectual Property Laws?

Intellectual Property Rights are developed to protect the Interest of creators/owners/assignee’s of original and new work. However, the nature and extent of applicability of these laws to NFTs and VDAs segment is still unclear. In Indian context also, Laws related to Intellectual Property are still silent on this new-age Intellectual Property. The scope of Intellectual Property Laws is continuously evolving and may adapt these new segments in near future. 

Since NFTs are unique form of Digital Art, it may be covered under the scope of Intellectual Property Laws. However, alike the traditional intellectual property, these new-gen intellectual properties must also contain certain features to obtain the protection under the Intellectual Property Laws. Some of these features include:

• Originality/Creativity: For any Intellectual Property seeking protection under IP Laws, it must be original and shall have certain level of creativity involved in it.
• Novelty: Another feature is, it must be new and has not been publicly disclosed anywhere in any form earlier.
• Distinctiveness: It must me capable of being distinguished from other existing Intellectual Properties.    

If the above specified features are present in an NFT, it can be considered as an Intellectual Property and claim protection under intellectual property laws.

NFTs and Infringement of Intellectual Property Rights:

Since it is easy to replicate a tangible work into an NFT, the risk of IPR infringement is quite high. NFTs are digital asset, having an underlying tangible asset and if such underlying asset does not belong to the creator or the creator does not have the legal rights for digital replication, then this will amount to infringement of IPR, if the underlying work is protected by the IP Laws. Thus, while creating or purchasing a NFT utmost care should be taken to ensure that it does not infringe the Intellectual Property Laws.   

Here are a few well known cases where IPR were infringed by the NFTs:

1. The case of famous US Luxury brand Hermes International Vs. Mason Rothschild makes the applicability of Intellectual Property Law to the NFT Segment very clear. In this case, Hermes International sued the Artist Mason Rothschild for creating the NFT of its most famous traditional luxury bag “Birkin” with the name of “Metabirkin NFT” thereby leading to the trademark infringement of Hermes.

The Jury stated that “Mason Rothschild’s use of Birkin Mark was intended to mislead potential customers into believing that Hermes was associated with Mason Rothschild’s Metabirkin project” The court awarded a damage of $1,33,000/- to the Hermes.

2. In Shenzhen Qice Diechu Cultural Creativity Vs. Hangzhou Yuanyuzu Technology, China’s first Copyright infringement case involving NFT, the plaintiff filed a case against the defendant, which was an NFT Trading Platform, for infringement of its copyright over the artwork “Chubby Tiger having its Shot”. The defendant pleaded that it is merely a trading platform and it was third party, which minted and sold this NFT. The court rejected this argument of the defendant stating that defendant was charging the GAS fees and commission for the minting and sale of such NFT on its platform, so it was the duty of the defendant to verify that the NFTs being listed and sold on its platform are not infringing the copyrights of any other person.

3. In Juventus FC Vs. Blockeras, Europe’s first trademark infringement case involving NFT, the plaintiff, Juventus FC, filed a case against the defendant, for unauthorised minting, advertising and sale of NFT that made use of Juventus’ trademark which included “Juventus” & “Juve” word marks along with the football clubs white and black jersey featuring their famous striker Christian Bobo. Defendant argued that the trademark was not registered for use on “downloadable virtual goods”. The Rome Court rejected this argument and held that the club’s marks are widely recognised, and Juventus has registrations for its marks in Class 9 of the Nice classification for use in connection with “digital downloadable publications” which would suffice for use as NFTs. Further the court held that protection in the non-digital space may be sufficient to grant protection in the digital space if the trademark owner can prove the actual use of the mark.

These cases have led the foundation for applicability of Intellectual Property Laws to the NFT Segment. Since this segment is very new and at a nascent stage the level and scope of the applicability of these laws shall be tested with time.

Whether Transfer of NFT automatically transfers the IP Rights associated with the underlying assets?

A major question that arises with the sale/transfer of NFT is whether the transfer of NFT automatically transfers the copyright, trademark or any other intellectual property right in the tangible work underlying that particular NFT? Although, giving an answer with universal applicability to this question is not possible owing to the absence of specific laws in this regard however, taking precedents from the decided cases depict that transfer of an NFT does not automatically transfers the copyright, trademark or any other intellectual property right in the tangible asset underlying that particular NFT. Artists or Creators need to transfer those rights specifically to the buyers of NFT. 

NFTs in Indian Legal Aspect: 

Presently there are no specific laws that govern and regulate NFTs in India. However, a few implications can be drawn from general acts to cover NFTs within their purview.

• NFTs and Income Tax Act, 1961

A new Section 115BBH has been introduced under the Income Tax Act that levies tax at a rate of 30% on Virtual Digital Assets dealing which include NFTs as well.  Moreover, no deductions are allowed against this income except for the cost of acquisition, if any, 

• NFTs and Intellectual Property Laws

Indian Intellectual Property Legislations are still silent on the NFTs and other digital assets. Moreover, Indian Courts are yet to rule on issues involving NFTs. However, precedents from the international cases cited above may be taken to form a primary view on these issues. 

• NFTs and Indian Contract Act 1872

In transactions involving the NFTs, if all the features of a valid contract (i.e. Offer, Free Consent, Lawful Consideration and Lawful Objective) are present then dealings in NFT may be covered under the scope of Indian Contract Act, 1872. 

• NFTs and Sales of Goods Act, 1930

As per Section 2(7) of the Sales of Goods Act, 1930, Goods means “Every kind of movable property other than actionable claims and money”. Section 3(36) of the General Clauses Act, 1897 defines moveable property as “property of every description except immovable property” and Section 3(26) of the General Clauses Act, 1897 defines immoveable property as “Immovable property shall include land, benefits to arise out of land, and things attached to the earth, or permanently fastened to anything attached to the earth.”

Taking into consideration the above definitions, NFTs may be covered under the definition of Goods and the provisions of Sales of Goods Act may be applied thereof.  

• NFTs and Consumer Protection Act, 1986

NFTs and Consumer Protection Act do not have direct relation. But the provisions of the act may apply to transactions involving NFT in certain cases where the NFT purchaser acts in the capacity of the Consumer. NFTs are frequently utilized to validate ownership or authenticate digital assets like artwork, collectibles, or virtual real estate. In accordance with the Consumer Protection Act, consumers are entitled to receive goods or services that align with the representations made by the seller. Consequently, if an NFT asserts ownership of a digital asset, consumers anticipate that the NFT accurately mirrors that ownership. Any disparity in this regard could potentially give rise to dispute which may be dealt with under the Consumer Protection Act. 

Moreover, the Consumer Protection (E-Commerce) Rules, 2020 introduced by the Ministry of Consumer Affairs, Food and Pubic Distribution, specifically cover under its ambit all goods and services bought or sold over digital or electronic network including digital products. These rules even apply to entities not established in India but systematically offers goods or services to consumers in India. These rules were introduced to curb the unfair practices against the consumers carried out by the entities via online platforms. Thus, NFTs being a Digital Product and the foreign NFT exchange plaforms providing their services in India are also covered under this rule.

• NFTs and Prevention of Money Laundering Act, 2002

NFTs being smart contracts based on blockchain technology can be used to hide the identity of the buyer and the seller. Money launderers might exploit this anonymity feature to obscure the source of illegal funds. NFTs are traded globally via online platforms, rendering them vulnerable to cross-border money laundering schemes. The Prevention of Money Laundering Act enforces regulations on international financial transactions to deter the transfer of illicit funds across borders. 

The Central Government vide notification dated March 07, 2023, has notified AML & CFT Guidelines for Reporting Entities providing services related to Virtual Digital Assets. These guidelines also cover NFTs under its ambit.

These guidelines are intended to set out the steps that a service provider shall implement to discourage and to identify any money laundering, terrorist financing or proliferation financing activities. It prescribes the procedures and obligations to be followed by the reporting entities to ensure compliance with AML/CFT/CPF guidelines including mandatory customer KYC requirement, making and implementing certain AML Policies in the organisation, reporting of certain transactions on a periodic basis to the Financial Intelligence Unit etc.

• NFTs and Information Technology Act, 2000

The Information Technology Act, 2000 grants legal validity to electronic transactions and the exchange of data and information. Given that NFTs are digital assets, they could come within the scope of this act, particularly regarding their inception, transfer, and validation.

NFT transactions commonly employ smart contracts, which are contracts that self-execute based on coded terms. The Information Technology Act recognizes the legitimacy of electronic contracts, including smart contracts, enabling them to regulate the transfer and ownership of NFTs. Thus any online transactions of NFT may be covered under the ambit of Information Technology Act, 2000.

Important points to be checked under the NFTs Purchase and Licence Agreement:

Going by the above standing it is very clear that NFTs are Intellectual Property. So, any purchase, sale or transfer of such property shall be governed by an agreement similar to other intellectual properties. There are a few points which must be kept in mind while drafting an NFT Purchase and Licencing Agreement:

• Purchase of an NFT does not automatically transfers the copyright or other intellectual property rights related to that NFT unless the creator or seller of the NFT specifically mentions this in the agreement. So, a specific clause in this regard must be mentioned.
• The Agreement must specifically mention all the technicalities related to that NFT including the basic nature and features of the smart contract.
• Must contain the clauses related to the right to resell, transfer, sub-licence that NFT specifically, if the purchaser wishes to resell the NFT further.
• Since the NFT Sale-Purchase transactions take place on a mediatory platform, it is very important for both the transacting parties to understand, and agree to the terms and conditions of that platform and after that incorporating the same in the Agreement. 
• Regulatory requirements related to NFTs are still evolving however, the general compliances related to Anti-Money Laundering, Income Tax, Intellectual Property, Cross-Border Transactions etc. must be adhered to.
• NFT transactions may involve international transactions as well. So, in this case the jurisdiction must be mentioned in the agreement, to determine the applicability of laws of that particular region to the transaction.  

Conclusion: 

NFTs being a new-age Intellectual Property is still trying to develop a foundation in the legislative segment. The legal landscape of the NFTs is still evolving based on the challenges being faced by the transacting parties. The existing legal framework shall have to play a crucial role to mitigate the challenges associated with the NFTs. Till the regulatory frameworks develops, it is very important for the stakeholders to remain cautious and exercise their due-diligence before entering into any NFT based transaction. A small mistake may lead to huge legal and financial risk.

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