Crypto Exchange Found To Hold Stolen Assets On Trust For Crypto Crime Victim | Cooley LLP

In the Jones vs Unknown Persons and others[1] the High Court has issued several rulings of interest in the developing area of ​​crypto fraud litigation.

After granting judgment in plaintiff’s favor on charges of deception and unjust enrichment of scammers, the court ruled that a cryptocurrency exchange that controlled the wallet holding plaintiff’s stolen Bitcoin was a constructive trustee. The court ordered the scammers and the exchange to hand over the Bitcoin to the plaintiff.

The decision that an exchange is a constructive fiduciary under these circumstances remains controversial and will likely be tested in future contested litigation where stolen funds were deposited and then withdrawn from an innocent exchange. Disputed cases can also explore the question of whether and under what circumstances stolen cryptocurrencies can be traced through intermediate accounts, particularly when they have been mixed with other assets that are not part of the fraud.

Background

The appellant, Mr. Jones, was the victim of a large-scale crypto fraud. Fraudsters created a fake online cryptocurrency trading company called Extick Pro (“EP”) by promising high returns to clients. Mr. Jones opened an EP account in 2019 and, over the course of a year, transferred 89.61616088 Bitcoins to the EP platform (valued at around £1.5 million at the date of the ruling).

Mr. Jones did not manage the account himself, but instead gave trading instructions to a so-called EP representative. The platform reported to Mr. Jones that large trading profits were accumulating in his account. In fact, the scammers running the EP platform had stolen the Bitcoin. After several largely unsuccessful attempts to withdraw his funds, Mr. Jones engaged attorneys and investigators to recover his assets. Investigators traced the stolen Bitcoin to a wallet on trading platform Huobi but were unable to identify the people who carried out the fraud.

Mr. Jones has initiated proceedings for the recovery and compensation of the stolen Bitcoin, on the basis of deception and/or unjust enrichment against the scammers. Mr. Jones has also filed complaints against Huobi as a constructive trustee of Bitcoin.

Early on, Mr. Jones obtained worldwide freeze orders against the scammers, as well as Huobi, trying to protect the funds left in the scammers’ wallet. The scammers and Huobi did not engage in litigation and it emerged that despite the injunctions, the amount of Bitcoin held in the wallet was decreasing.

Mr. Jones filed in court for:

  • summary judgment against the scammers for fraud and unjust enrichment, on the grounds that they had no reasonable grounds to defend the claim;
  • a delivery order (i.e. return) of the stolen Bitcoin traced back to the wallet on the Huobi platform;
  • continuation of the patrimonial and non-patrimonial precautionary injunctions already obtained;
  • permission to serve orders out of jurisdiction; And
  • authorization for service by alternative means against fraudsters and Huobi, in particular through non-fungible tokens (“NFTs”) in the Huobi-controlled fraudsters’ wallet.

The judgment of the High Court

Mr. Nigel Cooke KC issued summary judgment in favor of Mr. Jones, establishing that:

  1. Fraudsters were responsible for deception and unjust enrichment

Noting that no rebuttal evidence was presented by either defendant, the judge found that Mr. Jones’s evidence was compelling and sufficient to establish the fraud and unjust enrichment charges against the scammers.

  1. Huobi held the misappropriated funds on a constructive trust for Mr. Jones

The High Court has previously considered whether a cryptocurrency exchange could hold crypto assets on constructive trust in cases such as D’Aloia against Unknown and others[2] (as previously reported here). However, in these cases the issue arose in the context of applications for notification of out-of-jurisdiction proceedings and only required decisions establishing that a claimant had “questionable good cause”, rather than definitive decisions on the point.

As such, this is the first instance where a ruling has been issued that an exchange holds stolen crypto assets on a constructive trust. The judge made this decision on the grounds that Huobi was the controller of the wallet Mr. Jones’ Bitcoin was deposited into and there was no evidence that Huobi or any other party had any proprietary interest in the Bitcoin that would override the interest of Mr. Jones.

  1. The scammers and the exchange must return the stolen Bitcoin to Mr. Jones
  1. The freezing and property injunctions should be extended after the sentence to help enforce the sentence
  1. Mr. Jones may serve orders out of jurisdiction

The judge held that Mr. Jones was able to satisfy various avenues of access allowing the service of orders outside the jurisdiction on the basis that (among other things) he had suffered losses in England and, in respect of Huobi as constructive trustee, the claim arose from events that took place in England.

  1. Mr. Jones could serve orders via NFT

Following the motivation in D’Aloia, the judge held that there were exceptional circumstances which allowed for an alternative service by NFT, namely that the identity and whereabouts of the scammers were unknown. Thus, no traditional means of notification was found to be effective, and notification by NFT was more likely to bring the proceedings and orders to the attention of fraudsters.

As for Huobi, the judge found that the NFT service was appropriate as it was important that the order got to his attention as quickly as possible because Bitcoin can be dissipated easily and quickly.

Comments

The imposition of a constructive trust on a cryptocurrency exchange holding misappropriated assets is significant as the first final ruling of its kind in England. However, Huobi did not contest the proceedings, possibly because the Bitcoin balance in the wallet available to satisfy a ruling apparently exceeded the value of the claim. In future disputed cases, the court will be required to consider in more detail how exchanges receive and process cryptocurrencies, and exchanges are likely to raise various defenses that have not yet been fully explored, such as that:

  • as a bona fide buyer by value and acting in good faith, the exchanges are not constructively fiduciary, as they were not part of the underlying fraud, nor were they informed of the fraud in an actual or constructive manner; And
  • exchanges cannot be held responsible for unjust enrichment as they have provided value for the services they have provided.

If these arguments were successful, a victim would still have the ability to recover misappropriated assets remaining in wallets held by an exchange (or would be able to enforce a judgment for damages against those assets), but would be unable to recover from the exchange. same the value of assets that were initially deposited in wallets controlled by the exchange but were subsequently withdrawn (unless the victim proves wrongdoing of some kind by the exchange). This outcome is analogous to, for example, the position of other third parties who innocently received misappropriated funds.


[1] [2022] EWHC 2543 (comm)

[2] [2022] EWHC 1723 (Ch)

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