NFTs and the Legal Questions They Give Rise To


Introduction


NFTs are one of the hottest topics in the music industry, and understandably so. Just in the first few months of 2021, NFTs generated over $60 million for the music industry. For a brand-new revenue stream that barely existed a year ago, that is extremely exciting! While I encourage every music creator and music business to dip their toe into the NFT waters, it’s important to start taking some legal considerations into account before your next big NFT drop.


NOTE – If you are still figuring out what an NFT is, here is a helpful YouTube video explaining how NFTs work. Check it out and come back to learn the law.


In this article, I’m going to highlight some copyright pitfalls in your NFT releases. Be aware, there are a lot of other legal considerations surrounding NFTs, and I discuss them here. Here’s a quick look at what I will be tackling in this article:

  • What is being sold?

  • Is the transfer valid?

  • Can you sell what you are selling?

  • What agreements are required?

Why Am I Doing This?


Before diving into the nuts and bolts of the legal issues, I want to touch on why I am writing this article (and these other NFT articles). There are three main reasons these articles are necessary:

  • First, as I explained earlier, the revenue generated in the early stages of NFTs is already significant. As the technology continues to improve, platforms become more efficient, and creators get more…creative, the revenue potential in the NFT market is endless. It is important to start looking seriously at NFTs both from a creative standpoint, a business standpoint, and a legal standpoint.

  • Second, NFTs already touch every facet of the music industry. Run a quick Google search for NFT examples in music, and you’ll come up with album sales, songwriters selling their publishing, ticketing/touring, merchandising, and more. If you don’t think NFTs affect your role in the industry, you’re wrong.

  • Third, the potential exists for layers of legal complexities wrapped around the sale of just one NFT. I want those who are selling NFTs to know with certainty (a) what they are selling and (b) that they have the legal right to sell it.

NFTs and Securities Law


If the sale of a particular NFT is considered a “security,” it will be subject to federal and state securities laws, which require certain disclosures and may limit who can “invest” in (i.e., purchase) the security. So the question is, can an NFT be considered a security? As I said earlier, the questions I am raising haven’t been answered.


However, “fractionalized NFTs” (i.e., selling partial ownership to multiple purchasers of one NFT) seem to come dangerously close to being deemed a security. Under federal securities law, courts apply what is called the Howey Test (named after the Supreme Court case that created the test) to determine if an investment contract, like an NFT, is a security.


Consider this hypothetical: A musician sells 50% of his sound recording to 50 purchasers, who will each own 1% of the sound recording (or at least own the right to receive 1% of the royalties from the sound recording). This is something happening in NFT marketplaces as we speak. Let’s apply the elements of the Howey Test:

  1. There is an investment of money or some other consideration: The purchasers would be investing in the ownership of the master.

  2. In a common enterprise: The sound recording, the NFT itself, or the artist may be considered the common enterprise.

  3. With reasonable expectations of profit: Of course, the purchaser is expecting to make money from the purchase of the NFT.

  4. To be derived from the efforts of others: The efforts of the artist, the label, and the artist’s team (i.e., not the purchaser) will affect how successful the earnings from the NFT will be.

Applying this test, this type of NFT may be deemed a security. For this reason, it is important to track the Securities and Exchange Commission’s rulings on this matter, as safe harbor provisions have been proposed in the cryptocurrency space for this very issue (which will likely apply to NFTs).


Review the Terms and Conditions….Really


We all have signed up for websites, memberships, online stores, and more and clicked that check box saying we’ve reviewed the terms and conditions without ever really doing so. We simply don’t have the time. But when it comes to deciding on the NFT platform to use to sell your NFT, REVIEW THE TERMS AND CONDITIONS. The NFT Platforms will have different representations and warranties relating to copyright infringements, transfers of ownership, takedown provisions, fees, and more. It is important to find the platform you are comfortable with. You wouldn’t enter into a distribution deal without reviewing the contract (I hope!), so you shouldn’t be doing so with your NFT platform.


Data Privacy Laws


One of the best characteristics of NFT ownership and how it is tracked on the blockchain is its transparency. However, it can be a double-edged sword when it comes to data privacy laws. Be mindful of your state’s laws and avoid making sensitive information available to the public without the consent of any third parties.


Collective Bargaining Agreements


The main legal issue when it comes to NFTs and union members/collective bargaining agreements is “reuse” rules. When union performers, specifically under SAG AFTRA, sign on to record a work, terms are negotiated for them. The agreement may contain language requiring the parties to renegotiate terms if the recording is used for another purpose than initially negotiated (i.e., a “reuse” of the work). Be mindful of the language and how far it extends, as you may have to renegotiate with union performers prior to selling NFTs.


Royalties


Royalty issues may arise as blockchain technology grows. As purchasers and NFT platforms begin to host virtual museums of NFTs or host the NFT collections in virtual worlds, we may enter into a new world of public performance royalties for music-related NFTs. Similar to streaming, we will be sticking a square peg in a round hole when we are trying to interpret our current laws and how they apply to the blockchain.


Consumer Protection/Fair Trade


Primarily for the NFT platforms, areas of Consumer Protection and Fair Trade should be monitored and weighed heavily when considering their risk. Unfortunately, any manner in which revenue is generated is going to have scammers and infringers. The NFT platforms hosting the bad actors have to take all efforts to avoid such acts and may be liable for a failure to do so. Of course, similar to YouTube’s safe harbor, the Digital Millennium Copyright Act will allow for notice and takedown provisions for the NFT Platforms, which are often baked directly into the terms and conditions of the NFT Platform. Another reason to review them!


Conclusion


I wish I weren’t in a position to raise more questions than answers for my readers, but as stated earlier, technology moves faster than law. It is best to understand the ways to spot the potential issues to be aware of and track as time moves forward. To avoid leaving some unanswered questions, I highly suggest putting a proper agreement in place with all parties involved in the sale of the NFT. It will help to avoid issues in the future. I go into detail as to structuring those types of agreements in my article here.


About Colin


Colin is the founder of Whiskey Ghost Entertainment Law based in Nashville, TN. Colin has represented independent musicians, record labels and publishers with a wide array of representation including the drafting, review and negotiation of record/publishing deals, distribution and band agreements. He has also assisted in the formation of LLC’s, trademark registration and much more. If you have a legal question, please don’t hesitate to email Colin at cmaher@whiskeyghost.com or call him at 615-721-2233.

This article does not create an attorney-client relationship between you and me. Your use of this website is intended for general information purposes only and is not legal advice or a substitute for legal counsel. You should not act upon any information contained on this website without seeking professional counsel, licensed to practice in your jurisdiction for a particular problem.

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