Show me the Cryptocurrency: English High Court Grants Novel Information Orders Against Crypto Exchanges | Shearman & Sterling LLP

The High Court has once again grappled with novel issues raised by disputes concerning cryptoassets, this time in the context of an interim application for information orders.^[1]

The claimant (“LMN”), a company incorporated in England and Wales and operator of a cryptocurrency exchange, allegedly lost millions of dollars’ worth of cryptocurrency during an attack by hackers.

After conducting a comprehensive tracing exercise, LMN discovered some funds had passed to or through wallets owned and operated by the defendant cryptocurrency exchanges. The consequence of this were twofold:

• Such addresses generally held pooled assets from numerous customers. Assets were only attributed to customers “off-chain” (that is, on private internal databases). As such, once assets reached an exchange address, they could not be traced further without additional information from the relevant exchange.
• Each of the defendant exchanges was understood to carry out regulatory due diligence on their customers, such that they knew the identity of the persons who controlled the accounts receiving the relevant assets.

Having had little success pursuing for over two years the alleged wrongdoers with the assistance of U.K. criminal agencies, LMN brought an application in the Commercial Court against the defendant exchanges seeking information orders with a view to commencing proceedings for recovery of the alleged misappropriated cryptoassets. LMN also sought permission to serve the application on the defendants outside of the jurisdiction.

The English Court may grant an order requiring third parties to disclose certain information under its so-called Norwich Pharmacal and Bankers Trust jurisdictions. Norwich Pharmacal orders require disclosure from a third party who is alleged to be innocently “mixed up” in wrongdoing and has information which would enable the claimant to identify the wrongdoer. Bankers Trust orders require disclosure from third parties of information (including otherwise confidential customer information) which may enable the claimant to establish the whereabouts of its misappropriated assets and/or prevent the disposal 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 novel situations thrown up by cryptocurrency fraud. In particular, it indicates that the decentralised, cross-border nature of cryptocurrencies and their misappropriation can justify the “exceptional” use of the Bankers Trust and/or Norwich Pharmacal jurisdictions to obtain information about misappropriated cryptocurrency from foreign defendants to aid the recovery of such assets. It also shows the utility of the newly introduced information gateway in the English Court’s Practice Direction 6B for overcoming the jurisdictional issues which had historically been a barrier to seeking information orders against parties in other jurisdictions and/or persons unknown, both of which are common features of cryptocurrency disputes.

Service Out

The English courts exercise jurisdiction over parties on whom proceedings are properly served, and claimants must therefore generally seek the Court’s permission before serving a claim on parties outside the U.K. (which is colloquially known as “service out”). Considering LMN’s application for such permission in this case, the Court noted that LMN had to show that (a) there was a good arguable case on the merits, (b) the claim fell within one of the “jurisdictional gateways” under Practice Direction 6B 3.1 and (c) England and Wales was the appropriate forum for the claim.

Good Arguable Case

There was a good arguable case that the relevant assets were, at the time of the hack,
“located” in England and Wales, being the place where LMN was resident and carried on business. That was so notwithstanding that the servers on which the assets were technically located were in Romania—something the court described as merely an “adventitious circumstance.”

There was therefore a good arguable case that the alleged damage occurred within the jurisdiction, either because it was in England that the assets were taken or because LMN, as an English company, suffered loss and damage within England. 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 relief, the Court found, amongst other things, that:

• There were good grounds for concluding that the assets belonged to LMN;
• There was a real prospect that the information sought would lead to the location or preservation of such assets; and
• The interests of LMN in obtaining the information were not outweighed by the possible detriment to the defendants in complying with the order.

As to the first of these requirements in particular, there was a good arguable case that:

• Cryptocurrencies are a form of property, relying on the position adopted in AA v. Persons Unknown^[2] and the Legal Statement of the U.K. Jurisdiction Task Force.
• When cryptocurrency was obtained by fraud, equity imposed a constructive trust on the assets. This had been 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 each transfer of cryptocurrency on the blockchain created a new asset in the hands of the acquirer, this did not prevent cryptocurrencies from being the subject of tracing (on the basis that there was a relevant substitution).

The Court further considered that as there was no doubt the defendants were “mixed up” in the alleged fraud (though not suspected of actual wrongdoing themselves) and, having satisfied the requirements for Bankers Trust relief, there was also a good arguable case that Norwich Pharmacal relief should also be granted.

Relevant Gateway

The Court held that the claim “clearly” fell within new gateway (25), which applies to claims for disclosure of information concerning the true identity of a defendant and/or what has become of relevant assets.

The gateway, introduced this year, only applies where the information is sought for the purposes of English proceedings which can be served in the jurisdiction or which the claimant would be able to serve out of the jurisdiction. In this regard, however, the Court accepted there was a good arguable case that any subsequent claim against the hackers would fall within gateways (11) (concerning claims about property within the jurisdiction) and/or (15) (concerning claims about constructive trusts).

Proper Forum

The Court concluded that England and Wales did appear to be the proper forum for the action, listing a number of relevant factors, namely: LMN is an English company, there were good grounds for considering the location of the assets to be in England, relevant documents were in England and the law of England and Wales at least arguably governed LMN’s proprietary claim.

Information Orders

The Court noted that there was an argument that information orders against foreign parties constituted an infringement of the sovereignty of the relevant foreign jurisdiction, and should therefore be granted only in exceptional circumstances. However, the Court questioned the strength of this argument where the actual location of the relevant documents was unknown and (to the extent they were electronic), largely irrelevant. The claim concerned fraud and the pursuit of assets, so it was “exceptional” in any case.

As the defendants raised no other substantive objections to the ordering of Bankers Trust relief, and given there was a good arguable claim for such relief (in the context of service out), the Court was satisfied that the Claimant had a good claim for Bankers Trust relief and granted the information orders sought by the Claimant.

Comment

LMN v. Bitflyer indicates that the English courts may generally take a sympathetic view of claimants seeking to recover misappropriated cryptoassets, including through the granting of information orders.

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

The Court’s powers to grant service out of the jurisdiction, including on persons unknown, and orders requiring pre-action disclosure of confidential information by third parties are particularly important tools in a crypto context, given the wrongdoer’s ability to go “off-chain” by transferring assets through an exchange. The confidential nature of the assets concerned also means that such exchanges may be one of the only means available to claimants of identifying those who carried out any fraud. For these reasons, we can probably expect to see greater use of this powerful remedy in similar cases in future.

It is noteworthy that when determining the location of cryptoassets, the Court considered the domicile of the assets’ owner to be far more significant than the location of the servers on which they were technically represented. This is consistent with other recent English cryptoasset caselaw and may be significant in establishing a trend for determining the lex situs of particular assets in future cases.

The Court left open a number of questions, including:

• Whether LMN was correct that cryptocurrency exchanges held assets in their own name (rather than on trust for their customers) and simply owed a personal obligation to repay relevant amounts to each customer (in a manner analogous to bank deposits). This is a question that has much broader implications for practitioners in other contexts, such as insolvency, but the court did not address whether LMN’s position was correct.
• The basis on which it considered the defendants to be “mixed up” in the fraud, for the purposes of Norwich Pharmacal relief (i.e., whether this was a consequence of their role as exchanges, as operators of the relevant wallets, or both). This may have implications for the circumstances in which Norwich Pharmacal and Bankers Trust relief may be available as against other entities operating in the cryptocurrency market in future.

Finally, information orders had historically faced challenges when parties needed to seek permission to serve out of the jurisdiction. However, the decision shows the efficacy of the new informational gateway, which was introduced in October 2022, and should make it easier for putative claimants to secure orders against parties outside the U.K. and parties unknown, as is often necessary in cryptocurrency cases.

Footnotes

[View source.]