In more detail
The 2023 Legal Statement follows the earlier legal statement published by the UKJT in November 2019 on cryptoassets and smart contracts ("2019 Legal Statement"), which was published with the intention of building confidence in English law as a jurisdiction for developing and operating assets based on distributed ledger technology (DLT). The 2019 Legal Statement has subsequently been adopted by the English courts and elsewhere; the aim of the 2023 Legal Statement is to build on this success, by stating that digital securities can be accommodated and supported by English law. The 2023 Legal Statement is limited to private law, and deliberately does not address regulatory or criminal law or tax, or issues arising from conflicts of laws (the complexities arising from conflicts of laws being issues common to all legal systems seeking to facilitate the use of DLT, including in the context of the issuance and transfer of digital assets).
The 2023 Legal Statement focusses on "digital securities", meaning securities (either debt or equity) which are constituted, recorded and/or transferred using blockchain technology or DLT. In the context of equity securities, the analysis in the 2023 Legal Statement is limited to companies incorporated under the UK Companies Act 2006, as equity securities are invariably constituted under the law of the place of incorporation of the company in question. The 2023 Legal Statement is clear that English law can and in most cases does accommodate the issuance and trading of digital securities, without the requirement of a specific legislative framework as has been done in other jurisdictions. In particular:
- There are no particular difficulties in the analysis that blockchain / DLT can be used to issue bonds in registered form under English law. The 2023 Legal Statement notes that "Blockchain is ultimately just a type of electronic database and conventional registered bond structures already use electronic databases to record and effect bond transfers without any difficulty, and for many use cases the introduction of DLT and blockchain technologies gives rise to no particularly novel legal issues."
- Tokens and similar concepts can be used to create a form of digital bearer bond, which could be considered a negotiable instrument akin to paper bearer bonds if "mercantile custom" deems it to be or alternatively digital bonds could be structured and documented in a way that the digital bond operates in a similar way to a negotiable instrument.
- As regards equity securities, the 2023 Legal Statement considers that it is unlikely to be feasible for a purely on-chain system to effect share transfers outside of CREST or by any new designated operator under the Uncertificated Securities Regulations 2001 (USRs), unless the system can produce electronic transfer forms which can be submitted to HMRC; and it is also unlikely to be feasible to utilize a fully decentralized ledger as a register of members of a company (the register of members being a requirement of the Companies Act 2006) because the company in question is unlikely to have sufficient control over the ledger to perform its statutory duties.
- Digital securities linked to proprietary rights in other assets are unlikely to give rise to any particular novelty under English law beyond those issues that already arise in contractual securities such as bonds. Such securities will typically be expected, in English law structures, to use trusts and, therefore, may result in engaging section 53(1)(c) of the Law of Property Act 1925 (which specifies certain written and other requirements for the disposition of equitable interests, including beneficial interests arising under a trust). This issue is not unique to digital securities, and blockchain and DLT-based systems do not give rise to any particular difficult in meeting the statutory requirement for writing and signatures under section 53(1)(c).
The 2023 Legal Statement considers stapling (i.e., the method by which rights in digital securities are connected to blockchain / DLT records) in some depth, given that there is no single way to do so under English law (in fact, the statement considers five methods: deed poll, Third Party Rights Act, open offer, advance consent to transfer by way of novation and multilateral contractual framework). The statement summarizes its analysis by stating "Generally, it will be possible to structure arrangements using any of these mechanisms so as to ensure that future purchasers are in practice protected against the risk of the issuer revoking or amending its obligations."
The 2023 Legal Statement also discusses whether digital securities must comply with the USRs, and concludes that there is no general requirement to do so: "the USRs are not an exclusive scheme for electronic transfer of securities, and they do not preclude the issuance of Digital Securities outside CREST".
The 2023 Legal Statement noted that for digital bonds, there is no requirement for a register of holders to be maintained (as with conventional bonds) although as noted above, there is a requirement, under the Companies Act 2006, for a UK company to maintain a register of members, and that creates some complexities in the context of shares and other equity interests. The 2023 Legal Statement notes that in some structures which involve an intermediary holding assets on trust on behalf of token holders / DLT participants, section 53(1)(c) of the Law of Property Act may apply to any transfer of the rights of token holders under the trust arrangement, because the transfer would be a disposal of an equitable interest. As indicated above, the 2023 Legal Statement notes that this issue arises with conventional securities held via intermediaries and traded via beneficial interest, and the requirements of section 53(1)(c) may be satisfied by electronic means.
The 2023 Legal Statement noted that it is not practical to tokenize physical assets directly, but that equitable interests in physical assets via a trust structure may be tokenized.
Finally, the 2023 Legal Statement also includes appendices of various digital securities issuance structures, which will be helpful for developing industry practice, particularly in the context of contractual securities such as bonds.
While the 2023 Legal Statement does not have binding legal effect and does not constitute a binding precedent, the 2019 Legal Statement has, as noted above, been cited by both English and foreign courts, and we fully expect that the 2023 Legal Statement will, similarly, be of considerable interest to market participants and legal practitioners.