The Legit Ledger Podcast Ep. 7
NFT Enforceable Licenses with Jim Gatto and Yasamin Parsafar
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Listen to the original podcast released August 16, 2022 here: https://www.sheppard.com/multimedia-415
In this episode, Sheppard Mullin attorneys Jim Gatto and Yasamin Parsafar continue to explore intellectual property considerations in NFT licensing, this time focusing on how IP owners can ensure their licenses are binding on the purchasers of NFTs containing their intellectual property. Topics discussed include the way IP licensing terms may be passed on to an NFT owner, what steps IP owners should take to ensure specific license provisions are enforceable, and how they can modify license terms if necessary.
Guests:
About Jim Gatto
Jim Gatto is a partner with the Intellectual Property Practice Group in Sheppard Mullin's Washington, D.C. office, where he co-leads the Blockchain & Fintech Team. His practice focuses on blockchain, interactive entertainment, digital art, AI, and online gambling. He advises clients on IP strategies, development and publishing agreements, licensing and technology transaction agreements, and tech regulatory issues. Jim has been involved with blockchain since 2012 and has been recognized as a thought leader by leading organizations, including Best Lawyers in America 2021-2022; Cryptocurrency, Blockchain and Fintech Trailblazer, The National Law Journal, 2018; and Thought Leader on Blockchain & Cryptocurrencies, National Law Review, 2018.
About Yasamin Parsafar
Yasamin Parsafar is a partner with the Intellectual Property Practice Group in Sheppard Mullin's San Francisco office, where she serves as co-leader of the firm's Blockchain & Fintech team. Her practice focuses on protecting her clients' intellectual property rights through counseling, prosecution, enforcement, and litigation. Yasamin leverages her litigation experience to strengthen and protect her clients' intellectual property, manage risks, and position businesses to succeed in the event of a dispute. She frequently advises and protects brands venturing into Web3 on various issues related to non-fungible tokens, metaverses, games, online
Transcript:
Yasamin Parsafar:
Hi, everyone. Thank you so much for joining us today on this week's episode of The Legit Ledger. I'm Yasamin Parsafar and with me, I have Jim Gatto. We co-lead Sheppard Mullin's blockchain team together. And today we are going to be continuing our conversation that we had in the first podcast episode about license agreements, particularly with NFT owners. In the first episode we talked about different types of licensing terms and choosing what rights to grant, as well as the scope of those rights. And today we're going to talk about how IP owners ensure that those licenses are binding on the purchasers of the NFTs that include their intellectual property. Jim, some people think that their licensing terms are passed through to the NFT owner in the metadata or through smart contracts. Is that true?
Jim Gatto:
That is a common misconception. It is not true. It's not uncommon to include the license information or a link to it in the metadata, and we think that's helpful and it's useful, but that alone is not sufficient. And similarly, the smart contract itself, as I think we may have covered in some other episodes, while the term contract is used there, it really is not typically a legal contract. So both of those can play a role with respect to the terms of an NFT license, but from a legal perspective, what you really want and need is a well drafted, properly accepted, legally enforceable NFT owner's license. I know there's a lot there in that sentence and we're going to break that down in the next few minutes here, but the key is there typically needs to be a separate license and there has to be valid legal acceptance, which we'll talk about in a second.
Yasamin Parsafar:
So before we get to the acceptance, a lot of these NFTs are sold through third-party platforms like marketplaces that have their own terms of service. And sometimes terms of service has IP provisions in it. Is the terms of service like an owner license? And if not, what's the difference between the terms of service and a license with the NFT owner?
Jim Gatto:
It's an important point and it's important to understand the distinction. So if there's an NFT marketplace and they have a terms of service, the terms of service typically govern the user's use of that service, and they're typically designed to protect that marketplace or platform provider. The scope of the terms of service vary. Some of them refer to a license of NFTs that are sold, but in most cases with some of the more popular and some of the bigger marketplaces, what it says is here's the rules that govern your use of our platform, and to the extent that a seller sells an NFT to a buyer, there may be a separate license agreement for that NFT, but that's not our problem. That is something that the two parties need to deal with. And so some of the marketplaces expressly disclaim a role in being a party to that license.
Jim Gatto:
They're just saying we're a marketplace and it's a more like a peer to peer transaction. And so what you'll find is in some cases the terms of service doesn't include any NFT owner's license. And in other cases, even some that may include a license or some default license, if you want to have a custom license, if you want to craft a license that's not just the one size fits all that may be a default license on a platform, you still need to go through the steps that we talked about of having your own license and presenting it and having valid acceptance.
Yasamin Parsafar:
So it's generally not really feasible for an IP owner to work directly with the purchaser to pass on a license agreement or to enter into a license agreement because a lot of times they don't know who the purchaser is, that's the case with all these marketplaces. So how can IP owners work with an online marketplace or auction house to try and make sure that their specific license terms are passed on to the owner? Is there a way to do that?
Jim Gatto:
Yeah. With some marketplaces, and hopefully this will become more prevalent and pretty consistent over time, you can provide a link at the point of sale. So when you present the NFT or an image of it, for example, when there's an opportunity for the user to buy it, you can have a typical online click-wrap type agreement mechanism whereby you'll say something like, "By clicking here, I accept this NFT owner's license if I purchase this NFT subject to some additional conditions we can talk about at a high level." That's the most common way to do it is to get that juxtaposed in connection with the actual NFT at the point of sale.
Yasamin Parsafar:
And I think just one thing to add there, Jim, from our experience personally working on this with our clients who are IP owners and working with the marketplaces and platforms, I really would say that people should try and start this negotiation process, working with the platform sooner rather than later, before the NFTs are set to launch, because it does take some time to negotiate the agreements and make sure everybody's okay with what tech is going to be used to have these licensed terms appear and also how they're going to appear. And so the sooner that you can start on those discussions, I think the more likely you are to be able to get something that's acceptable to you.
Jim Gatto:
100%. There's a growing number of marketplaces out there and I think the ability to use your own license on a marketplace and the ease with which you can do that is certainly one factor that NFT sellers should consider in deciding which marketplace to sell their NFTs on.
Yasamin Parsafar:
So you spoke earlier, you mentioned that IP owners need to make sure there is proper legal acceptance or license by the purchaser to help make sure that the license terms are actually binding on the purchaser. So can you explain how we can do that?
Jim Gatto:
Yeah. So there's a body of case law not just specific to NFTs, but really to any online contracting, if you will, many terms of service or other online agreements, people will provide an agreement for users and courts have enforced some and haven't enforced others, and really the guiding principles on when there is enforcement is under traditional contract law there has to be affirmative acceptance by both parties in order for there be a binding contract. And so what that means in the context of online typically is courts require that there be an opportunity for the user to be notified that these are licensed terms, an opportunity to review the terms, and that they take some affirmative action to indicate that they accept the terms. And part of the acceptance is you can't just put a link, for example, at the bottom of a website and say, "Well, there was a link there," because if the user didn't see it or didn't affirmatively accept it, that's not going to work for you.
Jim Gatto:
If you try to bury the link or make it difficult for the user to find, that's not going to work either. The courts typically say there has to be a conspicuous disclosure. And what that means varies and some of it is fact specific, but you don't want to use smaller font for that than you're using to describe the basic text to describe the NFT, for example. While this is not necessarily magical, it seems to be a default, you want to show the link as a hyperlink in blue font and underline, for example, sometimes. Courts sometimes look at that and say that that's what people are used to seeing to know that they can click on it and see something. So you have a whole set of factors like this, but the guiding principle is you want something that makes it easy for the user to understand that they're actually entering into an agreement, they can review it and then accept it.
Jim Gatto:
And the last thing I'll say is there's different levels that people go to ensure enforceability. Just presenting the link and having a checkbox and saying, "By clicking, I agree," that's probably going to be okay, but some companies go further. And as you've probably seen this with Apple and some others is that literally you have to click on a box and they'll be a little text box that opens, and you literally have to scroll through the license and get to the bottom before you can actually accept it and move forward. That's probably a more belt and suspenders approach. So if you're going to put some mechanism up, you might as well make it as enforceable as possible. But there's a trade-off between people not wanting it to be too sticky or too much of an impediment or something that where users are going to just abandon the purchase because of that, but I think users have gotten so used to it that it's better to be safe than sorry in this context.
Yasamin Parsafar:
I definitely agree. Okay, great. So you mentioned that courts enforce some agreements and not others depending on the circumstances. That's also true for certain provisions in agreements. And we know that we've seen, in some cases, provisions such as arbitration provisions and class action waivers have been problematic or not enforced by courts. So can you tell us a little bit about that and what people can do to try to increase the chances that these provisions will be enforced?
Jim Gatto:
So even if you have a generally enforceable agreement where you've gone through the process we talked about where a user affirmatively accepts, because these agreements are typically not negotiated, there are certain situations where courts will not enforce certain provisions of the agreement even though the rest of the agreement is otherwise enforceable. And two of the ones that are most important, arbitration provisions and waiver of class actions as I think you touched on. So what's important here to understand is several things. One is that in most cases the arbitration provision and waiver of class action are going to protect the seller.
Jim Gatto:
So if you're doing, let's say, a PFP project and you've got 10,000 NFTs, if there's some issue and a class action lawyer says they're going to do a class action on behalf of all the NFT owners, it becomes economically more viable for the class action lawyer to do that because there's likely a bigger payday if there's liability found. Whereas if you limit anyone's ability to only arbitrate and waive any class action, many times the users will be less inclined to file a lawsuit because it may not be cost justified for them. So one of the things that you want to really think about is the judicious use of arbitration clauses and waivers of class action to protect you if you're the seller. And in order to make those clauses enforceable, there's, again, a set of guidelines that are not necessarily NFT specific, but in some cases, if it's in a consumer context, there's certain consumer protection laws that apply to these. In some cases you might have to make the arbitration subject to jurisdiction where the user is. That's one aspect that may be required.
Jim Gatto:
In other cases, there are limitations on payment of fees by consumers, there's a whole host of other categories of things that may be relevant. And so what's important to understand is even though a lawyer can draft anything they want and put in an agreement that's not going to be negotiated, if they go too far and or don't cover certain aspects that are necessary to have an enforceable clause within that agreement, a court will refuse to enforce it. And so these are areas where if done right from a legal perspective they can provide significant protection for the licensor, but they need to be done right from a legal perspective.
Yasamin Parsafar:
Thanks, Jim. That's really helpful. So the last thing I want to talk about is we've seen situations where, for whatever reason, either IP owners didn't thoroughly think things through in the beginning or they changed their mind and circumstances have changed, and they've said I want to go back and modify my license terms. So what happens in those situations where people decide that they want to modify their license terms? Can they do that?
Jim Gatto:
That's a really interesting question. And under, again, just general contract law principles, parties to an agreement can modify the agreement. Typically, a party cannot unilaterally modify an agreement. Typically, both parties must accept. So one of the challenges from a legal perspective is if you've already sold some NFT, then there's a license that was accepted at the time of purchase, the original purchase of the NFT, then the question is how can you, from a logistical perspective, get users, the current owners of the NFT, to sign another agreement? And that is a bit of a logistical challenge, to be honest. Theoretically, it can be done. Now, some people will say that, if you read whether a terms of service or NFT owner license, sometimes there will be a clause in the agreement itself that says that this agreement can be modified by the license or, for example, whoever the counterparty is on the terms of service if it's a platform or marketplace.
Jim Gatto:
But I think there's limitations to that because it's easier with the terms of service, for example. So let me start there. If you have a terms of service for a platform, users can accept it the first time. Let's say they create an account on the platform, they can accept the terms of service, and it can say this governs your use of the platform going forward. It can also be a version that says we can modify these terms going forward. And so if you modify the terms of service, and this is what you'll see many times with certain online platforms is when they modify the terms of service, they'll typically email you a copy in many cases, but best practice, again, is just giving someone notice that you're changing your terms may not be legally sufficient for a court to agree that there was affirmative acceptance.
Jim Gatto:
And so typically they'll be a popup or some requirement for the user to review or be presented at least the modified terms of service, and then affirmatively accept those. So that happens on the terms of service side. And of course the user in that situation will have the option of if they don't like something in the modified terms of service, they can refuse to accept it and then just not use the service anymore. But with NFTs, it's different because if you already own the NFT, you can't have someone change the terms really without your consent. And so that's where NFT owner's licenses are a bit different than terms of service when it comes to trying to modify. Now, what's happened, for example, with some well-known projects, there either wasn't a license or there wasn't a well-crafted license at the time of issuance, they became very popular and there's been a lot of questions about what people can and can't do with the NFTs and so there's been attempts to remedy that by introducing a license or introducing an improved license agreement.
Jim Gatto:
And I think the principles I mentioned are important. We've seen some of them where people are saying, "Hey, we're going to give you additional rights that you didn't have." I think as a NFT licensor you can always tell someone you're going to waive certain rights that you have. We've seen that in other contexts like patent pledges and things that other companies do. It's not necessarily a user has to agree to it. It's like you're just saying we won't take this action. But if you're going to couple that with other restrictions or limitations on the NFT owner, I think you likely in most cases would need to have affirmative acceptance for anything that's detrimental or additional burden, obligational limitation for the NFT owner. So it's a tricky thing because you can determine, from the blockchain, the NFT owner's wallet address, but actually notifying people and getting them to accept is logistically challenging as I mentioned.
Yasamin Parsafar:
Got it. Okay. That's a lot for people to consider. Another reason why it's really important to really think this stuff through, I think, at the start and make sure that you're not only thinking about currently what your plans are, but also what your future plans might be so that those can all be considered when drafting the terms of your license agreement. Jim, do you have any other recommendations or tips for people who are listening today about this issue of ensuring that license terms are binding on the NFT purchaser?
Jim Gatto:
Yeah. I think we've covered most of the big ones. I think the other thing that I would add is that it's just really critical to draft a license properly and cover all the relevant points upfront, because, as we just talked about, it's difficult to go back and amend it down the road. And if you don't think through all the issues up front, it can present legal problems for you. And so this is something we get from clients a number of times, there's this tension or trying to strike the right balance maybe's a better way to say it of trying to have an NFT owner license that's simple and short and consumer friendly, and that, of course, is always desirable, but because of the complexity of the legal issues and the number of things that can happen or go wrong, there's a lot of things you need to include that makes it hard to do that. And I think one of the recent examples that exemplifies this is the Seth Green situation where he was dispossessed of his NFT and there was uncertainty about the rights.
Jim Gatto:
Well, in our licenses, we address certain permitted transfers and what happens, and if there's an unpermitted transfer or an unauthorized transfer. And so given that those are unfortunately likely to not be one-off incidences and there may be more of those, a good license can address that and avoid the uncertainty. So I don't want to harp too much on that, but I think we see a lot of, I'd say, short, simple licenses, some are well-drafted and short, but they don't cover a lot of provisions and others are just short because they're sloppy. Like the Bored Ape Yacht Club license, they're granting commercial licenses, but they don't address what you can do from a trademark perspective, and that's one of the things, for example, they're trying to go back and make clear now. To your point earlier, it's really important to think about all the things that not only are important from your business perspective now and potentially in the future, but the issues or problems that can arise and to cover all of those in a well-crafted license agreement.
Yasamin Parsafar:
Thanks, Jim. And we're happy to help people with that, so please don't hesitate to reach out to us if you have any questions. And we wanted to thank everybody for joining us today. Please share and subscribe to our podcast if you find this content helpful or interesting. We appreciate all of you joining us. Thanks so much. And hopefully we'll have you on again next time.
Jim Gatto:
And until then, keep it legit.
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