NFTs in crisis and insolvency

NFTs are a hot topic, but their treatment under insolvency law – which will receive more attention due to the recent crisis – has not yet been explored in much detail. This contribution aims to provide a brief overview of the most relevant issues.

NFTs as collateral

A non-fungible token (NFT) is a data record stored on the blockchain under a specific address (smart contract address) that consists of a number (token ID) that is assigned to the address (public key) of its owner. This makes the token unique and uniquely identifiable, and thus non-fungible. In addition, tokens also contain further information, such as a unique link to an external decentralised file system, where, for example, the actual digital artwork is stored. The NFT therefore contains information that refers to the artist, the title and the storage location.

NFTs are regularly used as an investment. If the owner of the NFT runs into liquidity problems but does not want to sell their NFT and is therefore forced to take on debt capital, they may at least be able to use their NFT as collateral. The main question in this context is whether NFTs can be pledged.

To assess this question, it first has to be examined whether NFTs constitute a good within the meaning of Section 285 of the Austrian Civil Code (ABGB). There is consensus that the broad concept of a good as defined there also includes NFTs ("[a]nything that is distinct from the person and serves the use of people [...]"). It is also argued by doctrine that NFTs are immaterial goods within the meaning of Section 293 ABGB.

However, several uncertainties regarding the further classification of NFTs as goods remain. Under Section 292 ABGB only material goods are divided into movable and immovable goods, but not immaterial goods. Nevertheless, most legal writing qualifies NFTs as an immaterial good, which is not subject to this classification, so this part of the doctrine does not consider the application of the classification in movable or immovable. On the other hands, some say that crypto assets (and thus NFTs) can be moved on the blockchain by nature and should therefore be qualified as movable goods irrespective of their qualification as material or immaterial. Others believe that a distinction must be made between the token (record) and the object to which it refers or the right it certifies. So there is still a lot that is unclear regarding the classification of NFTS.

Much depends on this classification, not only the purchase of an NFT – in particular title and mode – but also whether and, above all, how an NFT can be pledged. In principle, however, it can be assumed that NFTs can serve as collateral and therefore be a helpful asset to their owner, especially when collecting debt capital.

NFTs in insolvency

If the owner of an NFT is insolvent, it becomes important to know whether their creditors can access the NFT and obtain satisfaction from it. For creditors to be able to obtain satisfaction from the realisation of an NFT, the NFT must form a part of the insolvency estate, which the insolvency administrator must realise (in the realisation bankruptcy). The creditors are subsequently satisfied from the proceeds of the realisation.

Pursuant to Section 2(2) of the Austrian Insolvency Act (IO), all assets which belong to the debtor at the time of the opening of the insolvency proceedings or which they acquire during the insolvency proceedings and against which execution is possible are part of the insolvency estate. According to the legal literature, the debtor's assets are part of this estate if they have an economic value, are objectively realisable and are not exempt from execution. Given that NFTs are a recent invention, it was unclear whether this new class of "assets" was covered by the Austrian Execution Act (EO). An execution on movable goods will most likely fail due to the lack of materiality. An execution on a claim must also be ruled out, because NFTs do not represent a monetary claim. Recently, however, a new Section 326 (1) EO was introduced, designed as a fall-back provision. It applies to all assets that are not covered by Sections 88-325 EO. Section 326(1) EO explicitly mentions crypto currency and includes NFTs (at least analogously), which, therefore, are not exempt from execution and are part of the insolvency estate. Thus, the insolvency administrator is under the obligation to realise NFTs.

Realisation of NFTs

What sounds complicated at first might – in fact – not be all to exotic: NFTs, like crypto currency, are held in wallets, which can roughly be compared to accounts with the wallet provider as the account bank. More precisely, a wallet is software that grants access to the respective NFT by administering so-called public keys (essentially an identification number) and private keys (in essence a password). To realise the NFT, the insolvency administrator needs to obtain knowledge of the wallet keys. If knowledge of both keys exists, the NFT can generally be transferred and, thus, sold by the insolvency administrator in insolvency proceedings. Accordingly, a debtor is obliged not only to fully disclose their NFTs in the list of assets, but also to provide all information about their wallet and keys. This can be enforced if necessary, for example through imprisonment (see Section 101 IO).

It is therefore generally possible to satisfy all creditors from the realisation of the NFT, but not if the NFT was effectively pledged before the opening of the insolvency proceedings. The pledgee can then assert a right of separation pursuant to Section 48 IO and will be satisfied with priority from the proceeds of the sale of the NFT.

authors: Felix Loewit, Tullia Veronesi