Defending claims against crypto exchanges in English law: the surprising benefit of turning up

It is a sad truth that cases of fraud in the "crypto space" have been rising year on year. According to Action Fraud, financial losses involving crypto reported in the period October 2021 to September 2022 rose by 32 per cent year-on-year to £226m.

Victims are faced with a daunting challenge in seeking recovery. With the fraudsters often being anonymous, victims must try to trace and recover their assets, while preventing them from being moved beyond their reach.

In recent years, the English courts have repeatedly shown themselves willing to extend the scope of traditional common law protections and remedies to this new asset class in an effort to assist victims. A recent trend of claimants obtaining interim proprietary injunctions against cryptocurrency exchanges, on a without notice basis, has prevented those exchanges from allowing cryptoassets to be transferred onwards.

Traditionally, those interim injunctions have gone unopposed – either because they are made without notice or, where there is a return date (a specific opportunity for the respondents to make their case against the injunction) the exchanges have chosen not to appear.

However, in the recent case of Piroozzadeh v Persons Unknown and Others [2023] the cryptocurrency exchange Binance, unusually, appeared and successfully applied to discharge an interim injunction. After years of claimants expanding the scope of the law on cryptoassets almost unopposed, the decision is a timely reminder that there are limits and that there is a risk in getting carried away in the pursuit of recovering lost assets: the claimant was forced to pay Binance's costs.

Alleged fraud

The claimant alleged that he was fraudulently induced to transfer a significant sum in Canadian dollars and the cryptocurrency Tether (worth US$870,818) to blockchain wallets. Realising the potential fraud, a forensic investigation traced the Tether to wallets in accounts registered with Binance and another cryptocurrency exchange, OKX.

The claimant issued proceedings in England against various defendants: the alleged fraudsters (persons unknown), the recipient account owners (again persons unknown), the banks operating the Canadian dollar accounts, and the two cryptocurrency exchanges Binance and OKX.

He also successfully applied, on a without-notice basis, for an interim proprietary injunction against each of the parties seeking to prevent the further dissipation of his assets. As against Binance, an interim order was granted that required it to “preserve the Claimant’s 470,904 Tether, or the traceable proceeds” which the claimant alleged it had received.

At the return date, Binance applied to set aside the injunction on a variety of grounds.

Constructive trust

One of Mr Piroozzadeh's primary arguments against Binance, and the reason for seeking the injunction against Binance specifically, was the allegation that Binance held the cryptoassets "on constructive trust".  A constructive trust is a legal construction which, in essence, recognises that the claimant has a "better" interest in the property than anyone else and should therefore be entitled to recover it.

Recent decisions in relation to the tracing of cryptoassets have held that stolen cryptoassets held in wallets operated by exchanges are potentially subject to constructive trusts.

However, in Piroozzadeh that argument was challenged. In particular, Binance argued that, because of the way it operates its platform, it was a "bona fide" purchaser of the transferred assets and therefore had no liability to the claimant. An innocent purchaser who takes the property without notice of the claim is recognised as having a "better" interest in the assets even than the victim of fraud, thus defeating the constructive trust (provided they have acted in good faith).

Specifically, Binance's practice upon receipt of a crypto deposit is to transfer the received assets into a "pool" with the assets of other account holders and then use those assets as its own. In exchange, users are then credited the amount of the value which they had deposited and which were swept into Binance's pool, with a right to withdraw on request.

High Court decision

The High Court accepted Binance's arguments and discharged the proprietary injunction against Binance. The court also ordered the claimant to pay Binance's costs on an indemnity basis in the sum of £90,000. In particular, the court held that the application against Binance should not have been without notice and there had been a failure to provide full and frank disclosure.

Without notice applications

The application against Binance should not have been without notice. Without notice applications are usually made where there is a risk that providing notice will give the served party the opportunity to dispose of the relevant assets or otherwise prejudice the application.

Mr Justice Trower determined that there was "no evidence that [Binance] would itself take any steps or permit any steps to be taken were it to be forewarned of the application''. The claimant should have made a distinction between the alleged fraudsters and Binance. This would not have prevented the claimant from seeking specific relief against Binance if necessary.

Full and frank disclosure

The court also held that there was a failure to provide full and frank disclosure. Where applications are made without notice, the respondent has no opportunity to appear and make arguments against the applicant. It is therefore a fundamental requirement that parties applying for without notice relief must provide full and frank disclosure of ''the crucial points for and against the application'', including anticipated defences which the respondent might wish to assert: the applicant cannot simply rely upon the judge to raise them. This duty is what Binance described as the quid pro quo for proceeding in the absence of a respondent, and with which the court agreed.

Bona fide purchaser

The High Court determined that the applicant's legal representatives had materially failed to comply with this duty by failing to raise the bona fide purchaser defence which the applicant was aware of as a possibility.

They had failed to make explicit reference to the "pooled assets" model, instead (it appears) implying that the assets were segregated and therefore still in Binance's control. That was not the case. Rather, Mr Justice Trower emphasised: "The evidence is overwhelming that they had long since been mixed and dissipated in the pooled addresses." The court ruled that the claimant was aware of this being raised as a possible defence, because Binance had raised it as a defence in separate but similar proceedings that the claimant had issued against Binance.

The applicant had also failed to address the question of whether damages would be an adequate remedy in lieu of the injunction (usually, a bar to the injunction being granted) or how Binance could actually comply with the order.

The court's discretion

Having determined that the application had not been presented fairly, the judge declined to exercise his discretion in favour of continuing the injunction. This was because:

1. The failure to distinguish between Binance and the other defendants was an important and significant distinction, and that claimants should take care to ensure that the court is fully apprised of any such distinction between each defendant. 
2. The court needed to encourage compliance with the duty of full and frank disclosure. This obligation is particularly acute in the context of cryptocurrency exchanges, which in recent years have found themselves on the receiving end of numerous injunctions and other applications for various forms of relief. The court stated that it was particularly important that ''the nature of the claims against them and whether there is a substantive claim or merely a claim seeking Norwich Pharmacal or Bankers Trust relief is properly differentiated.'' The claimant in this case had appeared to lose sight of that important distinction. 
3. Moreover, the judge had determined that the claimant's legal representative had actively taken the decision not to disclose the bona fide purchaser defence (although it was not suggested that this decision was dishonest). 
4. The court also held that there was no risk of injustice to the claimant in circumstances where it had not been explained why damages would be an inadequate remedy.

Osborne Clarke comment

The decision stresses the importance of presenting a case fairly and complying with disclosure duties, while victims of crypto fraud face a hurdle in challenging the "bona fide" exchange that pools assets and defeats a tracing claim.

Binance's approach in this regard may offer some relief to digital asset exchanges; indeed, the same approach has also deployed in another case: Scenna v Persons Unknown [2023]. However, using a "pooled assets" model could be risky. Under the "pooled" model (rather than the "deposit" model, where cryptoassets are kept segregated in individual wallets), the pool of cryptoassets is owned by the exchange. In the event of the exchanges insolvency, and as a matter of English law, the pool would therefore be an asset of the exchange, and its contents would need to be paid out to all creditors, not only the customers who deposited them. It is unlikely that regulators – whose primary focus is usually on the protection of consumers – would look favourably on such a model.

As crypto regulation evolves, exchanges may need to adapt to new requirements.