Digital Assets in Scots Private Law: Expert Reference Group minutes: November 2022

Attendees and apologies

 

• Rt Hon Lord Patrick Hodge, Supreme Court of the UK (Chair)
• Professor David Fox, University of Edinburgh
• Professor Sarah Green, Law Commission of England and Wales
• Martin Sloan, Brodies LLP
• Callum Sinclair, Burness Paull LLP
• Professor Daniel Broby, University of Ulster
• Antony McFadyen, Law Society of Scotland
• Gavin Davies, Law Society of Scotland
• Michael Thom, Burness Paull LLP

In attendance

• [redacted, s.38 – personal information], Legal Secretariat to The Lord Advocate
• [redacted, s.38 – personal information], Scottish Government, Directorate for Justice
• [redacted, s.38 – personal information], Scottish Government, Investment Finance
• [redacted, s.38 – personal information], Scottish Government, Investment Finance

Apologies

• Dorothy Bain QC, Lord Advocate
• Maggie Craig, Financial Conduct Authority
• [redacted, s.38 – personal information], Solicitor To the Scottish Government
• Stephen Ingledew, FinTech Scotland
• Nicola Anderson, FinTech Scotland

Items and actions

Welcome and Introductions

Lord Hodge welcomed everyone to the meeting and introduced Gavin Davies who recently joined the Expert Reference Group (ERG). Lord Hodge also welcome Michael Thom to today’s meeting. Lord Hodge gave an overview of the meeting’s agenda and advised that the main purpose of the meeting is to input to the Law Commission of England and Wales’ (LCEW) Digital Assets paper from a Scots law perspective.

Lord Hodge informed the ERG that the Scottish Law Commission is not intending of including Digital Assets in their 11th Programme of Law Reform. The rationale is due to the extensive scope of the ERG and potential future governmental reference, it would therefore not be appropriate for Commissioner David Bartos to contribute to the work of the ERG in a personal capacity.

Electronic Trade Documents Bill

Professor Sarah Green updated the group in the progress of the Electronic Trade Documents (ETD) Bill which is now at its second reading and due for Committee Stage evaluation on the 12th December. Professor Green noted that at the second reading there were some questions raised on technical aspects of the Bill, however she expects it to pass subject to scrutiny. There remains an outstanding question regarding consent for UK Government Secretary of State to add to the proposed list of ETDs.

In terms of the ongoing Digital Assets project, Professor Green informed the ERG that the consultation period closed in early November, with over seventy consultation responses received, noting that the commercial response rate was high. The next stage of the process is to analyse the responses in detail and include any proposals in a final report. The remaining objective is the production of the final report and advice to government on how to apply existing rules and how we think these rules need to develop.

Lord Hodge thanked Professor Green and paused for questions on the ETD Bill:

Professor David Fox asked about the funding of the bill, something which was spoke about at earlier ERG meetings in 2022. Professor Green advised funding would be forthcoming (via a HM Treasury Roundtable with the Economic Secretary to the Treasury) should legislation and drafting of a bill be required.

Martin Sloan asked Professor Green if any other Scottish stakeholders contributed to the LCEW’s consultation paper, to which Professor Green outlining they had received a very useful response from the Centre for Commercial Law at the University of Aberdeen.   

Formal Consultation Questions / Group Discussion

Professor Fox discussed a selection of questions outlined in the LCEW’s consultation paper which contains provisional law reform proposals to ensure that the law recognises and protects digital assets (including crypto-tokens and crypto assets) in a digitised world. Professor Fox provided his view on the following questions which have consequence for Scots common law:

Question 6: the characteristics of a third category of property

Professor Fox advised that he would be inclined to agree with the LCEW’s recommendation (1) to recognise a distinct third category of property In between traditional corporeal and incorporeal movables.

Professor Fox elaborated on it is about how one chooses to categorise, and it needs to be clear about the form of transaction required to make it effective in Scots law. The view of the LCEW is there should only be a transfer of a digital object if there is some change state in the ledger, which is a critical part for Scots law to follow.

Questions 16-19: The concept of control rather than possession

Question 16: LCEW suggested that the concept of control for data projects, rather than possession, be applied. Professor Fox advised this is true for Scots Law and in line with international practice.

Question 17: This question relates to the definition of what control might mean – a provisional definition of intangible data objects, same to tangible - an analogous idea of possession might work.

Question 18: LCEW conclude that for any basic definition of what control means and this should be left to common law development. Professor Fox advised that there is probably not much difference between English, Welsh, and Scots law in this regard

Question 19: Professor Fox agreed that there should be a panel of industry, legal and technical experts to provide non-binding guidance on the complex and evolving issues relating to control, and that this is the correct digital analytical approach.

Questions 20-26: The transfer of digital assets

Question 20 and Question 21: Professor Fox advised Q20 and Q21 should be read together. He agrees with the state change conclusion that transfer of a crypto token create a new and distinct crypto entity.

Question 22: Professor Fox in agreement with a special defence of good faith purchase for crypto tokens, and what is being proposed is in line with UNIDROIT with good faith acquisitions.

Question 23: Professor Fox agreed that legislation would be required, rather than case law, to develop an innocent acquisition rule.

Question 24: Professor Fox agreed with the premise of the question that the real right might reside with one individual, but the control being with another individual. This would not be out of line with UNIDROIT adopting this approach.

Question 25: Professor Fox agreed that it is not appropriate to treat crypto-tokens as analogous to “goods" and takes the view that this should not apply. This was also referred to in Professor Fox’s Digital Assets in Scots Private Law paper released earlier this year.

Question 26: Professor Fox stated this is a consequence of question 25: state change in ledger, the default position would be yes. Force of contract, sale of goods act – sale of ledger. Ideally these would move together. 

Questions 29-31: Custody services of crypto-tokens

Question 29: Professor Fox requested for further assistance from Martin Sloan’s in this area. In general, these issues of custody require further thinking.

Question 30:  Separation of assets in result of custodian's insolvency. Rather than notion of equitable property.

Question 31: No presumption of trust – Professor Fox in favour of not having trust.

Questions 36-37: How to constitute securities over crypto-tokens

Question 36: The conclusion that non-possessory securities can be satisfactorily granted in respect of crypto-tokens without the need for law reform. Need to consult with Professor Steven – expert in relations to Moveable Transactions Bill. Professor Fox suggested this could apply to crypto/digital tokens.

Question 37: Professor Fox agreed that it is not desirable to make provision for data objects to be the subject of possessory securities such as the pledge.

Question 42: The use of existing legal frameworks in relation to data objects

This refers to default aspects of private law, and whether they should be applied to Digital Assets given property status. Professor Fox advised that there is no great elaboration required, and to leave to common law development.

Questions from members

Lord Hodge thanked Professor Fox and opened the floor to comments on various questions of the consultation:

Callum Sinclair raised from a commercial perspective there is a need for harmonisation, not further dividing legal systems following Brexit, and asked Professor Fox if he views any areas problematic from a Scots/English harmonisation perspective. Martin Sloan echoed the consistency approach on custody which should be achievable in Scots law.

Professor Fox responded to Callum’s question, stating issues arise when digital assets are movable but are neither incorporeal nor corporeal. He added further with the idea of treating Digital Assets as an intangible corporeal but must define the method of transfer correctly which is appropriate to the digital status of things. Whatever categorisation is used may have similar outcomes across the UK.

Professor Sarah Green informed that one response in the LCEW’s consultation objected to state change analysis.

Lord Hodge emphasised that the key purpose of group is to get property law right, with a view to maximising opportunities in the fintech and the digital assets space.

Callum Sinclair asked whether consultation responses specific to financial regulation. In response, Professor Green said that in terms of sequencing private law is focus, and regulation will follow, however they have engaged with the FCA. She emphasised that in terms of effective regulation, behaviour, rather than the thing itself (i.e., in this case the digital asset) is the critical factor. She cited an example whereby some crypto companies cannot provide information, yet their desire to be compliant. Validators and staking, require different regulation, third party risk – needs to be regulated in different ways as technology changes. [“you don’t put blinkers on a range rover” - horses and cars, tech changes, safety on roads]. E.g., validators doing a different thing to investor compensation schemes – people within remit have been looking at this.

Lord Hodge made clear he was in favour of a legislative route, and he sees a bill as establishing a concept and allowing courts to run with it thereafter. With support of Lord Vos – common law can do heavy lifting, which is the Scottish perspective. Lord Hodge says he views Scots law incorporeal property as a serious blocker which only legislation will clear.

Professor Sarah Green added there is not a huge amount of litigation anywhere and noted that without specific legislation this will be left to vagaries of litigation. She informed that the LCEW have divided views –strict definitions may create problems when the technology moves on i.e., what even counts as a digital asset for these purposes, and whether this should be put in third category, incorporeal/intangible. She added that it should be criteria focused rather than descriptive - Intangibles subject to possession and control. As such the LCEW are moving from legislation to no legislation idea. Professor Green’s view is for a “nuts and bolts” description and remove the blocker which is intangible and subject to possession of control. It leaves everything else to the common law.

Professor David Fox’s view was to introduce basic legislation then case law may run with it. However there needs to be consideration given to being locked in with the technology question – proposing an underlying basic conceptual definition of digital property which will cover technological developments over the next 10-20 years or so.

Professor Broby was also in agreement with this, also suggesting the danger of scoring an “own goal” in technology with respect to Central Bank Digital Currencies (CBDCs). Professor Broby explained about the danger of shifting from one box of money to a digital assets box and highlighting our current financial system works well. Professor Green added their worry from reports will not be reflected by statutory change: The LCEW are only allowed to look at money as assets as money rather than money on its own.

Professor David Fox Different legal conceptions of CBDCs: either token based, or account based. For account based are we using tokens as a debt relationship in the conventional way and added will CBDC’s legal tender status does not depend on digital status.

Lord Hodge summarised the path forward is for Lord Hodge and Professor Fox to prepare a draft response on behalf of ERG to the LCEW’s consultation, noting that the need to legislate may prove to be a key difference of opinion. This will be circulated to the ERG to review.

Callum Sinclair introduced his colleague Michael Thom, who has expertise within English and Welsh law matters for corporate clients.

Actions

Lord Hodge and Professor Fox to provide a draft response to the LCEW’s consultation paper and to circulate draft response to ERG members.

There was no other business raised and Lord Hodge thanked members for their contribution.