2022 NFT Litigation Roundup

28 October 2022 Blog
Author(s): Andrew L. Lee Daniel F. Bernard Robert S. Weisbein Byron J. McLain Kathryn M. Trkla
Published To: Innovative Technology Insights Foley Ignite

The emergence of non-fungible tokens (NFTs) has spawned novel legal and regulatory considerations, spanning intellectual property rights, the potential classification of NFTs as securities, the recovery of assets held on decentralized platforms, and criminal considerations relating to fraud, money laundering, and insider trading. This roundup tracks ongoing civil and criminal actions involving NFTs and the various unique legal issues at play.

These actions provide a glimpse into how NFTs will be integrated into existing legal frameworks, and may provide clarity over legal questions that loom large over companies and individuals in the business of creating or selling NFTs. For instance, recent actions show that courts and government authorities are beginning to uncover or take jurisdiction over assets on the decentralized blockchain. Based on recent indictments, individuals are finding out the hard way that digital assets held on the blockchain—while often thought to be anonymous—are not beyond the purview of government enforcement and cannot be used to hide illicit gains. The methods used to uncover the identities of token or NFT holders may have implications not only for criminal enforcement, but also for actions where the identification or recovery of assets is significant such as divorce and bankruptcy. Recent enforcement activity by the United States and foreign governments should serve as a warning to those who think they can use digital assets for unlawful means. This compilation is intended to inform readers of the various legal risks that individuals and businesses in this space may encounter.

Ripple Litigation

SEC v. Ripple Labs, Inc., 1:20-cv-10832 (S.D.N.Y.)

Are NFTs regulated securities? This question factors prominently into decisions made by creators, sellers, and purchasers of NFTs. While this litigation does not concern NFTs in particular, it could potentially determine whether, and to what extent, digital assets such as NFTs are considered securities under federal securities laws. The U.S. Securities and Exchange Commission (SEC) filed an action against Ripple Labs Inc. and two of its executives, alleging they raised over $1.3 billion through an unregistered, ongoing securities offering through the sale of their native XRP cryptocurrency token. The SEC alleged that Ripple violated securities laws when it failed to register sales of XRP, in turn helping finance its platform and facilitate payments on Ripple’s network, as well as exchanging for non-cash consideration such as labor and market-making services. A putative class action was also filed arising out of the creation, dispersal, circulation, and sale of XRP as unregistered securities. After the close of discovery, the parties moved for summary judgment in October 2022.

Dapper Labs NBA Top Shot Lawsuit

Friel v. Dapper Labs, Inc. et al, 1:21-cv-05837 (S.D.N.Y.)

Like the Ripple litigation, the NBA Top Shot lawsuit could shed light into whether—and under what circumstances—a NFT is considered a security. This class action lawsuit, filed in May 2021, alleges that defendants Dapper Labs and its CEO operated an application called “NBA Top Shot” that promoted, offered, and sold NFTs (called “Moments”) as unregistered securities. The complaint alleges these Moments are securities because they are an investment of money, in a common enterprise, with a reasonable expectation of profits to be derived from the efforts of others—essentially, that they are considered securities pursuant to the Howey test. It was additionally alleged that Dapper used its control of the NBA Top Shot platform to control the market for its “Moments.” For instance, investors were prevented from withdrawing funds for certain periods of time and Dapper controlled the supply of and secondary market for Moments, thereby propping up the value of the NFTs. On August 31, 2022, the defendants moved to dismiss the lawsuit, arguing primarily that collectible sports cards, like NBA Top Shot Moments, are not considered securities, thereby failing the Howey test.

Frosties “Rug-pull” Scheme

U.S. v. Nguyen and Llacuna, 22-mag-2478 (S.D.N.Y.)

In March 2022 two individuals were criminally charged with conspiracy to commit wire fraud and conspiracy to commit money laundering in connection with a million-dollar scheme to defraud purchasers of NFTs advertised as “Frosties.” Rather than providing the benefits advertised to Frosties NFT purchasers, the defendants transferred the proceeds of the scheme to various cryptocurrency wallets under their control and shut down their NFT website. Notable from this case are the methods used by authorities to reveal the identities of the defendants and track Frosties NFT sale proceeds across several cryptocurrency wallets. Authorities were able to match cryptocurrency wallets—often perceived to be anonymous—to the real identities of the fraudsters using IP addresses and third-party subpoenas. To uncover the defendants’ identities, authorities discovered that one defendant posted on Discord, a social media website, from his home IP address, and that same IP address had accessed a particular Coinbase wallet to transfer cryptocurrency assets to another “fraud wallet.” In this way, authorities were able to reveal the identities of the individuals behind the scheme, despite defendants’ use of a VPN and “cryptocurrency mixer” that obscured the source of cryptocurrency funds.

Miramax v. Tarantino

Miramax v. Tarantino et al., 2:21-cv-08979 (C.D. Cal.)

On November 16, 2021, production company Miramax sued director Quentin Tarantino in California federal court, alleging breach of contract and copyright and trademark infringement over Tarantino’s alleged plans to auction off seven “exclusive scenes” from the 1994 motion picture Pulp Fiction in the form of NFTs. Miramax alleged that the original rights agreement granted Miramax all rights in and to the film, including the right to distribute the film in all media, excluding only a limited set of Tarantino’s reserved rights, which include the following:

Soundtrack album, music publishing, live performance, print publication (including without limitation screenplay publication, “making of” books, comic books and novelization, in audio and electronic formats as well, as applicable), interactive media, theatrical and television sequel and remake rights, and television series and spinoff rights.

These reserved rights, Miramax alleged, are too narrow to unilaterally produce, market, and sell the Pulp Fiction NFTs. Miramax further alleged that Tarantino’s use of Pulp Fiction branding and imagery would be likely to confuse the public as to the source of the Pulp Fiction NFTs, and would thus set negative precedent for other filmmakers. This case represents an early example of how NFTs fit into contractual intellectual property rights conferred in an era when digital assets were yet to exist. The parties have since settled this matter.

Hermès Lawsuit Over NFTs Allowed to Proceed

Hermès v. Rothschild, 1:22-cv-00384 (S.D.N.Y.)

Luxury fashion brand Hermès sued a digital artist over the creation of NFTs branded as “MetaBirkins” that depict the company's Birkin bags. Hermès’s lawsuit, which asserts claims of trademark infringement, dilution, and cybersquatting, claims the defendant began offering the NFTs without its permission and had sold over $1 million worth of them by early January 2022. In May, a federal judge denied the defendant’s motion to dismiss, allowing the case to proceed. However, it would be rash to say Hermès has this case in the bag. Historically, expressive works have been provided large latitude to avoid findings of trademark infringement. In order to succeed on its claims, Hermès will need to show a likelihood of confusion—that consumers mistakenly believed that the MetaBirkin NFTs and Hermès Birkin bags came from the same source. After the completion of discovery, both parties recently filed motions for summary judgment, which remain pending.

Nike v. Stockx

Nike, Inc. v. Stockx LLC, 1:22-cv-00983 (S.D.N.Y.)

In February 2021 Nike filed a lawsuit against online sneaker and clothing marketplace StockX, alleging that StockX, without Nike’s authorization or approval, minted NFTs that prominently use Nike’s trademarks, marketed those NFTs using Nike’s goodwill, and sold those NFTs at inflated prices to consumers. StockX asserts that the NFTs are like “digital receipts” to actual sneakers that are authenticated and stored in its facilities, and that it is not selling its NFTs as digital art, but instead using them as a means of selling the actual product pictured in the NFT. StockX further claims that its actions are “no different than major e-commerce retailers and marketplaces who use images and descriptions of products to sell physical sneakers.” Should a public outcome be reached, this case would have broad implications for the interplay of intellectual property rights among digital and physical assets.

Roc-A-Fella Records, Inc. v. Damon Dash

Roc-A-Fella Records, Inc., v. Damon Dash & Godigital Records, LLC, 1:21-cv-05411-JPC (S.D.N.Y.)

Roc-A-Fella Records (RAF), the record label founded by Jay Z with Damon Dash and Kareem Burke, filed suit against Mr. Dash, a minority shareholder, seeking a judgment preventing him from selling or disposing of any interest in Jay-Z’s debut album Reasonable Doubt. According to RAF, Mr. Dash was planning to auction off a portion of his purported rights to the album in the form of a NFT. After a judge enjoined the potential auction, the parties settled the case in June 2022, and in doing so, stipulated that Dash, as a RAF shareholder, has no direct ownership interest in Reasonable Doubt and is not permitted to sell or assign any interest in the album, including through the sale of a NFT.

OpenSea Employee Charged in Insider Trading Scheme

U.S. v. Chastain, 22-CRIM-305 (S.D.N.Y.)

On June 1, 2022 the U.S. Department of Justice (DOJ) announced its first insider trading charge involving digital assets. A product manager at OpenSea, a NFT marketplace, was charged with wire fraud and money laundering in connection with trading on confidential information about which NFTs were to be featured on OpenSea’s homepage. The employee used anonymous cryptocurrency wallets and OpenSea accounts to sell dozens of NFTs after choosing to feature them on the OpenSea website. Legal counsel for the defendant reportedly believes the case may be susceptible to dismissal, in part because it is believed that NFTs are “neither securities nor commodities" and cannot underpin an insider trading prosecution. While the indictment does not mention the words “security” or “securities,” it does highlight the risks of trading NFTs based on the use of non-public information. Regardless of how an NFT is classified, companies issuing or selling NFTs should consider implementing NFT trading policies in light of these charges.

Service of Process via NFT

LCX AG v. 1.274M U.S. Dollar Coin, No. 154644/2022 (Sup. Ct. N.Y. Co.)

In a case involving the theft of nearly $8 million worth of assets on the Ethereum blockchain, attorneys served defendants with a temporary restraining order (TRO) in the form of an NFT, following approval by Justice Andrea Masley of the New York Supreme Court. The NFT, which contained a hyperlink to an order to show cause and included a mechanism to track when the NFT was accessed, was airdropped to a cryptocurrency wallet address used to store the stolen cryptocurrency assets. The authorization of this method of service underscores the trend that seemingly anonymous digital wallets on decentralized platforms are not beyond the purview of the legal system.

Singapore Court Issues Injunction Halting Sale of Bored Ape NFT

Janesh s/o Rajkumar v. Unknown Person (“chefpierre”) HC/OC 41/2022

On May 13, 2022 a Singapore court issued an injunction freezing the sale of a well-known“Bored Ape Yacht Club NFT. The injunction is said to be the first to prevent the sale of an NFT in connection with a purely commercial dispute. As part of the dispute a borrower sought to repossess the NFT, which he had used as collateral for a loan from an individual lender. The borrower took particular care to specify in loan agreements with lenders that he was not willing to relinquish ownership of the NFT, and would make full repayment of the loan to redeem it back. When then borrower became unable to repay his loan, the defendant, in violation of their contract, transferred the NFT to a personal Ethereum wallet and listed it for sale on OpenSea. The court enjoined the sale of the NFT, and by doing so signified that courts may take jurisdiction over assets on the decentralized blockchain.

Yuga Labs v. Ripps

Yuga Labs Inc. v. Ripps et al., 2:22-cv-04355 (C.D. Cal.)

Yuga Labs, the creators of the prominent Bored Ape Yacht Club (BAYC) NFT, sued artist Ryan Ripps for trademark infringement, alleging that Ripps created and sold a line of NFTs that used BAYC imagery. Ripps had originally published claims that the Yuga Labs founders used racism and alt-right imagery throughout the BAYC project. Afterwards, Ripps re-minted Bored Apes, and sold them for profit as “a protest against and parody of” the original BAYC NFTs. He claims that the lawsuit was waged against him as a form of intimidation. Defendant’s motion to dismiss the lawsuit remains pending.

SEC Probe of Yuga Labs

News outlets recently reported (confirmed by a Yuga Labs spokesperson) that the SEC is investigating Yuga Labs for potential violations of federal securities laws in connection with its sales of Bored Ape NFTs and its subsequent issuance of ApeCoins as governance and utility tokens. The SEC has not filed any civil charges and the DOJ has not commenced any criminal action at this point, and Yuga Labs reports that it is cooperating with the SEC’s investigation. This is not the only pending SEC investigation into NFT projects, but the notoriety of the Bored Ape project in the NFT world, coupled with the various utility benefits inherent in Bored Ape NFTs, make this a significant investigation that could have repercussions throughout the industry, however the probe turns out. Given that decentralization has generally been considered a factor that distinguishes tokens from securities, the investigation’s focus on ApeCoins is also important because ApeCoins are governance tokens issued by the ApeCoin DAO, a decentralized autonomous organization. DAOs are becoming more and more prevalent in various commercial and charitable contexts, so the SEC’s perspective is worth keeping a close eye on.

United Kingdom Seizes NFTs in Tax Crackdown

British tax authorities made their first seizure of NFTs as part of a crackdown on suspected criminal activity to hide money. The authorities seized three NFTs after investigating a suspected value-added tax (VAT) fraud case worth £1.4 million ($1.9 million). The probe led to the arrest of three individuals for alleged tax fraud involving 250 fake companies.

Coinbase SEC Investigation

Coinbase is facing a SEC investigation into whether it facilitated trading of digital assets that should have been registered as securities. In response, Coinbase revealed that it has a rigorous diligence process that the SEC has already reviewed that keeps securities off its platform. The investigation comes in the wake of criminal insider trading charges against a former Coinbase product manager for perpetrating a scheme to trade ahead of multiple announcements regarding certain digital assets that would be available for trading on the Coinbase platform. As part of the insider trading complaint, the SEC alleged that of the 25 digital assets purchased as part of the scheme, at least nine were securities. The current investigation marks the SEC’s first public investigation into a NFT platform.

Williams v. Block.one

Williams et al. v. Block.One et al., 1:20-cv-02809 (S.D.N.Y.)

In Williams v. Block.one, a judge for the United States District Court for the Southern District of New York rejected a proposed class action settlement involving purchasers of digital assets due to concerns regarding whether the lead plaintiff’s interests adequately represented those of absent class members. In the lawsuit, plaintiffs alleged that Block.one violated federal securities laws by issuing tokens on various exchanges without registering them as securities with the SEC. After an initial settlement was reached, the judge declined to approve it. He reasoned that due to federal securities laws, tokens purchased on some platforms were more likely to be considered securities than on other platforms. Thus, the lead plaintiff may have an incentive to accept a lower settlement offer than would have been insisted upon by absent class members who may have had a stronger claim. While the tokens issued as part of this offering were not NFTs, this decision will have implications for any group of purchasers seeking to certify a class based on the purchase of any digital assets that could potentially be considered a regulated security.

Pepe the Frog NFT Lawsuit

Thayer v. Furie et. al., 2:2022-cv-01640, (C.D. Cal.)

Matt Furie, the creator of the “Pepe The Frog” meme, released at auction on the Chain/Saw platform an exclusive “Rare Pepe” NFT. The NFT, which depicted the frog featured in the well-known meme, sold for 150ETH, equivalent to over $500,000. After the sale, 99 other Rare Pepe NFTs remained in a DAO created by Furie. On Twitter, Furie advertised that only one card would be released during the auction, and the rest would be “held indefinitely.” Two weeks after the close of the auction, Furie allegedly transferred Rare Pepe NFTs free of charge to members of the DAO. The purchaser subsequently sued Furie and Chain/Saw, alleging that Furie represented that the rest of the NFTs would be held in the DAO indefinitely. According to defendants, plaintiff did not rely on defendants’ representations because, following the sale of the NFT, the plaintiff requested clarification about whether members of the DAO would own Rare Pepe NFTs and stated that he would not have changed his bid regardless of the answer. This lawsuit raises interesting issues, including whether a plaintiff who purchases an item using a cryptocurrency is entitled to damages in the form of that cryptocurrency or the dollar amount at the time of purchase.

Kim Kardashian SEC Settlement

In the Matter of K. Kardashian, File No. 3-21197

Celebrity influencer Kim Kardashian recently agreed to a settlement with the SEC in connection with civil changes that she violated the anti-touting provisions of federal securities laws by promoting a crypto asset known as Ethereum Max on Instagram without disclosing that she was paid a $250,000 fee for making the post. While Kardashian agreed to the settlement without admitting fault or liability, the settlement requires her to disgorge the $250,000 fee, pay a $1 million fine, and refrain from promoting any crypto securities for the next three years. The highly publicized charges and settlement should be a warning to NFT projects seeking to capitalize on celebrity involvement or endorsements because the SEC clearly considers such involvement to be a securities red flag.

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