Background

In 2019 the UK Jurisdiction Taskforce (UKJT) published its legal statement on crypto-assets and smart contracts. 

The statement addressed perceived areas of legal uncertainty in relation to how crypto-assets and smart contracts should be characterised, with the aim of building up market confidence around developing and operating assets based on distributed ledger technology (DLT). One conclusion from that statement was that smart contracts are capable of being legally binding and that crypto-assets could be treated as property under English law. This approach has been followed by courts, both in England and across the world. This area of law has continued to mature since the publication of that statement and in 2023, the UKJT published its legal statement on the issuance and transfer of digital securities under English private law (the Legal Statement), considering questions around the issuance and transfer of equity and other contractual securities based on DLT technology. Specific areas covered in this Legal Statement are analysed in this article.

The Legal Statement

The Legal Statement is "focused squarely on the question of whether English private law can support the issuance and transfer of equity or debt and other contractual securities using a system developing blockchain or DLT".

The UKJT considered the following types of securities in the Legal Statement: 

• debt and related contractual securities (bond/debentures or notes)
• proprietary securitisations of assets
• equity securities (in the form of shares in a UK company). 

The Legal Statement refers to any debt and related security as "bonds", and we will follow that nomenclature in this article.

"Bonds"

A bond is a contractual debt or other obligation of the issuer on agreed terms: a key feature is that a bond is transferable and unitised. The UKJT note that DLT could facilitate the issue of bonds (eg issuing token on a blockchain as opposed to issuing physical bearer bonds or using a DLT based register as a record of interested parties as opposed to a traditional database) and highlight the following advantages of using DLT compared to conventional structures:

• using a blockchain token enables remote transfer and removes the need to organise physical custody/transport of bearer instruments (which may be of significant value)
• a blockchain register may reduce the time, cost and risk of a central register or other intermediary
• administrative work to validate, reconcile and process transfers can be distributed over the network
• use of DLT facilitates payment in crypto-currency (or other digital asset), which can also be made on the blockchain
• the DLT ledger provides real time access to up to date information for all participants.

It is worth noting that blockchain is just a form of electronic database and there are already numerous registered bond structures that currently use electronic databases to record and effect bond transfers. As a consequence, this area of law is well established and there is nothing significantly novel that would need to be determined on the basis of utilising blockchain instead of a pre-existing electronic database. 

Bearer bonds and whether digital bonds could be "negotiable" 

• Traditional bearer bonds are negotiable (ie they are transferred by physical delivery or via endorsement and delivery). The recipient will take the bond free from any defects in title of the previous holder(s) (provided the recipient had no notice of the relevant defect). 
• The benefit of this set up is that these types of instruments are easily transferable (or tradeable) and do not require a separate written agreement to document such transfer.
• The UKJT considered whether digital bonds could be structured in such a way as to be negotiable.
• As bearer bonds have become negotiable through mercantile custom, there is no reason that this could not also happen for a digital token (noting that there is no bar to market custom, provided such custom has been established).
• A potential issue arises however whereby a crypto-asset or "token" is transferred by one party to a new third party (either directly or via a number of intermediaries). The third-party purchaser has no privity of contract with the original counterparty, so an alternative mechanism would be required for that third party purchaser to be able to enforce the contract with respect the original counterparty. 
• It is worth noting that this is not a problem unique to digital securities, as this would be the case in the paper world as well. 
• The Legal Statement refers to a number of options, with the simplest version being that the issuer of the token promises payment pursuant to the digital negotiable instrument by way of deed poll, which allows a third party to enforce such a contract without being a party to it (provided always that they are "sufficiently identified as the person for whose benefit the promise is made"). The UKJT do not see any issue with this approach in the case of a crypto-asset. Other options could involve the Contracts (Rights of Third Parties) Act 1999, open offers, advance consent to a transfer by way of novation or using a multilateral contractual framework (but these are outside the scope of this article). The UKJT consider that "[t]he practical effects of negotiability can also be emulated through the use of legal structuring technique."
• In the paper world the nemo dat rule does not apply to bearer bonds due to their status as negotiable instruments – therefore, the transferee will take title of the bearer bonds free of any defects (provided that they are a bona fide third-party purchaser for value). A bearer bond is a documentary intangible. Therefore "the bond is embodied in the physical document in which it is recorded and the two are incapable of becoming decoupled upon transfer". The UKJT do not see any reason why a digital token representing a digital bond should be treated differently to one in the paper world and they see no reason why this could not be achieved using appropriate structuring and drafting.
• The Legal Statement notes that there may be some hurdles (eg forks or pseudonymity) that will need to be overcome but is not of the view that these roadblocks are impassable. There is also discussion of a central register on the relevant system to keep track of transfers.

Share Securities

• The Legal Statement considers whether funds could be raised through the issue of digital shares. In the example given, tokens are sold and each token has the rights associated with one share.
• The relationship between shareholder and company is largely set out in a company's articles of association and shares are different from other types of debt securities.
• At first glance, there may not appear to be much of a difference in terms of digitalisation, but there are additional factors to take into account, namely:
  (i) the relationship between shareholder and company and
  (ii) the provisions of the Companies Act 2006 (CA06) applicable to shares.

The provisions of CA06 may present issues in terms of registration, certification and transfer. A UK company is required to maintain a register of members and can only register transfers in accordance with CA06. A share certificate typically should be in writing (although CA06 is silent on any formal requirements) and can be in electronic form and signed electronically. However, there would need to be an identifiable electronic document that constitutes the certificate and is capable of electronic delivery (which would need to be in a human readable format). It is possible that the articles could be drafted in such a way to dispense with share certificates to address this point.

Dispositions

The Legal Statement also discusses dispositions and concludes that while there is room for debate on whether certain types of transaction involve "dispositions" the issues are not specific to digital assets and apply to intermediated assets generally. As these comments are wider reaching than digital assets, this article does not seek to cover these in any more detail.

Concluding comments

The third legal statement relating to crypto-assets dives into more specific topics than have been discussed previously and there are a number of useful takeaways from it:

• The analysis as to how useful it is to present information via blockchain technology is very insightful, in particular the acknowledgement that this is a novel way of presenting information already available in an electronic form (eg an electronic database) and that, whilst there are certain advantages to the use of blockchain, these will need to be examined to see if their benefits outweigh traditional electronic databases.
• The takeaways in relation to bearer bonds and negotiation ie that there is nothing that would prevent a crypto-asset from becoming negotiable provided a number of rules are adhered to and hurdles overcome confirms that there is scope for much development in this area.
• The examination of the Companies Act 2006 in relation to shares and share security and whether these could be tokenised suggests that, provided the relevant company law rules are applied, there is no reason that these could not operate in a token format.

Find out more

To discuss the issues raised in this article in more detail, please contact a member of our Banking and Finance team.