NFT fraud: English court recognizes NFTs as “property” and makes proprietary temporary remedies available to protect investors | Dechert LLP

In an important ruling,¹ The English Supreme Court has for the first time recognized that it is an arguable case that non-fungible tokens (NFTs) should be treated as property under English law. This means that the powerful proprietary remedies available to victims of cryptocurrency fraud are also available to NFT fraud victims.

The facts

In September 2021, the founder of Women in Blockchain Talks (the claimant) gifted NFTs representing digital artwork from Boss Beauties, a women-led NFT avatar collection that funds initiatives to create mentorship and scholarship opportunities for girls and women. By January 2022, the NFTs had been removed from her wallet by scammers without her consent. The NFTs were then tracked to two accounts controlled by unknown individuals (the first defendant) at a US-based peer-to-peer NFT marketplace called Ozone Networks Incorporated t / a Opensea (Open sea) (the other defendant).

The creditor applied without notice for: (i) a temporary proprietary injunction limiting the spread of the relevant NFTs; and (ii) a disclosure order known as a Bankers Trust Order, which requires Opensea to provide information to enable the creditor to track or identify those who controlled the wallets to which the NFTs had been transferred.

The decision

Recognizing that the NFTs could disappear quickly, the judge granted each of the orders requested by the creditor and gave the creditor permission to serve both defendants outside the jurisdiction by alternative means. In reaching this decision, the Court made the following main findings:

1. Just like cryptocurrencies, there is an argument that NFTs are “property” under English law (which is a prerequisite for providing proprietary relief over an asset).
2. The NFTs were held by the unknown persons in a “constructive trust” for the creditor. In summary, when property is obtained through fraud, a constructive trust is imposed on the fraudulent recipient so that they have legal ownership of the assets in trust of the victim. This finding is in line with an earlier view expressed by the English court that digital assets were capable of being held in trust.²
3. As in previous cases of fraud with cryptocurrency (such as Ion Science Ltd v Persons Unknownas we reported in March 2021 (available here)), NFTs shall be treated as located at the place where their owner is domiciled for the purpose of determining the applicable law for a dispute.
4. Damages will not be a sufficient means of compensating the creditor for the loss as: (i) the financial capacity of the unknown persons to meet a compensation assessment could obviously not be assessed; and (ii) NFTs have a “special, personal and unique value to the creditor that extends beyond their Fiat currency” [i.e. conventional cash] This second justification distinguishes NFTs from exchangeable cryptocurrencies and increases the likelihood that an English court will impose injunctions in relation to stolen NFTs in future cases.
5. The plaintiff was granted permission to operate the Bankers Trust Order at Opensea in the United States, which is consistent with the approach taken in Ion science to service disclosure orders on cryptocurrency exchanges abroad. In this case, the court was prepared to grant the order in circumstances where Opensea had no presence in the English jurisdiction, and the possibility of enforcing an order against it would be questionable. It is not clear whether the outcome could be different if a point was taken during a full hearing with regard to inability or impracticality in enforcing an English order in the relevant foreign jurisdiction.

Conclusions

Although this is a temporary sentence and the defendants were not represented during the hearing to argue their case, it is an important step towards NFTs being recognized as property and will provide comfort to victims of NFT fraud that effective proprietary remedies are available through English courts to assist in the recovery of NFTs. The availability of powerful remedies such as disclosure orders against crypto exchanges based outside the UK can be used to break through the anonymity offered to holders of crypto wallets and thus facilitate enforcement against those who receive the stolen assets – just as happened in the case of Ion science where an exchange was forced to disclose the account holder of the stolen Bitcoin, which ultimately resulted in enforcement against funds held in that account. This is especially important as the (already high) number of scams and frauds in the crypto markets continues to grow. Although the vast majority of crypto cases in English courts have so far been about misused cryptocurrencies, we expect an increase in cases of stolen NFTs as the market for NFTs continues to mature.

The English courts continue to take the lead in protecting investors in cryptocurrencies by demonstrating their willingness to apply existing legal principles to emerging crypto markets and act swiftly to provide remedies to victims of crypto fraud. The English courts are aware of the commercial reality of crypto fraud, in this case the judge noted that “if [injunction] is not granted, there is a very real risk that these assets will be transferred through several different accounts at high speed, and in a way that will make it practically either very difficult, or possibly even impossible, for the creditor to track and pick her up. assets”.

The authors are grateful to Jennifer Hutchings, Trainee Solicitor in London, for her valuable contribution to this OnPoint.

Footnotes

1. Lavinia Deborah Osbourne v (1) Unknown Persons and (2) Ozone Networks Inc acting as Opensea [2022] EWHC 1021 (Comm)
2. Wang against Darby [2021] EWHC 3054 (Comm)