Show Me Crypto: England’s High Court Issues New Information Orders Against Crypto Exchanges | Shearman & Sterling LLP

The High Court has once again grappled with new issues arising from crypto-asset disputes, this time in the context of an interim request for information orders.[1]

The Plaintiff (“LMN”), a company incorporated in England and Wales and a cryptocurrency exchange operator, allegedly lost millions of dollars in cryptocurrency during a hacker attack.

After conducting a comprehensive monitoring exercise, LMN discovered that some funds moved into or through wallets owned and operated by the accused cryptocurrency exchanges. The consequences of this were twofold:

  • Such addresses generally housed the accumulated assets of numerous customers. Assets were only attributed to clients “off-chain” (that is, in private internal databases). As such, once an asset arrived at an exchange address, it could not be further traced without additional information from the relevant exchange.
  • Each of the defendant exchanges was deemed to conduct regulatory due diligence on its clients, so that they know the identity of the persons controlling the accounts receiving the relevant assets.

After more than two years of little success in prosecuting the alleged perpetrators with the help of UK crime agencies, LMN applied to the Commercial Court against the defendant exchanges seeking orders for information with the aim of initiating proceedings to recover the alleged embezzled crypto assets. LMN also sought permission to serve the motion on defendants outside the jurisdiction.

An English court can issue an order requiring third parties to disclose certain information as part of its so-called Norwich Pharmacal and Bankers Trust jurisdiction. Norwich Pharmacal warrants require disclosure from a third party who is alleged to be innocently “involved” in the wrongdoing and has information that would allow the prosecutor to identify the perpetrator. Bankers Trust the orders require the disclosure of information from third parties (including otherwise confidential customer information) that may enable the plaintiff to determine the whereabouts of its embezzled assets and/or prevent the disposition of such assets.

The case again highlights the English court’s willingness to apply English procedural mechanisms (in this case, in relation to service and pre-action information gathering) to new situations arising from cryptocurrency fraud. Specifically, it suggests that the decentralized, cross-border nature of cryptocurrencies and their misuse may justify “exceptional” use Bankers Trust and/or Norwich Pharmacal jurisdiction to obtain information about embezzled cryptocurrency from foreign defendants to assist in the recovery of such assets. It also demonstrates the utility of the newly introduced information gateway in English Court Practice Direction 6B to overcome jurisdictional issues that have historically been an obstacle to seeking information orders against parties in other jurisdictions and/or unknown persons, both of which are common features of cryptocurrency disputes.

Service Out

English courts have jurisdiction over parties who have been properly served, so claimants must therefore generally seek the court’s permission before serving claims on non-UK parties (colloquially known as “service”). In considering LMN’s request for such leave in this case, the Court noted that LMN had to show that (a) there is a well-argued case on the merits, (b) the claim falls within one of the “jurisdictional gates” under Instruction 6B 3.1 and (c) England and Wales was the appropriate forum for the claim.

A well-argued case

There was a good argument that the relevant assets, at the time of the hack, were
“located” in England and Wales, where LMN was resident and where it did business. This was despite the fact that the servers on which the assets were technically located were located in Romania – something the court described as nothing more than a “coincidental circumstance”.

There was therefore a good evidentiary case that the alleged damage arose within the jurisdiction, either because the property was taken in England or because LMN, as an English company, suffered loss and damage within England. In applying the Rome II Regulation, the Court therefore proceeded on the basis that English law applied to the dispute.

Therefore, considering each of the relevant requirements for Banker’s Trust assistance, the Court found, among other things, the following:

  • There were good reasons for concluding that the property belonged to LMN;
  • There was a real prospect that the information sought would lead to the location or preservation of such property; and
  • The interests of LMN in obtaining information were not outweighed by the possible harm to the defendants in acting on the warrant.

In particular with regard to the first of these requirements, there was a good argument that:

  • Cryptocurrencies are a form of ownership, relying on the attitude adopted in AA vs. unknown persons[2] and Legal Statement of the Task Force on UK Jurisdiction.
  • When cryptocurrency was acquired fraudulently, equity imposed a constructive trust on the property. This was the case in relation to other forms of intangible property even though they were neither things in possession nor things in action.[3]
  • While there was an argument that every transfer of cryptocurrency on the blockchain created new assets in the hands of the acquirer, this did not prevent cryptocurrencies from being subject to tracking (on the basis that there was a relevant exchange).

The court further held that, since there was no doubt, the defendants were “involved” in the alleged fraud (although they were not suspected of wrongdoing themselves) and, having satisfied the conditions for Bankers Trust relief, there was also a well-argued case which Norwich Pharmacal relief should also be granted.

Relevant gateway

The court held that the claim “clearly” falls within the new framework (25), which applies to requests for disclosure of information concerning the true identity of the defendant and/or what has become of the relevant property.

The applicant, introduced this year, only applies when information is sought for the purposes of English proceedings which can be served in the jurisdiction or which the claimant could serve outside the jurisdiction. In this regard, however, the Court accepted that there was a good arguable case that any subsequent claim against the hacker would fall within gateways (11) (relating to claims relating to property within the jurisdiction) and/or (15) (relating to lawsuits related to constructive trusts).

Correct forum

The court concluded that England and Wales did appear to be the proper forum for the action, citing a number of relevant factors, namely: LMN was an English company, there were good reasons to believe that the location of the property was in England, the relevant documents were in England, and the law England and Wales at least was arguably governed by LMN’s proprietary claim.

Information orders

The Court noted that there was an argument that orders to inform foreign parties constituted a violation of the sovereignty of the relevant foreign jurisdiction, and should therefore only be issued in exceptional circumstances. However, the Court questioned the strength of this argument when the actual location of the relevant documents was unknown and (to the extent they were electronic) largely irrelevant. The lawsuit was all about fraud and a search for property, so it was “exceptional” in any case.

As the defendants did not submit any other material objections to the order Bankers Trust relief, and given that there was a good claim for such relief (in the context of servicing), the Court was convinced that the plaintiff had a good claim for Bankers Trust relief and granted warrants for the information requested by the plaintiff.

Comment

LMN vs. Bitflyer indicates that English courts may generally take a favorable view of plaintiffs seeking the return of misappropriated crypto assets, including the issuance of information orders.

It also suggests that courts are taking an increasingly consistent approach to certain issues arising from such assets. It reaffirms, for example, that cryptocurrencies are a form of ownership.

Court powers to grant service outside jurisdiction, including to unknown persons, and orders requiring disclosure of confidential information to third parties before action is taken are particularly important tools in the crypto context, given the ability of infringers to “off-chain” transfer assets via exchanges. The confidential nature of the assets in question also means that such exchanges may be the only way available to claimants to identify those who have committed fraud. For these reasons, we can probably expect more use of this powerful drug in similar cases in the future.

It is important to note that when determining the location of crypto assets, the Court considered that the residence of the owner of these assets is much more important than the location of the servers on which they are technically represented. This is consistent with other recent English case law on cryptoassets and may be significant in setting the trend for determining lex situs certain assets in future cases.

The court left open a number of questions, including:

  • Was LMN correct that cryptocurrency exchanges held assets in their own name (rather than on trust for their clients) and simply had a personal obligation to repay the relevant amounts to each client (in a manner analogous to bank deposits). This is an issue that has much wider implications for practitioners in other contexts, such as insolvency, but the court did not address whether LMN’s view was correct.
  • The basis on which it held that the defendants were “involved” in the fraud, for the purpose Norwich Pharmacal relief (ie whether this is due to their role as an exchange, operator of the relevant wallets or both). This may have implications for the circumstances in which Norwich Pharmacal and Bankers Trust relief may be available in relation to other entities operating in the cryptocurrency market in the future.

Finally, information orders have historically faced challenges when parties needed to seek permission for extrajurisdictional service. However, the decision demonstrates the effectiveness of the new information gateway, which was introduced in October 2022, and should make it easier for purported applicants to secure orders against non-UK parties and parties unknown, as is often required in cryptocurrency cases.

Notes

[View source.]

Leave a Comment

Your email address will not be published. Required fields are marked *