Partners Kate Gee and Elliott Phillips and Outer Temple barrister Helen Pugh consider the future of crypto litigation and its rapid development.
This article follows an insightful panel discussion at the Gibraltar Digital and Crypto Funds Conference.
Kate, Elliott, and Helen’s article was published in Thomson Reuters Regulatory Intelligence, 9 October 2023, and can be found here.
Over the last five years since the first crypto cases were before the courts in England and Wales, developments in crypto litigation have moved very quickly. The courts have grappled with new technology and sought to find ways to bring a new class of assets into the existing legal framework. The innovative ways of applying existing laws and the speed at which concepts have been addressed by the courts reflects the receptiveness of the judiciary to modernising this area of the law and establishing England and Wales as a pre-eminent jurisdiction to deal with disputes involving digital assets.
Further, the courts have been proactive in adapting procedural tools (such as service by NFT) and making orders that allow for the nuances of digital assets. But the legal system has also actively launched consultations, commissioned and contributed to reports, and been at the forefront of legal thinking in this space since 2018, when Mr Justice Birss concluded in the decision in Vorotyntseva v Money-4 Ltd that there was nothing to suggest “that cryptocurrency cannot be a form of property or that a party amenable to the court’s jurisdiction cannot be enjoined from dealing in or disposing of it”. In the five years since, courts have repeatedly held that digital assets can be considered – on one basis or another – a form of property under English law.
How does this interact with regulation of the sector?
In circumstances where regulation of the crypto sector has been slow to develop, the court’s approach has offered some clarity for both businesses and consumers, and provided the crypto sector with some confidence in the event that the courts are required to deal with a dispute involving digital assets: ultimately, the courts have held to date that disputes involving crypto or digital assets can, in the main, be approached in the same way as disputes involving more traditional types of property. But the court’s forward-thinking approach has also brought another development: the Law Commission’s report on Digital Assets (published in June of this year) concluded that very few legislative changes are required – rather than a legislative overhaul – to build out the English legal framework relating to the treatment of digital assets.
Notwithstanding these developments, most participants in the crypto sector are in favour of some regulatory and legal constraints to tackle the problem of fraud and money laundering and the difficulty of tracing ‘black market’ transactions. It would be extremely problematic, not just to those in the industry but also consumers, if the c.US$1trillion held in cryptocurrencies were not subject to the same or similar protections as mainstream assets, and instead had to rely on common law developments to establish the relevant parameters in which companies can safely operate.
What does the future of litigation in the crypto sector look like?
The court’s treatment of cases involving crypto to date indicates that the courts of England and Wales are well equipped to hear claims involving this sector. We are seeing more cases involving cryptocurrencies or other digital assets, and also a rise in cases that – perhaps incidentally – involve one or more companies in the crypto sector. We can expect this to continue. In addition, we anticipate seeing a rise in certain types of crypto disputes.
- Disputes arising out of new regulation and regulatory compliance. As new regulations are introduced globally, companies will be required to stay abreast of new requirements and to swiftly implement comprehensive compliance and reporting measures to meet new standards. The UK FCA’s new financial promotion rules for cryptoassets are an early example of this development. In a sector that has been largely unregulated to date, and which is dominated by new and fast-growing companies operating across international borders, regulatory changes are likely to be a catalyst for disputes. With future regulation, we anticipate that – in due course – the risk of the type of poor corporate governance which contributed to FTX’s implosion will be less – but there are likely to be some issues unmasked before regulation is properly embedded, and which will go before the courts.
- Claims arising out of the actions of an unknown bad actor. One concern for investors and exchanges alike is the damage that can be done by bad actors, who are unidentifiable and who cannot be located, for example hacking an account and misappropriating crypto assets worth significant sums. Where those bad actors are “persons unknown” from whom claimants are unlikely to make a full recovery, claimants are looking to draw big players in the crypto sector – with deep pockets – into disputes as a source of information (at best) or a source of liability and funds (at worst).
- One example of this is the case of Jones v Persons Unknown, in which the court entered summary judgment for the claimant who had alleged that Huobi, a Seychelles-based crypto exchange, was the controller of the wallet into which the Bitcoin in question had been paid, no-one had a proprietary interest that would override the claimant’s beneficial interest, and so Huobi held the Bitcoin on constructive trust for the claimant. The Court made an order against the wrongdoers and also, for delivery up of the Bitcoin, against the exchange. However, exchanges can look to a more recent decision – Piroozzadeh v Persons Unknown – for encouragement. There, faced with similar facts, the Court expressed doubt that receipt of funds obtained as a result of an earlier wrongdoing – without more involvement of the exchange – would be insufficient to render the exchange a constructive trustee. The issue will be considered further in the trial of D’Aloia v Persons Unknown likely to take place in 2024.
- Claims arising out of the crypto winter. As the crypto sector emerges from the crypto winter, we anticipate a rise of claims generated by the market volatility of recent years. These may be linked to the insolvency or bankruptcy of crypto companies, or to the poor performance of companies in the sector. We expect to see an increase in disputes relating to investments, corporate transactions and joint ventures, perhaps where an investor or investment fund seeks to rely on a contractual right to exit a poorly performing investment, or disputes related to the valuation of collateral, which may be held in the form of crypto assets. As is common with new financial innovation, we expect there to be claims against bad actors exploiting that innovation, such as by way of ‘rug pulls’, where developers promote crypto asset projects and disappear with investors’ money without delivering the project.
- Claims involving DAOS. There is so far no English court decision considering a claim brought by or against a DAO. The English court will no doubt navigate the challenges of such a claim in the same way it has approached claims involving crypto to date. However, it will be interesting to see whether the Court will treat a DAO as a single unit such as an unincorporated association or – for example – as akin to an unlimited partnership, or whether a member would be able to bring a derivative action on behalf of the DAO. There will be important questions to ask concerning jurisdiction and the applicability of English law, in the specific circumstances in question.
What can companies do to protect themselves?
There are inevitably risks for companies operating within a rapidly developing sector, and for investors in the same space. Companies need to be sure they take a fresh look at standard contractual terms to ensure that they adequately address the specific challenges that may arise in relation to crypto assets and in the industry, more widely, and to ensure those terms are up-to-date with evolving regulation. Ensuring that those terms are tailored to avoid crypto disputes or, at a minimum, to simplify their future resolution is one important step to protect against later challenges. Companies must take care that their contracts expressly identify the applicable law and the dispute resolution method. Without an express disputes clause, the decentralised nature of crypto assets may complicate the question of which is the appropriate forum for the claim.
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28 November 2023
28 November 2023