[This piece has been authored by Impana Halgeri, a student at the National University of Advanced Legal Studies, Kochi.]

Introduction

Non-Fungible Tokens are unique units of data stored on a blockchain. They can be associated with digital or physical assets, and are usually associated with photos, videos or GIFs. Smart contracts are a kind of digital contract that exist as computer programmes stored on a blockchain and are usually used to automate the execution of an agreement without the need for any intermediaries. NFTs rely on smart contracts to handle their transferability and verify their ownership. NFTs are usually embedded within smart contracts. This is done by utilising computer programming, wherein the code allows for the integration of the NFT with the smart contract. 

The Issue of Consideration

The basic elements of a contract include offer, communication of offer, legitimate consideration, acceptance, and mutual consent of all competent parties subject to the contract. Section 10 of the Indian Contract Act, 1872, allows for quite a large scope of interpretation, permitting any agreement to have legal validation if it consists of free consent of parties which are competent to enter into a contract and lawful consideration. Therefore, the consideration needs to have value in the eyes of law. This puts forward the question of whether crypto-currency can be an acceptable form of consideration under Indian law. It is pertinent to discuss this question as NFTs are usually bought and sold using cryptocurrency, which acts as the consideration in these smart contracts and as per Section 23 of the Act, any consideration is considered lawful unless it is of such nature that it would defeat the provisions of any law.

In 2018, the Reserve Bank of India (RBI) released a notification effectively banning activities like trading, registering, settling of crypto-currency. However, the Supreme Court, in Internet And Mobile Association Of India vs Reserve Bank Of India on March 4th 2020, overturned this circular, stating that the power to outlaw something as res extra commercium is solely a legislative decision, and the RBI, being a regulating body, is outside its scope when ruling on this matter. This scenario is subject to change due to the Cryptocurrency and Regulation of Official Digital Currency Bill, 2021, a bill being introduced in the Rajya Sabha, that seeks to prohibit all private crypto-currencies in India and asks the RBI to facilitate the creation of an official digital currency. If this Bill passes in its current form, it could link a popular mode of buying and selling NFTs to government regulated crypto-currency. The complete effect of this bill on NFTs is yet to be determined based on how the final bill will define cryptocurrency.

The Issue of Digital Signature

Another issue that arises with respect to smart contracts is about the validity of a digital signature. As per Section 35 of the Information Act, 2000, a digital signature is only valid when it is issued by a government-designated Certifying Authority. This could be problematic as the digital signature created in a smart contract, called the ‘hash’, is made by the blockchain technology, which is not regulated by any legal authority. Section 65B of the Indian Evidence Act, 1872, finds digitally signed contracts to be acceptable evidence, in the court of law. This further complicates the issue, as the submission of a smart contract as evidence in court could be termed illegitimate, due to the fact that the digital signature was not created in consonance with the Information Act. This implies that if the terms of a smart contract related to an NFT is violated, the question of whether the smart contract can be presented in the court as a legally binding contract becomes uncertain. there exists a lack of legally binding precedent on issues concerning blockchain based contracts as such issues have not been raised in Indian courts.  

However,  at the global stage, it is seen that in 2017,  Arizona joined the growing number of states in the US to legalise smart contracts. Through the Arizona House Bill 2417, the state amended its laws, thereby allowing signatures obtained through blockchain technology to be considered as valid electronic signatures. As per Arizona’s laws, electronic signatures cannot be denied legal validity solely because they are electronic in nature. Additionally, in 2019 the United Kingdom Jurisdiction Task Force (UKJT) published a legal statement on  crypto assets which clarified the applicability of electronic signatures pertaining to smart contracts. As per the UKJT, the statutory signature requirement can be met by using a private key, allowing for the legal validity of electronic signatures secured via blockchain. These examples reveal that through concerted effort, the issue of the validity of blockchain based electronic signatures can be addressed in a legal capacity, thereby diminishing the uncertainty behind all smart contracts generally, and smart contracts attached to NFTs specifically. 

The Issue of Jurisdiction

Additionally, as smart contracts make use of blockchain technology, they operate through nodes. Any device can act as a node (mostly computers, laptops or even bigger servers). A blockchain’s infrastructure is made up of nodes. All nodes on a blockchain are linked together and regularly exchange the most recent blockchain data with one another, ensuring that all nodes are up to date. They store, distribute, and maintain blockchain data, thus a blockchain can theoretically exist on nodes. Since these nodes are situated all around the world, it causes conflict with regards to the jurisdiction of smart contracts. 

One solution propounded for this issue is the concept of party autonomy. Party autonomy is described as the principle that parties to a contract should be allowed to agree in advance on the forum and governing law to be used to resolve any conflicts that might arise. When this principle is examined in the Indian context, it is seen that Section 20 of the Code of Civil Procedure, 1908 offers three jurisdictions in which a suit can be filed: the voluntary residence of the defendant, the place of business of the defendant, or the place where the cause of action wholly or partly arises. However, judicial interpretation of Section 28 provides for parties to choose their own jurisdiction in cases where multiple jurisdictions can be lawfully applicable, as long as they have been conferred such a right under the Code of Civil Procedure. Hence, the concept of party autonomy can be compatible with Indian laws and procedures. This indicates that in cases wherein there is a breach of the smart contract linked to an NFT, the jurisdiction favoured by the parties will be applied to them, as long as there is a node situated in that jurisdiction that processed their transaction. 

The Issue of Transfer of IPR

Smart contracts, in the context of intellectual property rights, become relevant to  NFTs as one of the ways to transfer the copyright related to an NFT is by altering the smart contract linked to the NFT. Creators could allow NFT buyers to use their digital artefacts for commercial purposes by altering the terms of the smart contract, as can be seen through the terms of service of the Bored Ape Yacht Club, a collection of NFTs attached to digital drawings of apes that exist on the Ethereum blockchain. While this opens up many opportunities, it is bound by the constraints of the risky nature of smart contracts, especially in the current legal context. A solution that has recently gained traction to combat this issue is the insertion of an arbitration clause into the smart contract. In order to best serve the interests of the contracting parties, it would be logically sound for them to appoint an arbitrator who has an understanding of  NFTs and blockchain technology. 

In India however, it is important to note that not all IPR issues can be subject to arbitration. In the Supreme Court case Booz Allen and Hamilton Inc. v. SBI Home Finance Ltd., the court held that all disputes regarding ‘rights in rem’ are non-arbitrable whereas all issues pertaining to ‘rights in personam’ are arbitrable.  In Eros International Media Limited v. Telemax Links India Pvt. Ltd., the Bombay High Court adjudicated that all Intellectual Property cases are not necessarily ‘rights in rem’ and hence, could be subject to arbitration. It is pertinent analyse this issue while inserting an arbitration clause into the smart contract, if the copyright is also being transferred via the same smart contract, when under Indian jurisdiction.

A Probable Solution to Some of the Problems Posed by Smart Contracts

A long-term and comprehensive solution worth looking at with respect to the legality of smart contracts is an interpretive reform of the Indian Contract Act. The courts are generally receptive towards interpreting contract law so as to facilitate technological innovations, as can be seen through the legal validity of electronic contracts. As smart contracts abide by the basic principles of contract law, they work within the ambit of common law. Therefore, the flexible nature of common law should be utilised to facilitate the technical complexities entailed in smart contracts.

Conclusion

While the introduction of new technology like blockchain and NFTs pose novel and untested challenges to the existing legal framework, it is possible to lawfully facilitate the integration of blockchain and NFTs into the mainstream consciousness by updating and reinterpreting the existing legal framework and rules. However, specialised knowledge and effort is required to predict and counteract the legal intricacies involved in the legitimisation of this technology.