The Bill on the Federal Act on the Adaptation of Federal Law to Developments of the Distributed Ledgers Technology of 27 November 2019 (the “DLT Bill“) which was sent to parliament addresses among other issues the question of conflicts of laws related to rights recorded on a distributed ledger. Considering the ubiquity of the potential users of a distributed ledger and the difficulty to localize a distributed ledger, which does not present a strong nexus to any given place, this is an absolute necessity. This article aims to present the principles of the amendments to the PILA that are being proposed by the DLT Bill.

By Rashid Bahar (Reference: CapLaw-2020-04)

1) Overview: an evolution not a revolution

The DLT Bill is not a comprehensive piece of legislation. Quite to the contrary, it is a patchwork of amendments to no less than ten different federal acts including the Code of Obligations, the Debt Enforcement and Bankruptcy Act, various acts governing financial markets regulation and the Private International Law Act (“PILA“). Rather than taking creating a new sui generis asset, the DLT Bill aims at making adjustments to the existing legal framework to provide legal certainty for transactions based on the digital ledger technology, including blockchain-based assets.

The question of conflicts of laws is a case in point: the DLT Bill does not only address rights recorded on a digital ledger. Quite to the contrary, the amendments to the PILA that are being proposed in connection with the DLT Bill do not mention expressly the term of rights recorded on a digital ledger, crypto-currency or digital assets. Instead the amendments aim at integrating rights recorded on a digital ledger in the broader framework of negotiable instruments (Wertpapiere, papiers-valeurs), book-entry securities (Wertrechte, droits-valeurs) and other equivalent instruments (gleichwertige Titel, titres équivalents). The DLT Bill was, thus, also an opportunity to address systematically certain issues which were not addressed explicitly until now, such as the question of which law governs a negotiable instrument, which was until now only expressly determined in connection with titles to goods (Warenpapiere, titres représentatifs de marchandises).

2) General Principle: Law determined by the Instrument as the
Governing Law

The approach proposed by the Federal Council in connection with conflicts of laws is in line with the overall approach of the DLT Bill: it assumes that, from a conflict of laws perspective, rights recorded on a digital ledger are a special form of book-entry securities and amends the conflicts of laws rules to provide specific rules addressing the status of book-entry securities as a specific type of instruments that are neither proper negotiable instruments nor claims (Forderungen, créances). Doing so, the DLT fills a gap in the existing framework, which provided for a dedicated framework for book-entry securities only where they were held through an intermediary and booked to account, and, consequently, governed by article 108a PILA and the Hague Convention on the Law Applicable to Certain Rights in Respect of Securities held with an Intermediary of 5 July 2006 (Hague Securities Convention).

Under the proposed framework, right recorded on a distributed ledger receives together with rights incorporated in a negotiable instrument a dedicated set of conflict of laws rules which apply to the transfer and the creation of security interest over the underlying right. Pursuant to article 145a (1) of the draft PILA as amended by DLT Bill, the law determined by the instrument determines (i) whether the instrument represents a right and (ii) whether the right is transferred using the instrument; absent any such chosen law, the law of the seat or the place of common residence of the issuer governs these issues. This rule is not revolutionary, nor even new. This principle was, however, only codified expressly in connection with titles to goods (see article 106 (1) PILA), although it was generally recognized as a matter of Swiss international private law in connection with negotiable instruments more generally. Therefore, by introducing the new article 145a (1) PILA, the DLT Bill codifies a largely accepted principle of conflicts of laws and addresses not only negotiable instruments proper but extends the scope of this rule to book-entry rights and allows not only a paper instrument but any other instrument to determine the law applicable to the transfer of a right. The use of the term ‘other instrument’ term aims at including any text-based instrument. Therefore, not only written instruments stricto sensu, but also electronic instruments such as a digital ledger, an email or an annex to an email can determine which law shall apply to the question whether a right is incorporated in the instrument and to the question whether the instruments is necessary to transfer and exercise the rights it documents the transfer of the right to the use of the instrument. Therefore, this principle of conflicts of laws will apply not only in connection with rights on a digital ledger, but also in connection with book-entry securities, where the use of the books and records determines the transfer of the security. 

The same principles also apply to goods represented through an instrument. Indeed, article 106 (1) of the draft PILA as amended by the DLT Bill provides that article 145a (1) draft PILA determines whether the instrument represents goods. Consequently, the question whether an instrument represents goods will be determined by the law determined on the instrument, and absent such a choice, the law of the seat or common residence of the issuer. This approach offers legal certainty in terms of conflicts of law to the broad category of asset tokens that aim to incorporate a right in rem on moveable assets in a token. By contrast, this rule does not go so far as permitting the incorporation of rights to real estate on a digital ledger from a conflicts of laws perspective, as this question will continue to be governed by the law of the place of situation of the real estate as provided for by article 99 (1) PILA.

The metaphor of negotiable instruments does not carry through completely for book-entry rights, including book-entry securities and a rights recorded on a distributed ledger. Whereas a negotiable instrument is materialized in a physical instrument, typically a piece of paper, and can be transferred following the rules on transfer applicable to moveable goods and following the principle of the lex chartae sitae is subject to the law of the place where the physical instrument is located (article 145a (2) draft PILA as amended by the DLT Bill), a right recorded on a distributed ledger cannot be linked to a physical location. Therefore, the transfer of the underlying right recorded on the distributed ledger will continue to be governed by the law determined in the instrument or, absent such a choice of law, the law of the seat or common residence of the issuer, regardless of where the holder of the right is located. This approach has the benefit of being practicable and offering a high degree of legal certainty.

3) Exception: Security Interests 

With regard to security interests, the draft PILA as amended by the DLT Bill follows the same philosophy of applying the rules developped for negotiable instruments to book-entry securities and other equivalent instruments, which leads, however, to the application of different rules on conflicts of laws: article 105 (2) draft PILA amended by the DLT Bill extends the objective rule on conflicts of laws applicable to negotiable instruments and applies them absent a choice of law among the parties, to book-entry securities and other equivalent instruments (subject to the special rules applicable to securities held through an intermediary governed by the rules of conflict of laws determined by the Hague Securities Convention). The rule on conflict of laws, however, does not refer to the law determined by the negotiable instrument, the book-entry security or the equivalent instrument, but to the law of the place of common residence of the secured creditor.

This rule is consistent with the general principles of conflicts of laws applicable to negotiable instruments and the principles applicable to the creation of security interests in receivables. However, it is likely to lead as a practical matter to a high degree of uncertainty: unlike receivables, book-entry securities are likely to be transferred regularly and circulate among a number of persons. Moreover, unlike negotiable instruments, they are dematerialized, it is therefore difficult for third parties to identify or even suspect that a secured creditor may have taken a charge in a book-entry security. Yet, based on the rules on conflicts of laws that are proposed to be applied by article 105 (2) of the draft PILA, they may be unwittingly confronted with the laws of jurisdictions they did not consider as being potentially applicable. Indeed, how can a third party absent any means of publicity come to consider the law of place of residence of a secured creditor? Therefore, this approach is likely to yield a number of surprises in practice, in particular at a time where the principles governing rights on the digital ledger are far from being harmonized.

Against this backdrop, it would have been preferable, in my opinion, to rely on the general rule on the conveyance of rights or the rules applicable to the creation of security interests in so-called other rights which provide that the law applicable to the right itself governs the creation of security interests in such rights.

4) Cryptocurrencies

Whereas the DLT Bill offers a legal framework for conflicts of laws related to rights recorded on a digital ledger, it remains silent with regard to the use of crypto-currencies as instruments of payment. Consequently, the existing rules continue to apply. This leaves unanswered the question whether the use of crypto-currency should be treated as a form of barter, where a crypto-currency is exchanged for another good or a service, or rather as a form private tender, which can be used to pay a monetary debt. In the first instance, a choice of law and absent a choice of law, the law applicable at the place of common residence governs the issue (see article 116 et seq. PILA), whereas in the second instance the law applicable at the place where the debt has to be discharged determines whether a debt can be validly discharged using a given currency (article 145 (3) PILA).

This uncertainty may seem prima facie unsatisfactory, but it presents the advantage of leaving this issue to be solved by the courts one step at a time considering both the specific circumstances of the cases and the domestic and internationals evolution in this area: although, currently, crypto-currencies are not widely accepted as “true” currency and are consequently their use is likely to be treated as form of barter, this may change rapidly and in such a case the rules on conflicts of laws on money and means of payments will take over and apply seamlessly. In other terms, this approach may not offer legal certainty but promises flexibility and adaptability.

5) Conclusion

The amendments to the rules of conflicts of laws proposed by the DLT Bill may seem strikingly modest, especially when compared to the changes they make in substantive law. As mentioned above, they do not even mention rights recorded on a DLT or crypto-currencies explicitly, and apply by implicit inclusion only to rights recorded on a digital ledger without covering crypto-currencies, which do not have an identified issuer. However, this approach is sensible as due to their global reach digital rights using a digital ledger technology are likely to come into contact with a number of jurisdictions and are likely to be subject to be the object of suits in competing international fora. Against this backdrop, it is obvious that if Swiss law took a completely novel approach, it would inevitably clash with the laws of other jurisdictions that did not adapt their legal systems to the demands of the new technology. By taking a modest approach, the Swiss legal framework aims to fit these new asset classes in existing categories of conflicts of laws and thus ensure that the Swiss legal principles on conflicts of laws will remain compatible with those of foreign jurisdictions and ultimately maintain a certain harmony in this area as long as the rules on conflicts of laws cannot be harmonized at an international level through a treaty or another instrument.

Rashid Bahar (rashid.bahar@baerkarrer.ch)