Digital Assets in Scots Private Law: Expert Reference Group recommendations – letter to minister

To: the Minister for Small Business, Innovation, Tourism and Trade for Legislation
From: the Expert Reference Group on Digital Assets in Scots Private Law

We are writing to follow up our meeting on 21 August about the work of the Expert Reference Group on Digital Assets (ERG) and to outline some of the next steps which the ERG would propose to the Scottish Government.   

The ERG’s recommendation  

The ERG recommends that the Scottish Parliament enact primary legislation to clarify the status of digital assets as property in Scots private law.   

In framing that legislation, it should build on the Law Commission Report Digital Assets (Law Com No 412) which was published in July 2023. The report made a similar recommendation for the law of England and Wales. The report was the result of a thorough study of the status of digital assets in private law.  Members of the ERG contributed to the Law Commission project.   

We set out in section 6 below a summary of the legislation that we would recommend and give more detail in annex 1 to this letter. 

The Law Commission’s report on digital assets 

In its report, the Law Commission made four recommendations to the Ministry of Justice of the UK Government. These affect Scotland to different degrees.   

Most relevantly for the work of the ERG, the Law Commission’s first recommendation was that the UK Parliament enact legislation to clarify the status of digital assets as property in the law of England and Wales.   

The Law Commission made no recommendations about clarifying Scots property law since the Commission’s terms of reference were restricted to the law of England and Wales. Nonetheless, the ERG sees all the reasons identified by the Law Commission for enacting clarificatory legislation for England and Wales as applying in Scotland. If anything, the reasons are stronger here than they are in England and Wales.   

(We summarise the Law Commission’s three other recommendations in section 7 below and discuss their relevance to Scotland in annex 2 to this letter.) 

The legal need for legislation 

On an expansive view of the existing law, digital assets may well be recognised as a kind of property in Scots law. Nonetheless, there is a real risk that they would not or that the law would develop unsatisfactorily in a piecemeal way. The difficulty is that existing definitions of the kind of thing that can be objects of property were formulated long before digital technology was invented. They may now be out of date.  

The technical problem is as follows. Scots law has traditionally only recognised “corporeal” things and “incorporeal rights” as objects of property. Corporeal things have a tangible existence in space (e.g., coins or banknotes). Incorporeal things consist in networks of legally constituted rights (e.g., a right to draw funds from a bank account or an intellectual property right). Digital assets are neither one kind of thing nor the other. The risk is that they fall outside the legal definition of property, which could deprive businesses of the fruits of their enterprise and their creditors of the means of obtaining payment of their debts. It might also mean that the usual forms of civil recovery of misapplied property would not apply to digital assets. It would be unsatisfactory if, for example, the victim of hack had no means in private law of recovering their digital assets from the hacker. 

The way traditional definitions of property may apply to digital assets creates uncertainty for legal practitioners. It may discourage tech developers and legal practitioners from choosing Scots law to govern their dealings with digital assets, and those that are governed by Scots law risk finding that they are operating in a legal void. The commercially valuable digital assets they create and trade in may be outside the recognition of property law. 

The need for legislation in Scotland is stronger than in England and Wales. Five years ago, there were genuine doubts as to how the law of England and Wales would accommodate and analyse digital assets. Since then litigation in the English courts has generated a substantial body of case law that confirms that digital assets can be a kind of property and defines some of their legal characteristics. Even so, practitioners and the judiciary in England and Wales are still keen for legislation to confirm and support this emerging view in the case law. 

The need for clarification is even greater in Scots law. Litigation in Scottish courts about the status of digital assets as property has been rare to non-existent. Unlike England and Wales, Scots law cannot rely on a body of case law to provide the legal answers about digital assets. The necessary clarity needs to come from legislation. 

The commercial and economic importance of digital assets legislation 

Business people are investing very large sums in digital asset technology and Scotland has become the home of many financial technology start-up businesses. Scottish Development International estimates that the value of the blockchain technology market in Scotland is likely to reach £4.48 billion by 2030. This is spread across the fintech development sector, specialist digital asset trading businesses, as well as the generalist asset management companies, such as Abrdn and Blackrock, who operate in Scotland. All those businesses need to know that they will have the opportunity to turn their enterprise into profit. It is necessary to clarify that digital assets can be sold for value and that they are available to meet a business’s obligations to its creditors in the event of insolvency. 

In the absence of legislation in Scotland, businesses might protect themselves by adopting English law or a foreign legal system or by establishing themselves in other jurisdictions. If this were necessary, there is a risk that Scotland would not appear to be business-friendly. In any event, there would need to be rules in Scots law to deal with insolvency.  

As the tech industry operates on an international basis, it is important that the rules of Scots law are readily comprehensible to businesses operating internationally. The ERG proposals draw on international precedents for this purpose.     

Legislation should come from the Scottish Parliament 

Our recommendation is that any legislation to clarify the property status of digital assets in Scots property law is best enacted by the Scottish Parliament. This would not be an appropriate case to extend UK legislation to Scotland after a legislative consent motion. 

There are subtle but important differences between property law in Scotland and in England and Wales. The wording of any legislation for England and Wales is likely to be different from what would be suitable for Scotland, even though the legislation in each system would fulfil the same need. The legislation for England and Wales is likely to be somewhat lighter in content than Scotland needs. The Law Commission expects that the far greater volume of litigation over digital assets in English courts will generate clarity in the law without the need for detailed legislation there.   

Legislation clarifying the status of digital assets as property in Scots law 

The ERG would envisage a short Bill introduced to the Scottish Parliament. It would clarify that certain kinds of digital asset can be objects of property in Scots private law and outline a few main features of how they would operate in property law. In so doing the Bill would draw on and give legal recognition to the existing general practices in the tech industry. 

The Bill, which we explain in more detail in Annex 1, would cover three topics: 

• the use of a technologically-neutral term to describe assets that would be termed “digital objects” (the Bill would apply only to those digital assets having an independent existence and capable of rivalrous use), which would accommodate future technological developments, and a statement that they are moveable property
• rules to govern the transfer of ownership of digital objects
• the preservation of important rules of Scots private law, including a statement that digital objectss can be the objects of a trust, and the application to digital assets of the principles of the laws of property, contract, and unjustified enrichment

The Law Commission’s other recommendations  

Although these are secondary to our principal recommendation that there be legislation, we draw attention to three recommendations of the Law Commission which would not involve legislation by the Scottish Parliament but in which Scottish interests will be engaged. The ERG recommends that the Scottish Government should take steps to make sure that Scottish interests contribute to these initiatives. 

The first is that a panel of industry and academic experts be established to provide non-binding guidance to the industry. 

The second is that amendments should be made to the Financial Collateral Arrangement Regulations (No 2) 2003. 

The third is a project to formulate a bespoke statutory framework for taking collateral over digital assets. 

We set out more information on those recommendations in Annex 2. 

Further advice 

We would be happy to provide any other advice or assistance about our recommendations that you would find helpful. 

Yours sincerely, 

Patrick S. Hodge and David Fox 

13 November 2023 

Annex 1 - The suggested provisions of the Digital Assets Bill 

The scope of the Bill and the definition of digital assets as property 

There would first be a provision defining the scope of the Bill’s application. The Bill would be expressed to apply to digital objects having an independent existence and capable of rivalrous use. 

We think that a suitable legal term for the kind of digital asset included in the reform would be a “digital object”. This is the Law Commission’s preferred term, and the use of it in the Scottish legislation would help keep the legal rules and practice in Scotland and in England and Wales developing along similar lines. 

The Bill would not need to contain a detailed legal definition of a digital object. There is now plenty of case law from other jurisdictions to assist legal practitioners and the judiciary in Scotland to identify the kinds of digital asset that would be included in the definition. The definition assumes that not all the kinds of digital asset encountered in practice would be workable objects of property so as to qualify as “digital objects” in a legal sense. It is best to keep the definition brief to ensure that it remains technologically neutral. One of the risks of creating a detailed, prescriptive definition of digital objects is that it would quickly be overtaken by developments in technological and financial practice. Brevity is an advantage. 

However, two characteristics would need to be included in the statutory definition. The definition should provide that the digital objects included in the reform would be those which are capable existing independently and which are rivalrous in character. Unless the relevant digital assets were limited by these characteristics, they would not work as objects of property in the law.  

The requirement of independent existence calls for some explanation. Its purpose is to distinguish the kinds of digital object covered by the reform from other kinds of incorporeal property already recognised by the law. As noted above, a right to draw money from a bank account or an intellectual property right are kinds of incorporeal property. They consist in legally constituted networks of rights between persons. In contrast, a digital object can be created in cyberspace as a virtual entity and exist independently of the law or indeed of any person who might have rights in relation to it. In that respect, they are more like conventional corporeal property, such as coins or banknotes. 

A thing is rivalrous if the use or consumption of the thing by one person necessarily prejudices the use or consumption of the same thing by another person. For example, a coin or banknote is a rivalrous thing but mere data is not. Data can be copied and used many times over but only one person at a time can spend a coin or banknote. That is one reason why data cannot be owned in law but a coin or banknote can be. The statutory definition would need to include this same limitation for digital objects. 

There would then be a provision confirming the status of digital objects in the existing law of property. It would provide that for the avoidance of doubt digital objects are moveable things capable of being owned. 

This provision would remove the uncertainty about the status of digital objects in the existing law. 

The transfer of digital objects 

The Bill would next provide two rules about ownership of digital objects.   

One rule would provide that ownership of a digital object is transferred when the owner transfers control of the digital object to another person with the intention of making the other person the owner of it. 

The other rule would be an exception to the first. It would provide that a person who acquires control of a digital object in good faith and for onerous consideration acquires the ownership of it notwithstanding that the transferor from whom it was acquired was not the owner. 

These rules confirm the existing understanding from legal practice about how ownership of digital objects is acquired and transferred. Even though digital objects are intangible, they are transferred like ordinary corporeal moveable things. The ownership of a coin or banknote is transferred by handing over possession of it to the transferee. Similarly, the owner of digital object transfers it by passing the control over it to the transferee. Control is a kind of legal proxy for possession of tangible things. 

The rule also clarifies that even though digital objects would be a kind of incorporeal property, they are not the kind of thing that would be suitable for a transfer by assignation. Assignation is the usual way of transferring incorporeal things. It is a workable form of transfer for things that consist in legally-constituted networks of rights (e.g., debts owed to a person) but it cannot work for digital objects since they do not consist in legally-constituted rights.  

Preserving the general principles of private law  

Finally, there would be two provisions clarifying that the general principles of private law would continue to apply to digital objects. 

One provision would clarify that digital objects may be held on trust.   

We see benefits in specifically providing this clarification since trusts are the most relevant form of legal arrangement used for holding digital assets in custody transactions for safekeeping. The effect of the trust is that the party who deposited the assets for safekeeping is sheltered from the risk of the custodian’s insolvency. The depositor of the digital assets would recover them in priority to the general creditors of the insolvent custodian. 

The other provision would set out that the general principles of private law would continue to apply to digital objects so far as they were consistent with the characteristics of those objects.  

This final provision would confirm, for example, that general principles of property, contract, succession, insolvency, and unjustified enrichment law would continue to apply to digital objects.   

This would mean, for example, that person would generally remain the owner of a digital object if it was stolen in a void transaction, such as a hack. This would, however, be subject to the rule of good faith acquisition that we recommend. It would mean also that ordinary contract law principles would apply to digital objects. They could be bought and sold by legal contracts. But the way ordinary sales law applied to them would depend on their intangible characteristics. Thus, digital objects would not fall within the Sale of Goods Act 1979. Although the Bill would define them as moveable things for the purposes of property law, they would not be corporeal moveables so would not be treated as “goods” in the Sale of Goods Act 1979. 

Annex 2 - The Law Commission’s other recommendations  

The Law Commission’s three remaining recommendations are as follows. 

Non-binding guidance on control of digital assets 

The Law Commission’s second recommendation was the UK Government should set up a panel of industry and academic experts to provide non-binding guidance on the factual and legal issues relating to the control of digital assets. Control is a key concept determining the enforcement and transfer of legal rights in digital assets.   

The ERG considers that this recommendation would be directly beneficial to legal and judicial practice in Scotland. We would press for some Scottish representation on the panel of experts to allow for any differences in private law principles between Scotland and elsewhere in the United Kingdom to be taken into account.  

This recommendation would not require any action by the Scottish Parliament.   

Financial Collateral Arrangement Regulations (No 2) 2003 

The Law Commission’s third recommendation was that the UK Government should make certain amendments to the Financial Collateral Arrangement Regulations (No 2) 2003.   

The Regulations provide an especially adapted regime for lenders to take rights of security over corporate assets. The Regulations apply across the whole United Kingdom and some of its provisions refer directly to insolvency legislation in Scotland. The Law Commission found that the Regulations need to be adapted to fit dealings with digital assets.   

This recommendation would have implications for Scotland. We expect that specialists in the Scots law of security would contribute to formulating any necessary amendments to the Regulations to ensure that they fit with existing Scottish legislation. The ERG could assist in identifying specialists in Scotland.   

Bespoke statutory arrangement for taking collateral over digital assets 

The fourth recommendation was that the Government set up a multi-disciplinary project to formulate and put in place a bespoke statutory legal framework that better and more clearly facilitates the entering into, operation and enforcement of certain crypto-token and cryptoasset collateral arrangements.   

The Law Commission’s view was that although existing forms of security, apart from a traditional pledge, would apply to crypto-tokens and cryptoassets, there would be advantages in developing a regime that was specifically designed around the functionality of crypto-token and cryptoasset systems. 

The ERG sees the merits of this approach for Scots law too. It may be a project for the longer term, coming as it comes after the recent, and welcome, reforms to the Scots law of security in the Moveable Transactions (Scotland) Act 2023. The ERG could assist in identifying specialists in the law of security in Scotland who could contribute to designing any new statutory legal regime for taking collateral over digital assets.