By Kresimir Peharda, Partner
Non-fungible tokens have gotten a lot of media attention over the last year. Some of it has come from record prices for certain digital items like the Bored Ape Yacht Club NFTs and some of it due to hacks and outright theft.
In keeping with the times, the cannabis industry has begun exploring NFTs as a way to directly engage with consumers. The industry has been looking for alternative means to reach customers because cannabis is banned from traditional advertising platforms and restricted on social media.
While promising from a marketing perspective, the use of NFTs can raise a litany of legal issues.
Definition of an NFT
NFTs can represent ownership of a trading card, digital art, a skin in an online game, real estate in the virtual world, and physical objects in the real world.
The Securities Exchange Commission (SEC) has made it clear that the use of NFTs may implicate securities laws in several circumstances.
First, the sale of NFTs to raise money for a business may be viewed as an unregistered securities offering to the public. If the sale of NFTs is considered a public offering of securities, then the SEC would require the company raising funds to file a registration statement covering the offer and sale of such NFTs, or qualify the offering under a valid exemption.
The main reason why the SEC would view a NFT sale as a public offering is that the offer is typically made on social media (Twitter, Instagram and Discord) which means it is viewable by everyone—both accredited and unaccredited investors.
Second, the sale of fractional interests in a NFT could also be deemed a sale of unregistered securities to the public. While the SEC has not provided detailed guidance on this topic, it has made clear that dividing up the ownership in a NFT and selling those fractional interests as an investment may be considered a securities offering.
Intellectual property law
It is not clear how the courts will treat NFTs once disputes arise over their ownership. Are NFTs property just like a physical item, or are they merely licenses in someone else’s copyright.
Furthermore, what rights does the original creator retain in perpetuity and what rights does the first buyer have. More specifically, does the first buyer owe a “royalty” to the creator on a subsequent sale? Can the first buyer utilize the NFT for commercial purposes to make money?
Exchanges like SuperRare have tried to describe the rights between the original creator and first buyer but it is not clear if the described arrangement will be enforced as intended.
Contract law and security
Buying a NFT on exchange that has a detailed description of the rights of the parties makes it less likely that a dispute will arise between the parties.
Buying a NFT directly from a creator or from a company raises many of the questions discussed above in the IP section.
In either case the fundamental question is–what is the buyer getting.
Two areas to consider are: hacks and inability to view the NFT. For example, if the smart contract associated with the NFT is hacked and ownership is transferred to the hacker then who is responsible?
If the NFT image files are stored off-chain as opposed to the Ethereum blockchain, what happens if the website or server displaying the NFT goes dark?
The following are some of the practical applications of NFTs in the cannabis industry.
NFT as digital art
The Crypto Cannabis Club (CCC) is the poster child for cannabis themed NFTs called NFTokers & NFTokins.
CCC sells its NFTs on OpenSea which is a leading NFT exchange.
NFT as community builder
CCC is using the sale of NFTs as a way to build a community around real-world cannabis themed events.
There is an obvious synergy between someone buying a NFT with a cannabis theme and having that person attending an in-person cannabis event.
NFT as a security
There is a common misconception in the cannabis community and startup community generally about raising money. This ignorance is magnified in the NFT world.
Promoting a NFT as an “investment” and/or representing an interest in a company is a surefire way to venture into the securities law public offering arena.
NFT as a ticket for real world experiences
Saucey Farms and Extracts is exploring using NFTs as an entrance ticket to a cannabis lounge. NFT holders could also store their purchased products in the consumption lounge.
NFT to support a 420 cause
Cannasaurs is one of the best examples of using the sale of NFTs to support a cause favored by cannabis fans. According to Cannasaur NFT, the purpose of the project is to …“help non-profits with cannabis reform.“ Califari is another example of a cannabis company selling NFTs to fund criminal justice activity.
As in the community building scenario, it makes sense to gain awareness for cannabis reform using the lure of the shiny new object-the NFT.
While all of the applications give rise to contract law and security issues, the investment and money-raising ones create the most challenging problems that may attract the attention of the regulators.
Kresimir Peharda is Chair of the Cannabis Practice at YL Law LLP.
As one of the leading cannabis deal attorneys in Los Angeles, his practice includes representing cultivators, manufacturers, processors and retailers, MSOs, private equity funds and public companies.
Kresimir’s clients generally benefit from his experience representing public companies and hands-on operational experience in three start-ups, two in healthcare and one in real estate.
He represents companies in all stages of development from start-ups to public reporting companies.
Kresimir has assisted his public clients in IPOs, spin-offs, going private transactions, SEC compliance, corporate governance, corporate reorganizations and complex financing transactions. He advises startups and middle market companies on contracts, equity compensation, debt and equity financing, mergers and acquisitions, and shareholder matters.
His clients have raised billions in USD in capital through public and private securities offerings (including private placements and PIPEs), commercial bank loans, other asset-based lenders, private equity firms, strategic partners, and VCs.
Kresimir also structured, negotiated, and closed mergers and acquisitions in the billions in domestic and international settings. He has assisted his clients in alliance, development, distribution, licensing, marketing and sales agreements worth in excess of a billion USD. He can be reached via email at [email protected].
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