Crypto Alert – Service of UK Court Orders of ‘NFT Airdrop’, and Can Crypto Exchanges Be Constructive Trustees? | K&L Gates LLP

D’Aloia -v- Person unknown and others¹ is the latest in a series of preliminary application judgments that demonstrate the flexibility and innovation of the English courts when it comes to digital asset disputes.

Facts

The actual matrix may sound familiar: the claimant was tricked into transferring stablecoins (USDT and USDC) to digital wallets of unknown persons – believing he was depositing them on a bona fide online trading platform. Months later, the stablecoins had disappeared and his account was empty.

The plaintiff engaged a blockchain intelligence expert to trace stablecoins into digital wallets held on a number of crypto exchanges. The Supreme Court proceedings mark the concrete start of the claimant’s journey to try to recover them.

Claims

The plaintiff relies on a number of causes of action in the case:

• Against the fraudsters (Unknown Persons): claims of fraudulent misrepresentation, fraud, unlawful means conspiracy, unjust enrichment and constructive trust; and
• Against the crypto exchanges: claim in constructive trust – on the basis that the claimant has title to crypto assets held in digital wallets controlled by the exchanges.

The case is at an early stage; this judgment concerned a no-notice application for temporary injunctions, disclosure and additional orders against unknown persons and a number of crypto exchanges – aimed at freezing the stolen assets in situ and identifying the owner(s) of the wallets holding those assets.

The main findings

The judge thought:

Serious problems to be tried

There are serious cases to be tried against: (i) the persons who are unknown, on the basis that they misused the claimant’s crypto-assets; and (ii) the crypto exchanges, since they control the wallets into which the stolen assets have been traced, and once notified of the court order, may be subject to the duties of a constructive trustee with respect to those assets.

Jurisdiction

The English court has jurisdiction on the basis that:

• According to the decision in Ion Science v Persons Unknown² there is a good argument that the lex situs of a crypto-asset is the domicile of the owner;
• The creditor is domiciled in England, and the stable coins which were misappropriated from him were thus located in England; and
• The damage occurred in England, when the assets were misused.

This was a no-notice application for interim relief, and it is therefore open to any of the defendants to attempt to argue that the English court has no jurisdiction. In fact, many of the decisions so far in this new and developing area have been made in hearings without notice or hearings where the respondents have not engaged, and so the principles may evolve further as we see cases argued.

Permission to serve outside the jurisdiction

All of the defendants appear to be located outside England and Wales. The relevant crypto exchanges are located in Panama, the Cayman Islands, the Seychelles and Thailand, and although the claimant does not know the whereabouts of the unknown persons, it is likely that they are also outside the jurisdiction.

The judge held that England is the most appropriate jurisdiction on the basis that the claimant is domiciled in England, the assets were located in England at the relevant time, and the claimant was defrauded in England.

There are a number of “entries” available under practice guideline 6B of the Civil Procedure Rules, which enable the English court to exercise jurisdiction over foreign defendants where the dispute has a sufficient connection with England, including:

• Gateway 9 (claim in tort), satisfied in this case because damage was caused by an act in the jurisdiction;
• Gateway 11 (property in the jurisdiction), applicable here because the relevant property (the encryption means) was within the jurisdiction at the time of the misuse; and
• Gateway 15 – (claims on trusts), available to unknown persons and crypto exchanges on the basis that the relevant acts and events within the jurisdiction are the acts and events which may give rise to a constructive trust, i.e. misappropriation of the assets by the claimant in England.

Prohibition exemption

Damages will not be an adequate remedy since without relief that restricts the disposition of cryptoassets, other remedies for the claimant may be worthless, and the balance of convenience is in favor of granting relief.

Mediation

The relevant property (stablecoins) belongs to the claimant. There is a real possibility that obtaining the information sought from the exchanges will lead to the preservation of these assets, by identifying the unknown persons. The relief sought by the claimant is appropriate and proportionate, and is not wider than necessary. Weighing the balance between the parties, the judge moved to grant disclosure since: (i) the claimant agreed to pay the reasonable costs incurred by the exchanges in providing the information; and (ii) notwithstanding fiduciary duties that may be imposed by the exchanges, there is a good arguable case and serious issues to be tried that the claimant has been defrauded.

Service by alternative means

Following the lead of a New York court (in the recent case of LCX AG vs. John Doe No. 1-25): The plaintiff could serve unknown persons by “airdropping” an NFT (which itself provides the details of the court’s order) into the digital wallet of the unknown persons to whom the claimant’s assets were first transferred. The judge commented that there could be no objection to service by the NFT, which embeds the court’s order in the blockchain, as it is likely to lead to a greater prospect of notifying the unknown persons, and it reduces difficulties otherwise encountered in trying to serve. persons unknown.

Comment

This is the first time a court in England has allowed the service of court documents using an NFT, by sending the NFT in the digital wallet to unknown persons. An exciting and useful development in itself, but not the only reason why this judgment is important.

Crypto exchanges will note that the court believed there is a good case to be made that, once they have notice of court orders in relation to assets held in wallets they control, they can become constructive trustees with respect to those assets, and potentially find themselves on the wrong end of breach of trust claims if they do not act quickly to prevent these assets from disappearing from the wallets they control.

The judgment follows the same decision-making process and thinking as the line of recent English court decisions on similar issues involving the tracking and freezing of crypto-assets, and seeks to identify the owners of digital wallets in which these assets reside.³ This decision is an encouraging sign for legal practitioners of the English courts’ flexibility to adapt, using existing tools for new applications and embracing new tools, to assist litigants seeking to track and combat crypto fraud.

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Declan and Martin have previously written an article in Corporate Disputes magazine entitled ‘Digital Assets: Novel Dispute Solutions for Novel Technologies’ which can be found here.

¹ [2022] EWHC 1723 (Ch).

² (not reported, 21 December 2020, commercial law)

³ (e.g AA v Persons Unknown [2019] EWHC 3556 (Comm); Ion Science v Persons Unknown (unreported, 21 December 2020, Commercial Court); Fetch.ai v People Unknown [2021] EWHC 2254 (Comm); Mr Dollar Bill v Persons Unknown [2021] EWHC 2718 (Ch); Lubin Betancourt Reyes v Persons Unknown & Ors [2021] EWHC 1938 (Comm) ; Danisz v Persons Unknown & Ors [2022] EWHC 280 (QB); Osbourne v. Persons Unknown and Ors [2022] EWHC 1021 (Comm)).