Does Your NFT or Play-to-Earn Project Need Terms of Service?

Yes. In fact, well-drafted Terms of Service are critical to a successful blockchain business. Terms of Service (also known as terms and conditions, T+C, or TOS) are essentially a contract between you and your users that set out the terms on which they are allowed to use your product, interact with your game, buy your NFTs, or otherwise participate in the community. Importantly, the Terms will contain dispute resolution provisions, including mandatory arbitration and class action waivers. Properly drafted waivers and disclaimers are a business’s strongest defense against so-called “disappointed investors” and overzealous plaintiffs’ lawyers.

As the blockchain industry is currently in a “bear market,” there are a lot “disappointed investors” looking for someone to blame for their losses. Where lots of people lose money, litigation soon follows. For example, high-profile cryptocurrencies have collapsed – LUNA’s value went to zero overnight and its sister “stablecoin” TERRA is trading near zero despite being touted as pegged 1:1 to the U.S. dollar. Voyager Digital filed for Chapter 11 bankruptcy protection in July 2022, tanking its native VGX token. Celsius froze transactions (including withdrawals) in June 2022 and followed up with its own Chapter 11 filing in July 2022. Days before the Celsius bankruptcy filing, a high-profile investor filed a lawsuit against the company (and its affiliates) accusing them of fraud and running a Ponzi scheme. The same law firm is also spearheading a class action lawsuit on behalf of Solana (cryptocurrency) holders against its founder and associated companies, claiming that Solana is in fact an unregistered security and its sale to the public violates Section 12 of the federal Securities Act.

Even though a failed project or business is not enough for a cause of action by itself, the bevy of lawsuits claiming “fraud” are certainly enough for developers to take notice. As any business owner, blockchain developers must weigh risk and potential economic exposure, especially when it comes to launching a product in the largely unregulated blockchain space. Luckily, with the help of an experienced and knowledgable attorney, developers can leverage well-established contract law and “clickwrap/browsewrap” concepts to ensure maximum control and protection.

How can I use an arbitration clause to my advantage?

A mandatory arbitration clause is not a magic shield – it does not eliminate liability for selling unregistered securities for example. It does not eliminate liability for fraud. However, it makes the dispute resolution process more predictable, more efficient, private, and even potentially less expensive than litigation. Arbitration is a dispute resolution process conducted by a third party neutral (or a panel of neutrals) who act as the fact-finders and decision-makers in a dispute, much like a court. Arbitration decisions are binding and enforceable the same as a court order – the Federal Arbitration Act ensures that an arbitration decision can be taken to a court and transformed into a judgment. However, there is no jury, the parties can engage neutrals with specialized knowledge, and cost and outcomes are generally more predicable and manageable.

Back in 1989, the United States Supreme Court confirmed that a contract can compel investors to arbitrate their Section 12 securities claims against the broker or seller. In Rodriguez v. Shearson, 490 U.S. 477 (1989), the Court determined that an arbitration clause was enforceable because federal law generally favored arbitration and an arbitration clause did not limit the rights of injured parties under the Securities Act. Rather, the arbitration clause was construed as a forum or venue selection clause and procedural, rather than a substantive limitation on an injured party’s rights.

Another significant advantage of arbitration is that it eliminates conflicting state laws or decisions. The Federal Arbitration Act preempts state laws and court decisions that disfavor arbitration. Further, the Terms of Service will have a choice of law provision, as well as a choice of forum where disputes are to be resolved. This allows developers to exercise more control over disputes over their services, as well as deprives “disappointed investors” of the opportunity to forum shop and abuse procedural tools to increase cost and pressure on the business.

Do class action waivers really work?

Class actions are another potentially devastating consequence of disappointed investors. Section 12 claims may be brought as class actions and there are many examples. However, provided a class action waiver does impair substantive rights, it will likely be enforceable in the securities context. Section 14 of the Securities Act states that “Any condition, stipulation, or provision binding any person acquiring any security to waive compliance with any provision of this title [15 USCS §§ 77a et seq.] or of the rules and regulations of the Commission shall be void.” In Rodriguez, the Supreme Court interpreted this provision to preclude substantive remedy waivers (such as damage caps), but to permit procedural provisions like arbitration clauses. Arguably, a class action waiver is a procedural mechanism and will be enforced the same as an arbitration clause.

In a more recent case, AT&T Mobility LLC v. Concepcion, 563 US 333 (2011), the Supreme Court confirmed that class action waivers as part of arbitration agreements were enforceable. The Court explained that parties are free to agree to procedures for their dispute resolution processes, including limiting with whom a dispute will be arbitrated. The Court reiterated the goals of efficiency and specialization that arbitration provides, concluding that arbitration promotes those goals, permits for individualized (rather than class basis) dispute resolution, and the Federal Arbitration Act favors such individualized dispute resolution, especially in a highly-technical field.

From a practical perspective, even if a court ultimately rejects arbitration and class action waivers, they raise the bar for a successful lawsuit and provide the developer with an opportunity to file a motion to dismiss. An early motion to dismiss may also dispose of some of the plaintiffs’ substantive arguments. In any case, increased procedural hurdles disincentivize overzealous plaintiffs’ lawyers, increase the opportunities for settlement, increase predictability, and reduce the chances of an outlier jury verdict.

Remember that well-drafted Terms of Service are not a shield for wrongdoers and will not prevent liability where it is warranted. However, they do offer some protection against “disappointed investor” lawsuits and give developers substantial control over disputes that may otherwise result in potentially devastating class actions and jury awards.

Contact Dan Artaev by email or call or text to set up your initial consultation.

Disclaimer: This guide is for general informational and promotional purposes only. Nothing herein constitutes legal, investment, or tax advice. Every situation is different and faces its own unique set of challenges. Do not take any action or sign any contract until you have obtained specific guidance from a qualified professional.

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