NFTs have been the subject of both a financial boom and skepticism about their legal standing, in particular with regards to copyright law. In this op-ed piece written for Creative Industries News, Barry Scannell, Director of Legal Affairs & Regulatory Compliance at Irish rights society IMRO, offers his views on the potential copyright quagmire that royalty-based NFTs could run into in the European Union, in particular with regards to the Directive on Copyright in the Digital Single Market (CDSM Directive).

There is a possibility that the current European Copyright Directive potentially impacts the sale of music royalty NFTs. We are now seeing the sale of NFTs linked to royalty earning copyright works, where ownership of such an NFT grants you a share in the royalties of the work. US rapper Nas recently sold such royalty based NFTs linked to two of his works, reportedly earning over half a million dollars.

The first thing to point out, is that these royalty-based “NFTs” aren’t actually NFTs. NFTs are non-fungible — the clue is in the name. If I bought a royalty-based NFT, which gave me an X% share in the royalties of a song, and if you bought a royalty based NFT giving you the same X% share in the royalties of the same song, then we could swap our NFTs, and it would make no difference. Therefore, those blockchain tokens are fungible — just like cash, or cryptocurrency. At the very least, royalty-based NFTs have limited fungibility.

Selling NFTs of your royalties is similar to a partial “buy-out” of the work. Buy-outs are seen as being problematic by the creative industry, due to the common occurrence of uneven bargaining power between the rights holder and the purchaser. Recent legislation in Europe (on an EU level via the new EU Copyright Directive and on a national level, in countries such as France) seeks to regulate buy-outs and level the playing field.

Losing rights to creative works

However, the commercial reality is that sometimes creators feel that they have no other option and need the money that a buy-out provides. This, unfortunately, comes with the loss of their rights to the work. On buy-outs, CISAC (the International Confederation of Sicieties of Authors and Composers) has stated that “buy-out clauses come in different forms depending on the territory or situation.

In certain countries/territories, the ‘buy-out’ clause contained in copyright contracts refers to the transfer of all rights in a work for the entire duration of its copyright in exchange for a lump sum payment covering all exploitations listed in the contract.”

A royalty-based NFT doesn’t transfer all rights in a work, rather it gives the right to a percentage of royalties. This could be in perpetuity (a concept that, incidentally, does not exist in copyright law) or for a limited time — but in any case for the duration of the copyright).Articles 18 and 20 of the new EU Directive on Copyright in the Digital Single Market (CDSM Directive) are possibly relevant here.

Asymmetrical bargaining power

Article 18 says that when authors and performers license or transfer their exclusive rights for the exploitation of their works or other subject matter, they are entitled to receive appropriate and proportionate remuneration.Article 20 says that “authors and performers are entitled to claim additional, appropriate and fair remuneration from the party with whom they entered into a contract for the exploitation of their rights, or from the successors in title of such party, when the remuneration originally agreed turns out to be disproportionately low compared to all the subsequent relevant revenues derived from the exploitation of the works or performances.”

While the purpose of Chapter 3 of the CDSM Directive is to address asymmetrical bargaining power in buy-out situations, it is not clear if a-symmetry is one of the necessary conditions which are required in order to invoke Articles 18 and 20.

Recital 73 of the Directive says the remuneration of authors and performers should be appropriate and proportionate to the actual or potential economic value of the licensed or transferred rights, taking into account the author’s or performer’s contribution to the overall work or other subject matter and all other circumstances of the case, such as market practices or the actual exploitation of the work.

Proportional and fair remuneration

Where NFTs transfer a right to royalties, the question is, is this is a transfer of rights as envisaged in Recital 73? If a Royalty NFT is sold for €10, but the “actual or potential economic value” of the NFT ends up being €10k, is this caught by the CDSM?The question is: Is a royalty-based NFT a contract? NFTs incorporate smart contracts encoded into a blockchain token. Then we must ask, are creators’ rights being “exploited”?

Well, potentially yes, as they are selling the right to a share of their royalties. If NFTs exploit creators’ rights, then creators’ rights with regard to NFTs must be regulated and protected. It is worth pointing out that for NFTs, creators usually have a right to a percentage share of the resale of any NFTs.

BUT, the CDSM could be interpreted as saying that if the NFT takes off and is re-sold at a massive mark-up, the creator can potentially go back to the original purchaser of the NFT, and ask for a bigger chunk of money if they re-sold it for a higher value than originally expected. The remuneration must be proportional and fair.

What constitutes proportional and fair remuneration in the context of NFTs, and whether the principle even applies to this situation, remains to be seen.

By Barry Scannell

(Picture under license from AdobeStock)