Crypto

Crypto Exchange Holds Stolen Assets in Trust for Crypto Crime Victims | Cooley LLP

In Jones vs unknown persons and others[1] The High Court has delivered several interesting rulings in the evolving area of ​​crypto fraud litigation.

After ruling in favor of the plaintiff over allegations of fraud and unjust enrichment against scammers, the court further ruled that a crypto exchange controlling the wallet containing the plaintiff’s stolen bitcoins was a constructive trustee. The court ordered the scammers and the exchange to deliver the bitcoin to the plaintiff.

The determination that an exchange is a constructive trustee in these circumstances remains controversial and likely to be tested in future contested lawsuits where the stolen funds were deposited and then withdrawn from an innocent exchange. Disputes can also address whether and under what circumstances stolen crypto assets can be traced through suspense accounts, particularly if they have been mixed with other assets that are not part of the scam.

background

The plaintiff, Mr. Jones, was the victim of a large-scale crypto scam. The scammers set up a fake online crypto trading company called Extick Pro (“EP”) that promises high returns to clients. Mr Jones opened an EP account in 2019 and transferred 89.61616088 bitcoin to the EP platform over the course of a year (worth approximately £1.5 million at the date of the verdict).

Mr Jones did not hold the account himself, but gave trading instructions to a so-called representative of EP. The platform reported Mr. Jones that his account was accumulating large trading profits. In fact, the scammers running the EP platform had stolen the bitcoin. After several largely unsuccessful attempts to withdraw his money, Mr Jones directed lawyers and investigators to recover his assets. Investigators traced the stolen bitcoins to a wallet on trading platform Huobi, but were unable to identify the people who carried out the scam.

Mr. Jones initiated proceedings for the recovery and compensation of the stolen bitcoins based on fraud and/or unjust enrichment against the scammers. Mr. Jones also made claims against Huobi as the constructive trustee of Bitcoin.

In the beginning, Mr. Jones obtained worldwide freeze orders against the scammers as well as Huobi to secure the funds left in the scammers’ wallets. The scammers and Huobi did not participate in the litigation and it turned out that despite the restraining orders, the amount of Bitcoin in the wallet decreased.

Mr Jones claimed in court:

  • Summary judgment against the scammers for fraud and unjust enrichment as they had insufficient cause to defend themselves against the claim;
  • an order to deliver (ie, return) the stolen bitcoin back to the wallet on the Huobi platform;
  • Continuation of the temporary property and non-property injunctions already obtained;
  • permission to serve the orders outside of the jurisdiction; and
  • Permission to service in an alternative way against the scammers and Huobi, namely by airdropping non-fungible tokens (“NFT”) into the scammer’s Huobi-controlled wallet.

The judgment of the High Court

Mr Nigel Cooke KC entered summary judgment in favor of Mr Jones, ruling that:

  1. The scammers were liable for insidiousness and unjust enrichment

The judge found that no counter-evidence was presented by any of the defendants and found Mr. Jones’ evidence persuasive and sufficient to support the claims of fraud and unjust enrichment against the fraudsters.

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

The High Court has previously addressed the question of whether a crypto exchange would base crypto assets on constructive trust in cases such as D’Aloia vs unknown person and others[2] (as already reported here). In these cases, however, the issue arose in the context of requests for service of out-of-jurisdiction proceedings and required only decisions that a plaintiff had a “well-arguable case” rather than final decisions on that point.

As such, this is the first case where an exchange has been ruled to hold stolen crypto assets on a constructive trust. The judge made this decision on the basis that Huobi was the controller of the wallet into which Mr. Jones’ bitcoins were deposited and there was no evidence that Huobi or any other party had an ownership interest in the bitcoin that the interests by Mr Jones would override.

  1. The scammers and the exchange must return the stolen bitcoins to Mr. Jones
  1. The freeze and property orders should be extended after the judgment to support the enforcement of the judgment
  1. Mr. Jones could serve the orders outside of jurisdiction

The judge found that Mr Jones was able to satisfy various gateways allowing the orders to be served outside of jurisdiction on the basis that he had suffered losses in England (among others) and the claim against Huobi as a constructive one Trustees from this arose events in England.

  1. Mr. Jones could deliver the orders via NFT

After the justification in D’Aloiathe judge found that there were exceptional circumstances permitting alternative service by NFT, namely that the identity and whereabouts of the fraudsters were unknown. Therefore, no traditional means of service was deemed likely to be effective, and service by NFT would be more likely to alert fraudsters to the process and orders.

Regarding Huobi, the judge found that service by NFT was appropriate as it was important for the order to be known as soon as possible since bitcoin can be withdrawn easily and quickly.

Remarks

The imposition of constructive trust on a crypto exchange holding embezzled assets is significant as the first definitive decision of its kind in England. However, Huobi did not contest the proceedings, possibly because the bitcoin balance in the wallet available to satisfy a judgment appeared to exceed the value of the claim. In future contentious cases, the court will need to consider in more detail how exchanges receive and handle crypto assets, and exchanges are likely to raise various defenses that have not yet been fully investigated, such as:

  • As bona fide and bona fide buyers, exchanges are not constructive fiduciaries as they were not part of the underlying scam nor were actually or factually informed of the scam; and
  • Exchanges cannot be held liable for unjust enrichment as they have created value for the services they provide.

If these arguments were successful, a victim would still have options to recover misappropriated assets remaining in an exchange’s wallets (or be able to enforce a damages judgment against those assets), but would not be able to opt out of the exchange recover value of assets originally deposited in exchange-controlled wallets but later withdrawn (unless the victim discovers any sort of wrongdoing on the part of the exchange). This finding is analogous, for example, to the position of other third parties who innocently embezzled funds.


[1] [2022] EWHC 2543 (come)

[2] [2022] EWHC 1723 (Ch)

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