Written by Bryse K. Thornwell
In Free Holdings Inc. v. McCoy et al, No. 22-CV-881 (JLC) (S.D.N.Y., March 17, 2023), Magistrate Judge James L. Cott confronted an unclear issue regarding ownership of non-fungible tokens (“NFTs”), which are assets that have been tokenized via a blockchain. NFTs can be unique and quite valuable. The court in Free Holdings considered the issue whether initial registration of an NFT is the asset, or whether re-registration creates a new asset. Resolution of the issue has significance, because different individual entities have made competing claims to ownership based on registration status.
In 2014, Defendant Kevin McCoy, a digital artist, created a digital record of ownership of his work “Quantum.” McCoy registered the record of ownership under a “Name” on the Namecoin blockchain. With this registration, McCoy was credited as creating “the first NFT.” The Namecoin platform provided a disclaimer stating, “The property that the Namecoin blockchain was built to cryptographically secure ownership of…is a unique plot of digital space known as a Name. As such, Names, along with the history of Values associated to them, are the NFT property.”
In McCoy’s case, the “Name” for the record expired in 2015 because he did not re-register. Thereafter, in April 2021 Free Holdings allegedly reregistered McCoy’s “Name” regarding “Quantum.” In May 2021, McCoy created (or “minted”) another NFT for his work “Quantum,” this time by registering it as a moving image and placing it on the Ethereum blockchain. The Quantum NFT on the Ethereum blockchain was sold at an auction sale by Co-Defendant Sotheby’s for $1.4 million.
Plaintiff Free Holdings claimed that the auction sale harmed its ownership interest in its NFT and sued. Its complaint asserted five causes of action: (1) unjust enrichment, (2) slander of title, (3) deceptive and unlawful trade practices, (4) commercial disparagement, and (5) false or misleading representations. The defendants filed motions to dismiss for lack of subject matter jurisdiction and for failure to state a claim upon which relief can be granted. Because of the substantial uncertainty and differing opinions surrounding ownership of NFTs, and because Plaintiff Free Holdings failed to allege why the defendants’ original characterizations of ownership were “substantially false,” the court dismissed the complaint that alleged that mere registration is the NFT asset.
The court first granted the defendants’ motion to dismiss for lack of subject matter jurisdiction, holding that Free Holdings lacked standing under Article III of the U.S. Constitution. As a minimum requirement of standing, a plaintiff must have legal title or a proprietary interest in the claim. The court determined that Free Holdings failed to allege a proprietary interest in the NFT sold at the auction because Free Holdings had only alleged a proprietary interest in the NFT on the Namecoin blockchain – which was merely a record of ownership and not an interest in the image itself or in the NFT on the Ethereum blockchain. Indeed, Free Holdings conceded that it had no control over the “Quantum” image itself and that the NFT on Namecoin was a separate NFT from the one on the Ethereum blockchain.
The court also found that Free Holdings failed to allege an injury-in-fact because there was no evidence to support that Free Holdings was ever required to be made part of the sale and no evidence to support “lost profits,” since Free Holdings had never attempted to sell its Namecoin NFT. Because Free Holdings failed to meet its burden to show standing, the court granted the motion to dismiss for lack of subject matter jurisdiction.
However, while the court could have ended its analysis here, it chose to rule on the defendant’s motion to dismiss for failure to state a claim upon which relief can be granted. The court granted the motion on the ground that Free Holdings “ha[d] not pleaded any viable cause of action against the defendants…even if it were to establish standing.”
The court first noted that to establish an unjust enrichment claim, a plaintiff must allege (1) the other party was enriched, (2) at that party’s expense, and (3) that it is against equity and good conscious to permit the other party to retain what is sought to be recovered. Among other things, the court concluded that, “Free Holdings has demonstrated nothing more than an attempt to exploit open questions of ownership in the still-developing NFT field to lay claim to the profits of a legitimate artist and creator.”
The court then disposed of Free Holdings’ slander of title, commercial disparagement, false advertising, and federal and state unfair competition claims ruling that Free Holdings had not “plausibly allege[d] falsity, malice, and special damages.” Free Holdings had argued that the defendants’ statement during the auction that the Namecoin NFT had been “burned or removed” was false because Free Holdings now owned the original Name NFT. However, the court noted that the “Name” McCoy originally registered did “expire” in 2015 and that “defining the legal import of control of digital assets on the Namecoin blockchainis subject to differing opinions.” The court also noted that Free Holdings’ other claims of falsity were vague and inconsistent.
Therefore, the court entered judgement for the defendants. However, although the court found that mere registration was not the asset in the case – a victory for artists’ rights – NFT ownership rules still remain highly debated. Presumably, future opinions will further clarify the issue.