Crypto Exchange Found to Hold Stolen Assets on Trust for Victim of Crypto Crime | Cooley LLP


In Jones vs. unknown persons and others[1] the Superior Court issued several rulings of interest in the area in development of crypto fraud litigation.

After rendering judgment in favor of the plaintiff on claims of deception and unjust enrichment against fraudsters, the court ruled that a crypto exchange that controlled the wallet containing the plaintiff’s stolen Bitcoin was a constructive trustee. The court ordered the scammers and the exchange to deliver Bitcoin to the plaintiff.

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remains controversial and will likely be tested in future litigation where stolen funds were deposited and then withdrawn from an innocent exchange.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

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The plaintiff, Mr. Jones, was the victim of a large-scale crypto fraud. The scammers set up a fake online cryptocurrency trading company called Extick Pro (‘EP’) that promised clients high returns. Mr. Jones opened an EP account in 2019 and, over the course of a year, transferred 89,61616088 Bitcoin to the EP platform (valued at approximately £1.5 million at trial date).

Mr. Jones did not operate the account himself, but gave trading instructions to a purported representative of EP. The platform informed Mr. Jones that large trading profits were accumulating on his account. In fact, the scammers operating the EP platform had stolen Bitcoin. After several largely unsuccessful attempts to remove the funds from him, Mr. Jones instructed lawyers and investigators to recover the assets from him. Investigators traced the stolen Bitcoin to a wallet on the Huobi trading platform, but were unable to identify the individuals who had carried out the fraud.

Mr. Jones commenced proceedings for recovery and redress in respect of the stolen Bitcoin, based on deception and/or unjust enrichment against the fraudsters. Mr. Jones also filed lawsuits against Huobi as a constructive trustee of Bitcoin.

Initially, Mr. Jones obtained worldwide freezing orders against the scammers, as well as against Huobi, seeking to secure any funds left in the scammers’ wallets. The scammers and Huobi did not become involved in the litigation and it appeared that, despite court orders, the amount of Bitcoin in the wallet was declining.

Mr. Jones petitioned the court for:

  • summary judgment against the fraudsters for fraud and unjust enrichment, for lacking reasonable grounds to defend the claim;
  • a delivery order (i.e. return) of the stolen Bitcoin traced to the wallet on the Huobi platform;
  • continuation of the provisional and non-proprietary precautionary measures already obtained;
  • permission to serve orders out of jurisdiction; Y
  • permission for the service by alternative means against the fraudsters and Huobi, namely by airdropping non-fungible tokens (‘NFT’) into the fraudsters’ Huobi-controlled wallet.

The judgment of the High Court

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

  1. Fraudsters were responsible for deception and unjust enrichment

Noting that neither defendant presented rebuttal evidence, the judge found Mr. Jones’ evidence to be compelling and sufficient to establish the claims of deceit and unjust enrichment against the fraudsters.

  1. Huobi retained the embezzled funds in constructive trust for Mr. Jones

The High Court has previously considered the question of whether a crypto exchange could hold crypto assets in constructive trust in cases such as D’Aloia v. unknown person and others[2] (as previously reported in here). However, in these cases the question arose in the context of requests for service of out-of-jurisdiction proceedings, and only required decisions that a claimant had a ‘good moot case’, rather than final decisions on the point.

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

  1. Scammers and exchange must return stolen Bitcoin to Mr. Jones
  1. Freezing and property injunctions should be issued after trial to assist in the enforcement of the judgment.
  1. Mr. Jones could deliver orders out of jurisdiction

The judge concluded that Mr Jones was able to comply with various requirements that allowed service of the out-of-jurisdiction orders on the basis that (among other things) he had suffered losses in England and, against Huobi as constructive trustee, the claim arose from Events in England.

  1. Mr Jones could serve the orders by NFT

Following the logic of D’Aloia, the judge found that there were exceptional circumstances that allowed alternative service by NFT, namely that the identity and location of the fraudsters were unknown. Therefore, traditional means of notification were not considered likely to be effective and NFT notification was more likely to draw fraudsters’ attention to procedures and orders.

Regarding Huobi, the judge found the NFT service appropriate as it was important that the order come to his attention as quickly as possible because Bitcoin can easily and quickly dissipate.

Comments

The imposition of a constructive trust on a cryptocurrency exchange holding embezzled assets is significant as the first final decision of its kind in England. However, Huobi did not contest the proceeding, perhaps because the Bitcoin wallet balance available to meet a lawsuit apparently exceeded the value of the claim. In future contested cases, the court will be required to consider in more detail how crypto assets are received and handled by exchanges, and exchanges will likely come up with various defenses that have yet to be fully explored, for example, that:

  • As bona fide purchasers of security, and acting in good faith, the exchanges are not implicit trustees, as they were not a party to the underlying fraud, nor were they put on actual or implicit notice of the fraud; Y
  • exchanges cannot be held liable in unfair enrichment as they have provided value for the services they have provided.

If these arguments were successful, the victim would still have avenues to recover embezzled assets remaining in wallets held by an exchange (or could enforce a judgment of damages against those assets), but would not be able to recover from the exchange itself. the value of assets that had initially been deposited in wallets controlled by the exchange, but were subsequently withdrawn (unless the victim establishes some sort of wrongdoing by the exchange). This result is analogous, for example, to the position of other third parties who have innocently received embezzled funds.


[1] [2022] EWHC 2543 (communication)

[2] [2022] EWHC 1723 (Ch)

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