Developing Crypto Caselaw – Exchanges as constructive trustees of stolen crypto and service by NFT

• United Kingdom

• Financial services disputes and investigations

27-09-2022

D’Aloia v Binance Holdings & Others [2022] EWHC 1723 (Ch)

The High Court continues to ensure that the Courts of England and Wales remain at the forefront of the developing area of crypto related disputes.  In the case of D’Aloia v Persons Unknown & Others [2022] EWHC 1723 (Ch), Mr Justice Trower confirmed that: (1) there is a good arguable case that crypto exchanges will come under the duties of a constructive trustee; and (2) the claimant could serve court documents by air drop of a non-fungible token (“NFT”) into a crypto wallet.

Background

Between December 2021 and May 2022, the claimant opened an account with tda-finan.com and transferred 2.1 million USDT and 230,000 USDC from his wallets held with Coinbase and Crypto.com.  The tda-finan.com website sought to represent that it was connected with a legitimate US regulated business, TD Ameritrade.  However, the website and e-mail address used by the claimant to communicate with tda-finan.com was registered in Hong Kong and had nothing to do with TD Ameritrade.  In February 2022, the claimant’s account with tda-finan.com was blocked.  The claimant was induced into making further payments.  By May 2022, the claimant realised that he had been a victim of fraud and instructed an investigator, Mitmark, to trace the transactions.  Mitmark established that 2.175 million of USDT and USDC had been transferred from tda-finan to a number of private addresses and exchanges, operated by, or under the control of the crypto exchange defendants.

The claimant made an application for injunctive relief and, inter alia, alternative service.  The claim which the claimant sought to advance against the first defendant (i.e. persons unknown) was in fraudulent misrepresentation and deceit, unlawful means conspiracy, and unjust enrichment.  Mr Justice Trower accepted the claimant’s submissions and evidence and found that there was a serious issue to be tried.

Constructive Trust

The claimant also advanced a constructive trust claim against all defendants, such as to give rise to proprietary rights, on the basis that the crypto exchange defendants control or hold the exchanges into which the assets were traced.  Mr Justice Trower agreed, save in respect of the third defendant (Binance Markets Limited, which did not have sufficient control), that there was a good arguable case that the crypto assets were held on constructive trust by both the fraudster(s) and the crypto exchange defendants.  Injunctive relief was granted to the effect that the assets are frozen to prevent dissipation.

The Court confirmed its finding that the crypto assets were held on constructive trust by relying on gateway 15 (i.e. the constructive trust gateway) under Practice Direction 6B to grant permission to serve out of the jurisdiction.

Whether or not crypto assets are capable of being held on trust was addressed by the High Court for the first time in Zi Wang v Graham Darby [2021] EWHC 3054 (Comm) (see our earlier briefing).  The Court in Zi Wang gave the impression that it could, but determined on the “ultra-bespoke” facts of that case, namely that the crypto assets were subject to a sale and buyback agreement which precluded a trust from arising, no trust arose.

Alternative Service by NFT

Mr Justice Trower then moved on to the claimant’s application for service on the first defendant (as persons unknown) by an alternative method or at an alternative place.  The application was sought in relation to service by e-mail and NFT into the tda-finan.com wallets which the claimant first made his transfer.  The effect of service by NFT would drop the documents into the system and embed service in the blockchain, which would likely lead to a greater prospect of those behind tda-finan.com being put on notice of these proceedings.  The Court held that, in this particular case, it was appropriate for service to be effected by NFT and e-mail, and that there was good reason for service on the crypto exchange defendants to be by the alternative means.

Commentary

Whilst it is noted that the judgment in D’Aloia is only interim, and the issues arising may be substantively argued at a final hearing in due course, the High Court appears to be open to the idea that that claimants can have arguable constructive trust claims against both fraudsters who misappropriate crypto assets and the exchanges into which those misappropriated crypto assets are transferred.  This is a significant development, particularly where an exchange may have concerns around particular crypto asset transactions in a customer’s account or wallet.  If an exchange is determined to have “dishonest” knowledge regarding the crypto assets or transactions in question, it opens itself to potential liability if the crypto assets are subsequently paid away.  In turn, if the exchange freezes the crypto assets in question, it may open itself up to claims from its own customer.

Crypto exchange providers should consider whether they have adequate mechanisms in place to deal with scenarios where it may be deemed that they are on notice of misappropriated crypto assets held in wallets in which they have control over.  If necessary, crypto assets should be frozen in line with terms of service to allow any competing claims to the crypto assets to be resolved.