In Germany, it is possible to issue bearer bonds in accordance to the Electronic Security Act (eWPG) without securitization in form of so-called crypto securities since last summer. The German legislator thereby created the option to grant owners of security tokens a legal position comparable to the ownership position of owners of paper documents. Acquirers of crypto securities can become legal owners of said crypto also if the seller was not the owner, as long as the acquirer blamelessly did not possess any knowledge of the sellers missing authorization. When it comes to crypto securities, the eWPG stipulates that the rights resulting from the bond are inseparably connected with the token representing them. Next to this, businesses continue to have the possibility to issue security tokens without the use of the options provided by the eWPG. This may e.g. make sense if the issuer does not wish to involve a central registry administrator, which is compulsory to be involved in issuances of crypto securities. In these cases, a legal mechanism has to be created which ensures the inseparable connection of the rights stemming from the bonds with the tokens, just like prior to the eWPG coming into effect.

Secure Merging of Rights and Token Via Assignment Restriction

Connecting factor for the connection of investor rights with a token in case of a tokenized bond are the terms and conditions of the bond, commonly also referred to as Token Terms. These Token Terms contractually regulate the rights and obligations of the issuer and investors. Token Terms inter alia contain provisions concerning the rate of return, duration, possible subordination agreements and rights of cancellation. Token Terms of tokenized bonds which are not designed in accordance to the eWPG may include provisions stipulating that token bearers may only assign their tokens to third parties, if they simultaneously assign all rights and obligations stemming from the bond to the assignee of the tokens. This mechanism ensures that token and investor rights and obligations as defined in the respective Token Terms are always allocated to the same person. In order for the mechanism to work reliably, token bearers additionally have to be obligated by the Token Terms to not assign the rights of the security token in any other way as explained above – e.g. without the simultaneous assignment of the token itself.        

New Consumer Protection Law Complicates the Inclusion of Assignment Restrictions in Token Terms

The obligation of security token bearers to only dispose of the rights of the tokenized bond via token transaction on the underlying blockchain and only en bloc, constitutes a restriction of the assignment right of the investor. As of October 1st, 2021 the German consumer protection law contains a protective provision according to which clauses in general terms and conditions that restrict the assignment of claims of monetary nature versus the user of the clause may be invalid. Token Terms are designed and worded for a multitude of investor contracts and are therefore always general terms and conditions. According to the explanatory memorandum the new provision – contrary to its wording – is not intended to only be applicable to clauses that entirely eliminate the option to reassign a claim but also to clauses merely restricting it. Assignment restrictions in Token Terms could therefore be affected in the future by this new legal regulation. This whole complex is only relevant to security tokens which are distributed to private investors, because the new provision takes no effect on contracts between professional parties.

Better Arguments for Inapplicability in Security Token Terms

The new legal regulation is intended to protect consumers versus businesses and prevent the restriction of the general assignment right of contractual parties via general terms and conditions. The right to assign claims to third parties is a manifestation of the general principle of contractual freedom and therefore an essential civil liberty which should not and cannot be taken away from consumers without good cause. However, the new legal regulation is a provision with margin of discretion. This means that if good reasons are given that argue for the assignment restriction and the rights of the consumers are not unjustifiably restricted, an assignment restriction can still be vaild. Generally, the assignment restriction in Token Terms benefits all involved parties. Issuers can rely on the fact that the token bearers are also the bearers of the bonds. Investors can be sure that the acquired security tokens are really connected to the investor rights of the tokenized bond. Assignment restrictions are therefore instrumental in the creation of legal certainty for all involved parties and they do not restrict consumer rights unreasonably. In the end, the civil courts will have to decide on a case by case basis on the effectiveness of assignment restrictions in general terms and conditions. The specific wording of the restriction and the entire design of the Token Terms will be the decisive factors in cases relating to security token offerings.  

Attorney Lutz Auffenberg, LL.M. (London)