From the Discord Server to the Courthouse: Lessons Learned From Early NFT Lawsuits

By: Moish E. Peltz, Esq. and Steven C. Berlowitz, Esq. with contributions from Michelle S. Kabel, Esq.

Introduction

A few years ago, as ‘smart contracts’ emerged, statements circulated along the lines of "smart contracts will remove the need for attorneys." Several recently filed lawsuits illustrate why lawyers will likely maintain gainful employment for the foreseeable future.

NFT projects are now maturing from informal projects (often founded by like-minded individuals connecting in NFT-related Discord servers) to legitimate businesses with global media aspirations. A corresponding rise in NFT litigation has accompanied the industry’s growth. Indeed, NFT projects have witnessed a precipitous rise in formal legal actions concerning issues ranging from intellectual property infringement to securities violations. These lawsuits demonstrate that even early-stage NFT projects should include a legal strategy as part of their initial “roadmap.”

NFT Background

Non-fungible tokens (NFTs) had a breakout year in 2021 and look set to take the world by storm in 2022. The technological functionality and cultural relevance of NFTs are beyond the scope of this article, and conversational background is assumed.

In 2021, NFT projects matured from informal ventures into successful global businesses and brands. The meteoric rise of NFTs, and their entrance onto the cultural stage, was one of the major news stories of 2021. These projects are commonly established by founders with complementary skills who will work to develop a prospective NFT launch. Nascent NFT projects usually have little to no starting capital, but promise large financial rewards if they can successfully tap into the ‘meme economy'.

Media companies and brands alike have taken notice of the success of the NFT marketplace. These same companies have either stepped into the NFT market or more actively sought to protect their ability to do so in the future. In a world that is becoming increasingly digital, NFTs represent luxury status symbols that are slowly replacing physical items and have the potential to have an ongoing positive impact on their bottom lines.

This modern-day wild west gold rush has led to frontier legal skirmishes, which are increasingly finding their way to the courthouse.

Legal Considerations in Starting an NFT Business

Prospective NFT businesses have difficult decisions to make about how to stretch a small startup budget. A recent lawsuit is an example of why it may be a good idea to allocate some of that budget to up-front legal costs, in order to prevent more costly headaches down the road.

The Low-Hanging Fruit

Top of mind for NFT founders should be consideration as to whether to form a legal entity, put in place an operating agreement amongst company founders, and create contracts with other project contributors.

A recent lawsuit concerning the Robotos NFT project evidences why early company formation may deserve additional attention. In August 2021, artist Pablo Stanley created the Robotos NFT collection which consists of 9,999 droid NFTs each with unique generative traits (such as metal outfits, tin faces, or even frog hats). The collection of 9,999 NFTs is governed by a “smart contract,” which in this case is software code deployed on the Ethereum blockchain that enables the purchase and sale of a Robotos NFT. While Stanley was the artist on the project, he brought in a contributor (Moynihan) to assist with the technical development of the project’s smart contract. The smart contract tracks the assignment of ownership of each Robotos NFT by managing their purchase, transfer, or sale. Robotos NFTs were ‘minted’ from the collection’s associated smart contract (generating revenues of approximately 500 Ether, or about $1.25 million at the time). Each purchaser of a Robotos NFT was granted a non-exclusive worldwide license to the Robotos NFT for personal and commercial use and purposes. See Robotos NFT Licensing Agreement. Following the project’s mint date, Robotos NFTs became quite prominent with several subsequent derivative projects and in November 2021, they announced a partnership with TIME Studios for an animated children’s show.

Despite this illustrious start, it appears there was significant turmoil behind the scenes, as now made public by court filings. As a result, on January 20, 2022, Pablo Stanley (in his individual capacity), filed a declaratory judgment action in the Eastern District of California against Moynihan seeking a declaration from the court that he exclusively owns the underlying copyright of all of the Robotos Works and derivatives, and a declaration that the Robotos NFT project is not a partnership (and specifically that a former contributor and developer of the project’s smart contract is not a partner). (Compl. ¶ 5).

Specifically, the first claim for relief seeks to establish that Pablo Stanley is the “sole author and copyright owner of the Robotos Works.” (Compl. ¶ 59.). It also seeks a declaration that Moynihan is not a “joint author” of the Robotos Works and has no copyright ownership interest in the Robotos Works. (Compl. ¶ 61). A joint work of authorship under copyright law is a “work prepared by two or more authors with the intention that their contributions be merged into inseparable or interdependent parts of a unitary whole.” 17 U.S.C. §101. To establish co-ownership of a copyright, an alleged co-author must show that they made an independently copyrightable contribution and qualified as an author of the joint work. Aalmuhammaed v. Lee, 202 F.3d 1227, 1231-32 (9th Cir. 2000).

The second claim for relief in the complaint seeks a declaration to establish whether the Robotos NFT project is in fact a “partnership” and whether or not Moynihan is a “partner” in the project. In the U.S., partnerships are governed by the law of the state in which the partnership was formed. Despite slight differences among the states, the general rule is that a partner relationship forms when two or more persons carry on as co-owners of a business for profit. This relationship may result from either an express or implied contract. Additionally, when there is no written partnership agreement, the courts may infer the existence of a partnership by considering several factors, generally including (1) intention of the parties, (2) sharing of profits and losses (3) joint administration and control of business operation, (4) capital investment by each partner, and (5) common ownership of property.

In support of his claim that Robotos NFT is not a partnership and that Moynihan is not a partner, Stanley asserts that the parties never agreed to form a partnership and Moynihan merely worked for him as an independent contractor to develop the code for the smart contract. Stanley alleges in the complaint that he retained complete managerial and operational control over the project and Moynihan completed tasks that were delegated to him by Stanley. However, the smart contract (as developed by Moynihan) had an explicit purpose of sharing the profits generated by the smart contract with Moynihan.

Nevertheless, through counsel, Moynihan responded to Stanley’s cease-and-desist letter and remained firm in his beliefs that he is a partner in the Robotos NFT project partnership, and as partner, he has equal ownership in any copyright or derivatives arising from the Robotos NFTs. As a result, Moynihan demanded payment of royalties “pursuant to their unambiguous agreement” (the unambiguous agreement in question: “I would be down to split everything three ways”).

Although this case is interesting as it is among the first publicly filed cases involving an internal dispute amongst NFT project contributors, it is illustrative of what could happen, and what could have potentially have been avoided, if the parties took the time to define the legal roles of each of the parties before large amounts of money were at stake. Based on the complaint, it appears that a properly drafted contract that defines copyright ownership, payments, responsibilities, etc. could have prevented a trip to the courthouse.

Some takeaways include:

• Define who is a ‘founder’ of an NFT project (and who is not)
• Consider whether the NFT project should be formed as a separate legal entity (LLC, Corporation, etc.)
• Consider the legal jurisdiction where the NFT project will be formed, and what laws will apply
• Consider having in place agreements with all owners or contributors to a project (for example, an operating agreement or shareholder agreement, employment agreement, independent contractor agreement, as appropriate). Document the rights and responsibilities of all contributors.
• Consider in advance how legal disputes will be resolved (such as negotiation, mediation, arbitration, or litigation), and the jurisdiction for resolving such legal disputes.

For Existing IP, Consider Related Agreements

As NFTs continue to increase in popularity and enter mainstream culture, global brands, such as Nike, Adidas, and Mcdonald's have begun to enter the NFT market with projects and/or collaborations of their own. And as institutional brands confront burgeoning NFT project marketplaces and communities, some friction is inevitable.

One example is when Quentin Tarantino, the writer and director of the film Pulp Fiction, planned to sell NFTs of the original hand-written manuscript of the Pulp Fiction screenplay (which was the predecessor of the final draft of the screenplay eventually delivered and licensed to the film’s producer, Miramax). On November 16, 2021, Miramax filed a complaint against Tarantino alleging that Tarantino’s NFT Pulp Fiction themed project constituted a breach of the license agreement Miramax has with Tarantino, as well as copyright and trademark infringement, and unfair competition. Miramax claims that Tarantino’s “’Reserved Rights’ under the operative agreement which licensed the screenplay to Miramax are far too narrow for [Tarantino] to unilaterally produce, market, and sell the Pulp Fiction NFTs.”

Miramax’s lawsuit against Tarantino, although involving NFTs, will likely turn on issues of contract interpretation. More importantly, Miramax’s lawsuit appears to constitute a play to protect its intellectual property, its stable of existing license agreements, and its future potential entry into the NFT market. Miramax does little to hide this, and in fact, makes it evident in its pleadings. Miramax alleges:

Tarantino’s conduct has forced Miramax to bring this lawsuit against a valued collaborator in order to enforce, preserve, and protect its contractual and intellectual property rights relating to one of Miramax’s most iconic and valuable film properties. Left unchecked, Tarantino’s conduct could mislead others into believing Miramax is involved in his venture. And it could also mislead others into believing they have the rights to pursue similar deals or offerings, when in fact Miramax holds the rights needed to develop, market, and sell NFTs relating to its deep film library.

Compl. ¶ 6 (emphasis added).

Another example is a dispute that commonly arises between business partners. NFT projects suffer the same kinds of business and contract disputes that any commercial business might face. For example, on June 18, 2021, Roc-A-Fella Records sued Damon Dash to prevent him from selling the copyright to Jay-Z’s album, Reasonable Doubt, as an NFT. Roc-A-Fella claims that, while Dash owns one-third of Roc-A-Fella, the company itself owns the album. Accordingly, Roc-A-Fella asserts that Dash has no right to sell the NFT he plans to auction.

Takeaways include:

• Conduct due diligence to determine whether there are any intellectual property concerns with an NFT launch, including who has the rights to create or use such intellectual property;
• For any existing IP, evaluate existing agreements to determine if you have the right to make NFTs from that IP, balancing contract entitlement with litigation risk;
• Consider seeking express consent if entitlement is unclear or such use would be unauthorized.

Infringement or Free Speech?

Other major brands have taken similar legal action to protect their contract and intellectual property rights in the face of disputes regarding NFTs. For example, on January 14, 2022, Hermès sued the artist Mason Rothschild over his NFT project “MetaBirkins,” which depicts fur-covered bags shaped like Hermès bags. Hermès’ complaint asserts claims for trademark infringement, trademark dilution, injury to business reputation and dilution, and misappropriation and unfair competition. As with the Miramax complaint, Hermès makes it clear that the lawsuit is, at least in part, about protecting its potential entry into the NFT market. Hèrmes alleges:

Unless enjoined by this Court, Defendant will continue to advertise and sell NFTs under the METABIRKINS brand, build a company offering a range of virtual products and services under the METABIRKINS brand, and ultimately preempt Hermès’ ability to offer products and services in virtual marketplaces that are uniquely associated with Hermès and meet Hermès’ quality standards.

Compl. ¶ 9 (emphasis added).

Rothschild responded to the trademark lawsuit from the MetaBirkins Twitter account, citing Andy Warhol's Campbell's soup cans as artwork protected by the First Amendment. See Rothschild's response.

Even brands outside of entertainment and fashion appear to be carefully monitoring the NFT space in order to police their intellectual property rights. Of particular note, Olive Garden’s parent company, Darden, recently took steps against a small group of self-described Olive Garden enthusiasts who created a collection of 880 Olive Garden inspired NFTs called “Non-Fungible Olive Gardens” (“NFOG”). Each token in the collection represents and pictures 1 of 880 real Olive Garden franchises. And therein lies the problem -- NFOG arguably misappropriated the Olive Garden trademark. NFOG draws heavily from the Olive Garden brand in other amusing ways. Members purportedly greet each other in their Discord server by typing “wyhyf” (when you’re here, you’re family), and exchange pictures of themselves enjoying meals at real-world Olive Garden locations. The project even offers free (digital) breadsticks which can be minted as NFTs!

Unsurprisingly, Darden did not appreciate the express appropriation of their trademark in the promotion of unauthorized goods. Darden successfully moved to take down NFOG from OpenSea, the world’s largest NFT marketplace.

Nor does NFOG appear to be a unique phenomenon. Another NFT collection, called “Waffle Frens” has created a strikingly similar project, albeit surrounding the decidedly different, but equally delicious, Waffle House franchise. Waffle Frens even recently tweeted at NFOG to discuss a potential collaboration – which they adorably and purposefully misspelled as “carbolaboration.”

Neither the NFOG, nor the Waffle Frens matter, have resulted in lawsuits. Darden could conceivably piece together a complaint for intellectual property infringement. However, Darden may have achieved its goal merely by successfully removing NFOG from OpenSea.

Additional Takeaways

Cases like Miramax v. Tarantino, Hermès v. Rothschild, and Roc-A-Fella v. Dash have the potential to shape the legal landscape of NFT litigation. While courts are new to NFTs, they will have to learn to grapple with them as they further penetrate mainstream culture and as intellectual property and business disputes surrounding NFT projects continue to arise.

Second, and as already mentioned, it is significant that these cases, and many others, will likely turn on well-known principles of contract and intellectual property law. The use of blockchain technology to verify and trade ownership of jpeg profile pictures is novel and relatively new for U.S. courts. However, the business relationships and contractual underpinnings upon which these NFT projects rest are familiar to courts and judges. For example, courts are well-positioned to rule on issues of trademark infringement in cases such as Hermès v. Rothschild, and are similarly well-versed in deciding declaratory judgment actions to decide ownership in Marquez v. Moynihan. While NFTs are relatively new, the bedrock structures regulating NFT projects are familiar to courts, and may therefore result in some quick guidance as the first few big cases are decided in the coming years.

Third, these cases are a tacit acknowledgment that large brands will soon be, and in fact already are, entering digital marketplaces. At the very least, they signal that brands are still looking to protect their intellectual property rights as they relate to NFTs. Indeed, these principles are encapsulated in the Miramax v. Tarantino and Hermès v. Rothschild actions. As NFTs continue to grow in popularity, it is likely that more and more brands will begin to aggressively police their intellectual property as it concerns the digital marketplace. We are just now seeing the beginning of that era.

DISCLAIMER: This summary is not legal advice and does not create any attorney-client relationship. This summary does not provide a definitive legal opinion for any factual situation. Before the firm can provide legal advice or opinion to any person or entity, the specific facts at issue must be reviewed by the firm. Before an attorney-client relationship is formed, the firm must have a signed engagement letter with a client setting forth the Firm’s scope and terms of representation. The information contained herein is based upon the law at the time of publication.