India has recently been elected by consensus as the Chair of the General Assembly of the International Institute for the Unification of Private Law (‘UNIDROIT’) at its 81st session held in Rome. UNIDROIT is an independent intergovernmental organisation that works towards the harmonisation and modernisation of private law between states. Towards this end, UNIDROIT develops positions on uniform law instruments, principles, and rules. The organisation has 65 member states carrying their own varied economic, political, and cultural contexts.
Representations received from Hungary and the Czech Republic sparked the UNIDROIT’s interest in digital asset governance. In 2020, the UNIDROIT Governing Council approved a project to study digital assets and private law. Deemed high priority, the project aims to develop a legal taxonomy of digital assets.
In furtherance of this aim, the Working Group for the project released a set of draft principles on the subject for public consultation earlier this year. The draft principles “are designed to facilitate transactions in digital assets” which are “often used in commerce”. The draft principles were adopted on 10th May 2023 (‘Principles’).
The Principles are geared towards ensuring that transactions in digital assets enjoy the maximum efficiency via clear rules spelling out critical aspects of such transactions. In other words, the principles seek to minimise inefficiencies, reduce uncertainty, and lower costs in transactions involving digital assets. Furthermore, the draft principles are meant to guide practitioners, judges, legislators, and market participants on future-facing issues concerning digital assets (¶20).
As a nation belonging to, and representing the larger interests of, the Global South, India’s engagement with UNIDROIT on the Principles is crucial. Such engagement would prevent the development of a skewed set of standards that display a predominantly Eurocentric/Global North orientation. Engagement is also likely to ensure that the unique incorporation challenges that the Principles may present in the Global South are better understood. Considering India’s current presidency of the UNIDROIT General Assembly, it is an opportune time to bring such oft neglected legal systems to the fore.
This article is situated in this backdrop. It identifies select areas for analysis within the Principles. Using India as a jurisdiction for analysis, it posits for the UNIDROIT areas for clarity and further engagement within the Principles. In doing so, it offers municipal regulators and the UNIDROIT a glimpse into the asymmetry between the Principles and domestic law in the Global South. Consequently, we recommend solutions to address such asymmetry.
In this article, we limit our scope to the definition of the term ‘digital asset’. This definition forms the crux of the Principles and has significant implications for the exercise of proprietary rights over such assets. ‘Digital asset’ is defined under Principle 2 of the draft Principles as “an electronic record which is capable of being subject to control”. An electronic record, per the Principles, is information that is stored in an electronic medium and capable of being retrieved.
This definition potentially encompasses a variety of use cases that are not traditionally understood as digital assets. For instance, the present definition could cover an e-mail, in-game loyalty points, or a domain name – as these are also electronic records capable of being subject to control. Furthermore, the scope and content of this definition is critical, as it will influence the ease of adoption and implementation in member states. Getting the definition of digital asset right is especially pertinent to ensure that perspectives from the Global South are adequately represented in the Principles.
Part II presents an analysis of certain areas of clarity that are required from the UNIDROIT on key aspects of the draft principles. Part III will outline the way forward.
Clearly, the UNIDROIT has advanced a pervasive definition of digital assets. However, deploying this definition manifests key implementation challenges. In our view, these challenges manifest across two paradigms. The first set of challenges are global in nature, and therefore, are jurisdiction-agnostic; it is likely that the Digital Assets Working Group need to refine the Principles document to remedy concerns along this paradigm.
The second set of challenges are municipal in nature. These challenges arise on account of two reasons. One, municipal law – the Principles term them as, “other law” – has previously adopted a definition of digital assets that teases conflict with the Principles’ definition of such assets. Two, the design of extant municipal laws does not allow individuals to readily incorporate these definitions into their ambit.
Across the two paradigms, we have identified three unique challenges that merit discussion. These are discussed below.
As stated above, digital assets stand defined broadly under the Principles. The Principles admit as much, noting that the definition allows regimes to capture all such assets that may be classified as digital assets. Once classified, the Principles lay down a framework for governing such assets. The Principles, inter alia, enunciate how such assets may be deemed to be transferred, controlled, kept in custody of a third-party and resolved in an insolvency proceeding.
Curiously, however, the Principles note that the framework may not materially impact select digital assets. To illustrate this, the Principles use the example of digital files that are password protected. The Principles state that while such files may technically connote digital assets, since they are electronic records and are capable of being controlled, the Principles do not materially impact them.
It reasons that in sending a password-protected file to another party does not diminish the control of one party over the file. Instead, it creates a separate electronic record, subject to the control of the recipient.
This illustration contains merit. It clarifies how information comprising an asset, and the information used to control the asset may be different. However, it also sheds light on the ambiguity that may arise in determining whether a particular digital asset is capable of being controlled or not. Coupled with the Principles’ assertion that select assets may fall outside its purview, the illustrations may confuse municipal regulators on the extent to which an asset may be substantially covered by the Principles.
While the Principles shed light on the relevance of control for digital files, such clarity is not provided for other assets that possess commercial relevance. Scholarship supports this claim. Responding to the draft principles’ request for comments, Michels and Millard note how claims have been litigated over assets not recognised explicitly under the Principles. These include emails, domain names, carbon credits or European Allowances to remit CO2, domain names or in-game items.
Additions may be made to this above-identified assets. There is merit to exploring how the sale and purchase of assets like digital gold or silver may be impacted by the application of the Principles. Considering the broad appeal of such assets in emerging markets, clarity on how these principles apply to these assets/asset classes can help states formulate coherent private and public laws around them.
A local issue concerns the presence of contradictory definitions to digital assets in Indian law. Indian law does not define digital assets. However, in 2022, the Income Tax Act, 1961 was amended to tax virtual digital assets. To do this, the 1961 Act introduced a definition of such assets. Under it, virtual digital assets are:
This definition is narrower than the one contained in the Principles. Demonstrably, the definition excludes Indian and foreign currency from its ambit. A review of the Act’s definition of such currencies suggests that the 1961 Act excludes foreign Sovereign Digital Currencies from its ambit. This means that, illustratively, an individual holding Digital Yuan will not likely be a holder of digital assets under the 1961 Act.
Further, the 1961 Act empowered the Central Government to exclude certain asset classes from the ambit of this definition. The Central Government has subsequently exercised this power. Assets thereby excluded include gift cards or vouchers, mileage points, or subscription to websites or platforms or applications. Also excluded are NFTs whose transfer may result in the transfer of ownership in an underlying tangible asset, the transfer of which is legally enforceable.
The exclusions demonstrate the layered, and incremental, approach that India has adopted to defining digital assets. It has, curiously, adopted a similar approach to excluding such assets from its ambit as well. The definition is poised to be dynamic; evidently, the Central Government continues to modify its statutory understanding of digital assets.
Admittedly, this approach is rooted in public law. However, it has private law significance. First, the presence of a well-formed definition of digital assets incentivises regulators to adopt a similar definition even in the context of private law. Such adoption favours legal certainty and stymies domestic regulatory conflict.
Second, from a design standpoint, it empowers the state to exclude or include assets from the purview of digital assets. This is useful[as it provides the state with flexibility to curate the spectrum of assets based on its unique context and specific policy goals. States may have an incentive in excluding certain assets from the application of private law. Digital food or education vouchers may, illustratively, be excluded from being attached in a personal insolvency proceeding.
It is this design choice that explicitly contradicts the Principles. Substantively, the Principles take away the power of the State to comprehensively exempt an asset from the application of relevant law. States are now tasked to creatively exempt assets from the effects of such laws.
Moreover, this design choice tethers digital assets to the Principles’ understanding of control and transfer. This is a second-order limitation. Viewed broadly, the Principles take away the power to impose novel control or transfer paradigm on select digital assets. This is undesirable; states may, for instance, want foreign digital currencies to be controlled differently.
The need for exceptions, or different control paradigms, is understudied within the Principles. In this context, greater clarity on how the definition of digital assets may be suitably modified by municipal governments can be useful for the adoption of these Principles in India.
There are also structural challenges to incorporating the Principles’ definition of digital assets into Indian law. Certain Indian laws governing digital assets contain a mix of public law and private law principles. Unlike the Principles, which apply squarely to private law, it is difficult for such laws to incorporate a definition of digital assets that works only for private law purposes.
Consider the Information Technology Act, 2000 (‘IT Act’). The IT Act does not define digital assets. However, it regulates various private law aspects of electronic records. It prescribes the manner in which such records may be attributed to their originators. Further, it prescribes the paradigm of authentication for such records. Additionally, it creates the deeming fiction by which these records may be despatched or received between the places of business of originators and addressees. A review of the definition of an electronic record suggests that digital assets are electronic records; this is also in line with the Principles. Accordingly, IT Act will likely govern various dimensions of digital asset exchange in India.
Parallelly, the IT Act also houses public law protocols for virtual assets. A recent direction issued under the Act requires, inter alia, entities to report attacks on virtual assets to the Indian Computer Emergency Response Team (‘CERT-IN’). Virtual asset service providers, virtual asset exchange providers and custodian wallet providers are also required to maintain Know Your Customer information for a period of five years.
In this backdrop, it is unfeasible for the IT Act to incorporate the Principles’ definition of digital assets. An ordinary password protected Word file may, for instance, be subject to the same regulatory scrutiny as cryptocurrencies. This overburdens businesses, who may incur enhanced compliance costs. This also inconveniences regulators. Illustratively, more incidents will likely be reported to the CERT-In due to the wide definition.
This incorporation challenge is understudied by the Principles. The Principles recommend, correctly, that states will determine how the Principles are incorporated. Notably, however, the Principles do not discuss the challenges to incorporation. Specifically, the Principles do not discuss models where state laws on digital assets are a mesh of public-private principles.
There is merit to studying this model. Principally, they may reshape the Working Group’s understanding of how the Principles are likely to be incorporated into domestic law.
Presently, the Principles discuss three strategies of incorporation. First, the Principles may be codified as part of a special law on digital assets. Second, the principles may be codified in extant laws. Third, codification may follow a mix of Strategy I and Strategy II. These choices are presented to evidence the jurisdictional neutrality of the Principles. States are free to choose their paradigm of incorporation, from within the above discussed choices.
The Indian model demonstrates how this claim may be contested. As shown earlier, mixed laws – laws containing both public and private law provisions – effectively render the second strategy sub-optimal. It also adversely impacts the third strategy. A fourth strategy remains difficult to conceive; observably, the three strategies broadly cover how the Principles can be statutorily incorporated.
A robust study on incorporation is likely to reveal the practical latitude afforded to states to incorporate these Principles. Observably, for mixed law jurisdictions like India, such latitude is limited. It is also likely that such latitude is further limited by the Principles’ design. If the Principles are incorporated in their present form, domestic law cannot curtail their envisaged scope. Nor can they overrule the Principles, in the event of conflict.
A regulator in a mixed law jurisdiction, therefore, is triply tasked by the Principles. First, such regulators must consider a method of incorporation. Second, they must sieve private law from public law, to portend conflict. Third, they must train judicial authorities to apply these Principles and the definition of digital assets as contained therein.
Considering the regulatory capacity involved in performing these tasks, it would be appropriate to treat them as challenges. These challenges incentivise states to resist incorporation. Accordingly, guidance on appropriate paradigms of incorporation can prove useful. Offering states less rigid incorporation choices, as part of the study discussed before, can help gradually introduce these private law principles into law. This calibrated approach may minimise disruption and build trust.
An excessively broad definition of digital assets may lead to unforeseen complexities in implementation. Going forward, it is desirable that the draft principles intensify engagement on this front. For this, the UNIDROIT may consider conducting an impact assessment to assess implementation-related disruption induced by the Principles. However, since this article deals with the narrow question of defining digital assets, the contours of a broader impact assessment of the Principles is beyond its scope.
This article was originally published in Indian Journal of Law and Technology on 10 October 2023 Co-written by: Sohini Banerjee, Research Fellow; KS Roshan Menon, Research Fellow. Click here for original article
Contributed by: Sohini Banerjee, Research Fellow; KS Roshan Menon, Research Fellow
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