The advantages of real-world tokenization, such as enhanced liquidity, increased transparency, and reduced transaction costs, are particularly compelling for owners of both movable and immovable income-generating assets, who are increasingly interested in tokenizing their rights over such assets. The tokenization process encompasses converting all or part of their management, administration, or economic rights (especially the right to collect income generated by such assets) into digital tokens generated through blockchain technology. The use of blockchain not only secures the record of transfers but also significantly improves the tradability and accessibility of the rights over the assets (represented through the 'digital tokens').
While the traditional and most common method of tokenizing real-world assets involves tokenizing securities, units, or other instruments of a juristic entity—such as trusts, funds, companies, or LLPs—that own these assets, this practice has increasingly come under the scrutiny of global regulators for purported violations of securities exchange and control laws. Some of the proactive regulators around the world have deepened their oversight and formulated laws specifically governing these practices. However, these newly promulgated regulations often lag in adopting and accommodating the underlying technology and the real purpose of tokenization through blockchain.
In India, in response to the growing popularity of web-based Fractional Ownership Platforms, the Securities Exchange Board of India recognized the need for regulation and introduced the Securities and Exchange Board of India (Real Estate Investment Trusts) (Amendment) Regulations, 2024 ("Amendment Regulations"). These Amendment Regulations were designed to accommodate Micro, Small, and Medium Real Estate Investment Trusts ("SM REITs") within the existing framework of the Securities and Exchange Board of India (Real Estate Investment Trusts) Regulations, 2014. While the Amendment Regulations established a new asset class for small-scale REIT structures, they fell short of integrating the transformative potential of blockchain technology, a tool that could significantly enhance transparency and trading efficiency. Furthermore, the continued requirement for trading on designated stock exchanges, which are encumbered with various limitations, highlights a significant gap between regulatory intent and the technological advancements that could further benefit the sector.
Needless to say, the Amendment Regulations focus exclusively on the fractionalized ownership of real estate. The realm of tokenization and fractionalization of other asset types, however, still remains mired in a legal grey area. There is a distinct lack of clarity regarding the legal framework necessary to govern the tokenization of these other assets, leaving stakeholders without definitive guidance on how to legally structure such transactions.
Within all this fiasco, this article aims to present a fresh perspective on how an effective tokenization framework could be developed by reimagining tokenization through a different perspective.
What are 'Digital Tokens' and 'Real World Tokenization'?
A 'digital token' can be described as a piece of software with a unique asset reference, properties, and/or legal rights attached. As such, 'Real World Asset' ("RWA") Tokenisation is the process of converting rights pertaining to physical assets that exist in the real world into digital tokens on a blockchain ("RWA Tokens"). These RWA Tokens, also referred to as 'Asset-backed Digital Tokens', represent a share or fraction of the management/economic rights in the underlying asset and can be technically bought or sold on a blockchain platform.
Asset-backed digital tokens – Digital assets that represent value owing to a link between the digital asset and some "real world" tangible or intangible asset, such as goods or digital products (or rights therein), receivables (i.e., rights to payment) and other claims. The link is established by the rules of the system in which the data constituting or representing the digital asset is stored or processed. The linked asset may be referred to as a "tokenized" asset by reference to the creation of a digital "token" to which it is linked; thus, the process of issuing such tokens is referred to as the "tokenization" of assets and the tokens issued are referred to as "asset-backed".1
RWA Tokenisation is undertaken as it offers some cogent benefits such as:
- Reduced Transaction Costs: Transfer of management/economic rights in real-world assets typically involves intermediaries like banks, brokers, and lawyers, leading to high fees. Blockchain eliminates or reduces the need for intermediaries, significantly lowering transaction costs.
- Transparency: Every transaction on the blockchain is recorded on a public ledger, ensuring that all stakeholders can verify and audit transactions independently where the RWA Tokenization process and the related transactions happen on-chain.
- Simplified Fractional Ownership of Rights: Any real-world assets (like yachts, cruise ships, private jets, real estate, etc.) can be tokenized and divided into smaller units, allowing multiple people to invest in fractions of the asset and democratizing access to them.
- Instantaneous Transactions: In traditional systems, rights transfers within an asset can take days. With blockchain, this can be reduced to minutes or even seconds.
- Immutable: Blockchain's decentralized nature and cryptographic hashing make it secure against malicious attacks. Once a transaction is added, it becomes immutable, ensuring that no single entity can alter past transactions.
As such, RWA Tokenisation allows for fractional ownership, increased liquidity, clear traceability, and auditability.
The RWA Tokens themselves, on the other hand, actually represent a contractual position, i.e., the rights of a party under a 'Smart Contract' ("Smart Contract"). While the International Organization for Standardization ("ISO") defines a 'Smart Contract' as a "computer program stored in a DLT system wherein the outcome of any execution of the program is recorded on the distributed ledger"2; legal doctrine, as well as legislation in some jurisdictions, employ the term – or the variant "smart legal contract" – to refer specifically to a computer program that embodies or performs a contract.3 Therefore, essentially, the rights of the RWA Token holder are defined in such a 'Smart Contract', and that contract creates binding obligations for its issuer. The Markets in Crypto-Assets Regulation (MiCA) also provides clarity by distinguishing RWA Tokens from other types of crypto-assets, emphasizing their role in providing a digital extension of traditional property rights rather than creating new financial instruments.4
Given that the RWA Tokens are nothing but a mere digital representation of rights, we advocate a paradigm shift in the approach to RWA Tokenization. Instead of tokenizing portions of the assets or the shares, debentures, and units of entities holding these assets, a more nuanced approach can be employed. One may instead tokenize 'contractual rights' over an asset. These rights would enable RWA Token holders to engage in the management and economic benefits of an asset without holding its actual ownership. Such digital tokens would then represent specific management and economic rights over the assets, managed by an impartial third party such as a trustee/custodian (appointed for and operating on the instructions of the RWA Token holders).
For, e.g., let's say a 'Special Purpose Vehicle' ("Asset Co. SPV") is the owner of a real-world income-generating asset, e.g., a 'Cruise Ship'; a 'Commercial Building' or a 'Private Jet' ("Asset(s)") and the shareholders/sponsors ("Sponsors") of the Asset Co. SPV, which own the Asset, are looking to 'discount' this rental income for an upfront lump sum payout. Therefore, they instruct the Asset Co. SPV to 'Tokenize' such Asset Co. SPV's 'right to collect a rental yield' from the said Asset ("Economic Rights"), as well as confer the right to participate in the management of the Asset to a Decentralised Autonomous Organization ("DAO") which effectively allows participation by the token holders in the day-to-day affairs of such property ("Management Rights"). Such Economic Rights and Management Rights, through precise legal structuring and the involvement of an impartial third-party custodian and trustee, can be tokenized and divided into a million fractional units, each represented by an RWA Token.
While achieving this may seem daunting and legally complex, in the following section, we will delve into how the digital representation of rights could be interpreted within the current Indian legal framework.
How can RWA Tokens confer and represent binding contractual rights over the Economic Rights and/or Management Rights in the Asset?
In order to address this, it is first pertinent to assess (in our example above) what the Asset Co. SPV is essentially tokenizing and what the RWA Tokens actually represent. The Asset Co. SPV has certain rights over the Assets, which include inter alia the Economic Rights as well as the Management Rights.
The Economic Right over the revenue that an Asset generates or may generate in the future is an 'actionable claim' of the Asset Co. SPV in terms of the provisions of the Transfer of Property Act, 1882 ("TP Act"). The TP Act is a central legislation setting out the provisions relating to the transfer of property by an act of parties (i.e., inter-vivos transfers).
Section 3 and Paragraph 6 of the TP Act defines an "actionable claim" as follows:
"actionable claim" means a claim to any debt, other than a debt secured by mortgage of immoveable property or by hypothecation or pledge of moveable property, or to any beneficial interest in moveable property not in the possession, either actual or constructive, of the claimant, which the Civil Courts recognise as affording grounds for relief, whether such debt or beneficial interest be existent, accruing, conditional or contingent.
In English Law an 'actionable claim' is known as a 'chose in action', which includes a wide variety of rights in contract or in property that can only be claimed or enforced by action and not by taking physical or constructive possession. It is also some type of beneficial interest in a movable property that may not be exercised by taking physical possession of such property but can be claimed and enforced otherwise than by physical possession.
Based on a perusal of the definition of an 'actionable claim' it may be noted that a claim recognized by the courts as affording grounds for relief can exist either:
- Over an unsecured debt; or
- As a beneficial interest in a 'moveable property'5 not in possession (either actual or constructive) of the claimant.
Although 'debt' in ordinary parlance means money advanced to a person that is to be paid back by such person to the lender on a future date; however, in terms of the wide definition of an 'actionable claim' as well as judicial precedents on the subject matter, the term 'debt' is said to mean any monetary obligations that are not secured by any property (whether moveable or immoveable) but certainly exist, accruing or would arise on the happening of a certain contingent event/condition.
On the other hand, the beneficial interest of a claimant in a moveable property refers to the right of an individual to possess a movable property but not having possession of such moveable property, thus, the existence of an 'actionable claim'. The essentials to constitute an actionable claim in respect of movable property in terms of Section 130 of the TP Act is that the claimant has a right to claim the possession of such moveable property but is, for the time being, not in such possession.
Chapter VIII of the TP Act regulates the transfer of 'actionable claims'. Sections 130 and 131 of the TP Act permit the transfer of an 'actionable claim' subject to the following conditions and requirements:
- The transfer must be effectuated through a written instrument signed by the transferor; and
- A notice of the transfer must be given to the debtor.
On the valid transfer of the 'actionable claims', the transferee obtains all the transferor's rights, and claims in the 'actionable claims' as well as the authority to bring actions to enforce such rights and claims. The transfer essentially operates as an assignment of rights of the transferor in the debt or beneficial interest. Upon the assignment, the transferee steps into the shoes of the transferor and can enforce all such rights against the debtor without the need to obtain the consent of the transferor.
The High Court of Allahabad in the case of Mewa Lal and Ors. vs. Tara Rani6 while differentiating a transfer of 'actionable claim' from the sale of a property under the TP Act held that the transfer of an 'actionable claim' is not to be registered.
Indian courts have broadly recognized a range of rights and claims as 'actionable claims', affirming their transferability under the legal framework. 'Copyrights', 'benefits under purchase contracts', 'claims for the return of earnest money', and the 'right to a refund of sale consideration' have all been treated as transferable 'actionable claims'. This extends to other claims such as 'salary due', 'arrears of rent', 'lottery tickets', 'future book debts', 'claims to receive business proceeds', and 'future rent'. Each of these emphasizes that such rights, whether present or future, are regarded as 'unsecured debt' or 'beneficial interests in movable property', falling within the ambit of transferable property under the TP Act.
Furthermore, we know that the Assets will be generating rental income in the future. The question of whether an assignment of 'future rent receivables' from a party can be assigned as 'actionable claims' under the TP Act was answered in affirmative by the Supreme Court of India in the landmark case of Infrastructure Leasing and Financial Services Ltd. v HDFC Bank Ltd and Anr. (Civil Appeal No. 4708 of 2022)7.
Building on the established legal precedents interpreting the term 'actionable claims', it is logical to assume that RWA Tokens, which essentially represent rights to claim revenues to be generated from an Asset (i.e., Economic Rights) as well as to take all management decisions with respect to such Asset (i.e., Management Rights), would also constitute 'actionable claims'. As such, their transferability and enforceability under the TP Act should be similarly supported and recognized.
Based on the analysis above, it is pertinent to take note of the following points of consideration:
- The Asset Co. SPV may assign the Economic Rights as well as the Management Rights that are nothing but 'actionable claims' in order to receive consideration in lieu thereof from the RWA Token Holders;
- The Asset Co. SPV may tokenize these 'actionable claims' to represent them as cryptographic immutable RWA Tokens that represent nothing but a 'property' of the Asset Co. SPV (an intangible moveable property);
- A standard immutable and tamper-proof Smart Contract (codified electronic contract) may be coded that would entail the terms of assignment of 'actionable claims', i.e., the Economic Rights as well as the Management Rights in the Asset of the Asset Co. SPV. Such a Smart Contract (in the tone and tenor of a conventional assignment deed) may be embedded into the RWA Tokens and would have all the essential ingredients of a contract. Such a Smart Contract would entail the terms and conditions of the assignment of the 'actionable claims'. Any transfer of the RWA Tokens would happen solely in terms of the Smart Contract. No transfer without the implementation of the Smart Contract would be possible on the blockchain;
- Furthermore, the Smart Contracts may be coded in such a manner that any transfer immediately notifies all the relevant parties who have any interest in the Assets, such as the tenants, licensees, custodians, trustees, escrow agents, etc. As such, the requirement of giving due notice as envisaged under Section 131 of the TP Act can also be duly fulfilled;
- The transferring of the RWA Tokens from the Asset Co. SPV to the RWA Token Holders would be construed as an assignment of 'actionable claims' that is permissible in law; and
- Once the RWA Token holders purchase the RWA Tokens, they are essentially assigned the 'actionable claims' which become their 'property', and such RWA Token Holders can further assign these 'actionable claims'/RWA Tokens to other purchasers (only on the terms of the Smart Contract).
With regards to the ownership of the Asset, the ownership/title may legally remain in the name of the Asset Co. SPV but effectively charged in favour of the RWA Token holders and custody of a third-party trusted custodian/trustee. Furthermore, a contractual mechanism can be established to facilitate changes in ownership or transfer of the Asset in order to enable the RWA Token holders to participate in the capital appreciation of the Asset as well. The arrangement would require binding the Asset Co. SPV to transfer/liquidate the Asset on the satisfaction of specific criteria and upon the consent of the RWA Token holders (exercised through the DAO).
While it has been observed above that the process of RWA Tokenization and transfer of RWA Tokens is essentially a transfer of 'actionable claim'/rights that is permitted under law, one must now assess whether such a transfer (through the transfer of RWA Tokens on the terms of the Smart Contract) is valid and in consonance with the provisions laid down under the TP Act primarily Section 130. The transfer of 'actionable claims' requires the execution of a written 'instrument'8 duly signed by the transferor. It may be noted that Section 130 does not require that any particular words be used or any particular form be adopted or that the terms of transfer must be discernible from a single instrument. Any document that captures the intent of the transferor to absolutely assign the 'actionable claims' to the transferee and is in consonance with the essentials of a valid contract under the Indian Contract Act, 1872 will be considered a valid document to confer the 'actionable claims' to the transferee. As such, the Smart Contract, if carefully executed, keeping the essential ingredients of a valid contract in mind, could be acceptable as a valid legal instrument for transferring 'actionable claims'. However, ensuring that each transfer is compliant with stamp duty obligations may present a challenge. Nonetheless, there are effective strategies that can be implemented to ensure compliance with such requirements.
Conclusion
In light of the above, it may be noted that the Smart Contracts (being embedded into the RWA Tokens that would regulate their transfer first from the Asset Co. SPV to the RWA Token Holders and then inter se between the RWA Token Holders) could be recognized by courts as valid written instruments pursuant to the provisions of Section 130 of the TP Act. Resultantly, the RWA Tokens Holders (assignees of the 'actionable claims') would have binding and enforceable rights in the subject matter of such 'actionable claims', i.e., the rights to collect future revenues arising from the Assets and the right to vote on the management and administration of the Assets.
As we conclude, it is evident that technology's potential to surprise and exceed expectations is profound. For us as legal professionals, there is a pressing need to look beyond traditional legalese and fully engage with how emerging technologies can reshape the practice of law. The ever-evolving landscape of technology, especially in areas like blockchain and AI calls for a proactive approach to exploring new legal avenues that not only opens new pathways for adaptation but also enhances our capacity to foresee and navigate the challenges and opportunities that lie ahead.
Footnotes
1 Taxonomy of legal issues related to the digital economy; Prepared by the secretariat of the United Nations Commission on International Trade Law, Vienna, 2023, Para. 84, Page 36.
2 ISO, Blockchain and Distributed Ledger Technologies — Overview of and Interactions between Smart Contracts in Blockchain and Distributed Ledger Technology Systems, ISO/TR 23455:2019
3 Taxonomy of legal issues related to the digital economy; Prepared by the secretariat of the United Nations Commission on International Trade Law, Vienna, 2023, Para. 32, Page 14.
4 Regulation (EU) 2023/1114 of the European Parliament and of the Council of 31 May 2023 on Markets in Crypto-Assets.
5 Section 3(36) of the General Clauses Act, 1897 defines a "movable property" to mean property of every description, except immovable property.
6 AIR 1973 All 165.
7 2023 SCC OnLine 1371.
8 Instrument is defined under Section 3 of the TP Act to mean a non-testamentary instrument.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
