On Wednesday 23 November 2022, we were delighted to co-host a panel discussion with Outer Temple Chambers, on the future of cryptocurrency disputes. The discussion centred around two hypothetical case studies raising topical issues:
- The first case focused on a claimant's rights and remedies following the enforcement of her entire loan collateral by a cryptocurrency lender, when the market value of a fictional token plummeted following the FCA's investigation into the blockchain issuer of the token, causing her LTV to drop.
- The second case centred around a situation where a claimant's broker had invested his money in an exchange, operating out of Singapore, which subsequently became insolvent. It later transpired that the broker's email was hacked – leading to some of the funds being transferred to another wallet. The claimant wanted to know a) the causes of action that could be taken against the broker; b) if the stolen cryptocurrency could be retrieved, and c) what would happen to the remaining cryptocurrency as a result of the insolvency of the exchange.
Chaired by Mishcon de Reya’s Stephanie Melone, the panel consisted of Guy Wilkes and Henry Farris, both Partners in the Finance and Banking Disputes team, along with Andrew Spink KC and Helen Pugh, barristers at Outer Temple Chambers.
The speakers examined both case studies, the challenges and legal issues that may arise from them and shared insight into how cryptocurrency litigation and regulation may evolve in the coming years.
Please see below some of the key issues discussed in relation to these case studies.
- Although cryptocurrencies per se are not directly regulated in the UK, crypto investments frequently involve activities which are subject to financial services regulation, for example where crypto derivatives are traded or where advice is given about liquidating a regulated fund in order to invest in cryptocurrencies or where ancillary services are provided. All aspects of an investment scheme need to be considered in light of the regulatory framework.
- When considering appropriate causes of action, it is essential to identify the correct jurisdiction. Nearly every crypto case involves a jurisdiction issue, with parties and entities situated abroad. Jurisdictional gateways that permit claimants to serve defendants out of the jurisdiction are critical starting points to have in mind. Arbitration clauses in contracts involving cryptoassets may definitively determine jurisdiction in respect of corporate customers but a question mark remains in respect of UK-based consumers.
- For a conversion claim, there does not have to be a contractual relationship; the facts of the case can be analysed in order to ascertain the parties' rights and which rights have been breached. However, there must still be a proprietary right over the cryptoassets for a claim in conversion to succeed. One should consider whether the facts present a potential trust analysis, since trusts can give rise to proprietary rights and remedies.
- The Law Commission has recommended creating a third category of proprietary rights in relation to digital assets, since they are neither tangible nor intangible assets or property. This is likely to continue the trend towards recognising that purchasers of cryptocurrencies are entitled to the full range of proprietary remedies, particularly relevant in an insolvency event.
- Many crypto-lending platforms appear to work in similar ways to traditional banks and brokerages. However, the terms and conditions vary hugely, are updated continuously and are not necessarily what one would expect of a mainstream lender. When it comes to margin calls, consider whether the terms & conditions give the lending platform the right to disregard a collateral token for the purpose of LTV classification. It is one thing to account for a plunge in market value, but a total unilateral suspension without notice or regulatory justification may not be permitted under the contract.
- In mainstream financing, most currencies are relatively stable and it would be reasonable to expect a borrower to mitigate their loss by paying down their loan with other assets. Whether the same expectation would apply in the crypto sector, given the volatility in value of cryptoassets (as we have seen with FTX), remains to be seen.
- In determining the quantum of damages in a claim for breach of contract, the value of the asset at a particular point in time is important. Normal principles suggest that an English Court would value the loss of investment as at the date of the breach. However, the "Wilberforce" exception gives the Court the power to take a different point in time where justice requires. For example, the appropriate measure of loss may be the difference between the value of the assets at (i) the date of breach and (ii) the date of assessment (usually trial). This could be significant if the value increases over time, or indeed reduce the loss to zero if the assets' value falls. The nature of the breach must also be assessed as this will have an impact on the appropriate timing for valuation.
- The Law Commission has provisionally recommended in its Digital Assets Consultation Paper 2022 that the Court should have a discretion to make awards of unliquidated damages that arise out of a cryptoasset claim in the form of crypto-tokens. If parties are bringing a liquidated claim (for example a price to be paid under a contract, where the contract specifies 'payment' to be made in crypto) that may be more difficult because the Law Commission also considers that crypto is not 'money' and that may remain the position.
- The rights that may be owed to cryptoasset holders by third parties is one of considerable importance, and the Court of Appeal decision in Tulip Trading is eagerly awaited in the context of establishing fiduciary and common law duties that may be owed by open source software developers.