Tokenizing contracts. The case of Cabernet Sauvignon

Last time, we discussed in general which types of assets can be tokenized without complex legal schemes entailing intermediary bridges with special purpose legal entities.

We promised you a real case. Well, here we go with the first one. This time, we shall assess a case of tokenizing a contractual obligation.

To elevate the general mood, our illustration will relate to the appreciated alcoholic beverage made from grapes.

Photo by Evgeniy Alekseyev from Pexels

Let’s imagine a case of a winery that sells Cabernet Sauvignon from the year’s harvest to distributors. Our winery has interest to conclude deals in larger quantities to save on transaction costs.

The buyer is also interested in buying a large quantity to get more favourable terms. The parties agree to enter into the purchase contract where the buyer shall be obliged to collect the purchased wine as needed until the agreed date in the future. The buyer’s purchase of a large quantity comes with the risk that their retail sales could not go well, and that it may end up with excessive stock. It would be in the buyer’s interest to have mechanisms at disposal to mitigate that risk – to simplify getting rid of the obligation to collect and to recover the related potential financial losses.

In case retail sales turn out to be poor, the buyer could sell the amounts of unclaimed wine to third party wholesalers and assign to them the collection claims. Legally, this means the assignor (the buyer) will be burdened with striking assignment agreements with third parties. Furthermore, the assignor will have to provide the assignees (other wholesalers) with the relevant proof of the assigned claim. Moreover, it will have to inform the debtor (the winery) of each assignment.

The assignee (other wholesaler), on the other hand, risks that the assignor assigned the same claim multiple times to different assignees, and therefore risks not having its claim honoured due to a prioritized assignee. Also, the winery must trust the authenticity of the assignment notice and is exposed to the risk of honouring its obligation to an incorrect claimant which could in some circumstances result in an obligation to honour the same claim twice.

However, if the wine sold to the buyer is tokenized, and the buyer’s claims are embodied in tokens, matters can be simplified, and the above risks vastly removed. Subject to adequate arrangement, assignment of claims can be done simply by the buyer’s (assignor’s) transfer of the relevant amount of tokens to a third party wholesaler (assignee), of which the winery (debtor) is automatically informed. Moreover, neither party needs to deal with the trust issues outlined above as they can easily check the relevant circumstances that are immutably stored on the ledger.

Striking such deal with a tokenization arrangement can:

  • extend post-signing flexibility at neither party detriment (probably on the contrary);
  • decrease illiquidity risks;
  • optimize sales terms, since lessening the risks should be likely reflected in the transaction terms;
  • remove many key trust issues;
  • remove administrative costs and burdens;
  • significantly eradicating the risks of potential disputes since the performance history of the contract is clearly and immutably verifiable;
  • even lessen the negative externalities connected to business inefficiencies (e.g. reduce waste).

Obviously, there is a case to appeal to such tokenization opportunities, especially where complex and costly “legal bridges” are not necessary.

Lately, we are seeing a boom in art sector. Which do you think will be next? Perhaps our Cabernet Sauvignon.  

Anže Skodlar, Legal specialist

Timotej Kozar, Legal specialist

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