Besides of the regulatory qualification of security tokens as security, shares in investment funds or alternative investment assets quite a number of private law issues are raised when conducting securities token offerings. The most prominent pitfall when it comes to private law and security tokens is the fact that the German Civil Code BGB in its current form does not foresee electronic debt securities so far. Classical securities which must be freely tradable at the capital markets are therefore still issued in paper form in traditional manner so they are tangible assets that can be subject to property rights and be acquired on the secondary markets in good faith and free from encumbrances. Tangible assets however in German private law are only physical objects. For security tokens, being not more than virtual information in a smart contract on a blockchain, a different legal construction for transfer must be found. The only suitable alternative is probably a cession of the obligation represented by the security token by which the obligation against the emitter can be transferred to the acquirer of the security token. In this case however it must be made sure that the obligation will strictly be tied to the token because otherwise a separation of the token and the obligation and a confusion on the markets may happen.
LEGAL CONSTRUCTION OF TRANSFER IS CRUCIAL FOR CAPITAL MARKETS ELIGIBILITY
The necessity of a valid construction of the transfer of a security token is not at all only an academic problem. As the unlimited fungibility of a security token and therefore its’ eligibility for the capital markets can only be given, if the acquirer of the security token can be sure that he has not only acquired the token but also the obligation against the STO emitter. In case the token and the obligation can get separated, such security tokens being traded at the capital markets will not be standardized anymore. In such case the eligibility of the security token to the capital markets would have to be declined because the acquirer of such token could not be sure whether he has acquired only the bare token but also the obligation against the STO emitter. In addition to that, such token could not be qualified as a security from a regulatory law perspective. The token could at best be qualified as an investment asset according to the German Investment Asset Act (Vermögensanlagengesetz) as these instruments characterize by their limited fungibility in comparison to securities.
SECURITY TOKEN TERMS SHOULD EXPLICITLY SET OUT RULES FOR THE TRANSFER MECHANISM
With regard to the massive legal consequences that may occur in case of non-existent rules for the legal transfer of the security token, the security token terms should set out a clear legal mechanism for the initial acquisition of the security token during the STO as well as for the secondary acquisition after the STO. The security token terms should definitely regulate, how exactly the obligation of the STO emitter to repay the investment and/or the payment of interests will be transferred to the acquirer of the security token in case of a secondary acquisition. It is of utmost importance that these rules factor the technical peculiarities of the blockchain technology and of smart contracts to make sure that the security token and the associated obligation can never be separated. The legal conception of a security token therefore differs fundamentally from the legal conception of classical securities’ terms and requires a profound consideration of the peculiarities of blockchain technology and technical knowledge. FIN LAW combines the necessary technical understanding and the regulatory expertise and is therefore the right legal partner for security token offerings.
Rechtsanwalt Lutz Auffenberg, LL.M. (London)