High Court assists alleged victim of crypto-theft to seek recovery

In LMN v Bitflyer Holdings Inc and others [2022] EWHC 2954 (Comm), the High Court granted powerful ‘information orders’ under the court’s Norwich Pharmacal and Bankers Trust jurisdiction against cryptocurrency exchanges that are competitors to the claimant-applicant LMN. The court orders require these exchanges to provide LMN detailed customer information (including Know Your Client information), in aid of LMN’s efforts to recover $10.7 million worth of misappropriated cryptocurrency. 

Key Takeaways

The LMN judgment illustrates the English High Court’s willingness to exercise its broad powers to help victims of crypto-theft and fraud seek recovery of their assets. We expect judgments like this are a positive signal to market participants that England and Wales is a favourable jurisdiction for conducting business involving cryptoassets (or, for that matter, other novel financial technology). If cogent evidence of wrongdoing can be presented, and existing legal doctrines can be invoked, then the English courts are open to flexibly applying those doctrines to formulate pragmatic, fit-for-purpose remedies, notwithstanding the novelty of the subject technology involved.  The case also highlights that, as a matter of English law, cryptocurrencies are likely to be recognised as property, and accordingly subject to proprietary remedies (asset tracing, for example), that have been available to litigants before the English courts for centuries.  LMN therefore provides a useful roadmap for victims of crypto-fraud to engage the English court system to assist in recovering misappropriated assets.  As for crypto-exchanges generally, the decision tacitly suggests the types of information, records, and checks about customers that the courts may reasonably expect the exchanges to hold or carry-out, and be prepared to produce. 

Background

LMN is a cryptocurrency exchange that was hacked in 2020.  The hackers obtained access to LMN’s systems and allegedly extracted millions of dollars-worth of cryptocurrency denominated in Bitcoin, Ripple, Tether, Ethereum, ZCash and Ethereum Classic. 

LMN initially engaged various regulatory and law enforcement authorities to assist in tracking down the cryptocurrencies, ultimately to no avail.  LMN then decided to seek recourse from the High Court by initiating civil proceedings against a number of rival cryptocurrency exchanges thought by LMN to have control over ‘exchange addresses’, to which the hackers allegedly transferred the misappropriated cryptocurrencies.

LMN made three applications across two court hearings held in London in late October and early November 2022:

1. for permission to serve court documents (i.e. the Claim Form) on the defendants out of the jurisdiction, since they were all registered outside the United Kingdom;
2. for service by alternative means (i.e. by email and by posting a link to the relevant documents on the online contact form on one of the defendant’s websites); and
3. for so-called Bankers Trust relief, which would require the defendants to produce to LMN information regarding customer accounts within the defendants’ respective control or possession, subject to LMN providing undertakings as to damages, expenses, and restricting its collateral use of the information received from the defendants pursuant to the court order.

Service out

The court granted LMN’s application for service out of the jurisdiction. In doing so, the court adopted the test emanating from the Privy Council in Altimo Holdings and Investment Ltd v Kyrgyz Mobil Tel Ltd [2011] UKPC 7 at [71] per Lord Collins, which identified the following requirements:

1. that there be a “serious issue to be tried on the merits”;
2. that “there was a good arguable case that the claim fell within one of the ‘gateways’ in CPR PD 6B para. 3.1” (we recently considered CPR PD 6B here and here); and
3. that “England and Wales [was] the appropriate forum for the claim to be tried”.

On the merits, the court determined that LMN had a good arguable case as to its entitlement to the substantive information orders that it sought against the defendants. In summary, those orders required the defendants to produce detailed information about their respective customer accounts to the claimant in aid of the claimant’s attempt to trace and recover its misappropriated assets.  In reaching this conclusion, Mr Justice Butcher first articulated the common law basis for such information orders, which stems from the famous House of Lords decisions Norwich Pharmacal Co v Comrs of Customs and Excise [1974] AC 133, and Bankers Trust Co v Shapira [1980] 1 WLR 1274.

The basic principle underpinning Norwich Pharmacal is that where “a person gets mixed up in the tortious acts of other so as to facilitate their wrong-doing he may incur no personal liability but he comes under a duty to assist the person who has been wronged by giving him full information and disclosing the identity of the wrongdoers. […] justice requires that he should co-operate in righting the wrong if he unwittingly facilitated its perpetration.”  (As Mr Justice Butcher noted, the courts have since extended the application of this basic principle to cases involving contractual wrongdoing, and to cases where the identity of the wrongdoer is known, but “where the claimant requires disclosure of crucial information in order to be able to bring its claim or where the claimant requires a missing piece of the jigsaw”.)

Applying this principle, Mr Justice Butcher stated that “given that there seems no doubt that the Ds [Defendants] were ‘mixed up’ in the fraud (in the relevant sense, which does not involve any fraud or wrongdoing on their part) […] there was a good arguable case that relief should be granted under the Norwich Pharmacal jurisdiction”.

As for the cases descending from Bankers Trust, the court applied the five principles that emerged from those cases, and found that LMN satisfied each principle as follows:

1. The cryptocurrencies belonged to LMN: There was a “good arguable case that whoever holds the cryptocurrency or traceable substitutes thereof does so as a constructive trustee for [LMN]”.In this regard, the court reiterated what is now becoming a well-established position under English law, namely that “cryptocurrencies are a form of property”.The court also recognised that property obtained by fraud may be subject to a constructive trust in favour of the victim of the fraud and that, in the case of cryptocurrency, and despite the suggestion by one defendant that the transfer of Bitcoin on the Bitcoin blockchain “may create a new asset in the hands of the acquirer”, there was at least “a good arguable case that the [fraudulent] transfers can nevertheless be the subject of tracing”.
2. The requested information will lead to the misappropriated assets:Applying the second principle from Bankers Trust, the court determined that there was a real prospect “that the information sought will lead to the location or preservation of the misappropriated cryptocurrencies”.We expect that evidence was submitted by LMN in support of this contention; the judgment reveals that LMN engaged an expert to trace the cryptocurrency, and we expect that such evidence hinged on the expert’s findings.
3. The requested relief was appropriately scoped:In granting Bankers Trust relief, the court must be mindful not to overreach given the invasive nature of the relief.Where, as in this case, the claimant is seeking information from a competitor, the court will be all the more cautious and surgical in fashioning a remedy.Therefore, a claimant seeking an information order must be careful not to ask for more than it needs to accomplish the objective of gathering information about the whereabouts of its misappropriated assets.In LMN’s case, with the benefit of submissions from certain of the defendants, the court issued a court order that provided LMN with what it required vis-à-vis the location of its cryptocurrencies, but not more than was strictly necessary for that purpose.
4. The defendants’ interests were balanced against the claimant’s interests:In determining whether to grant an information order the court must balance the claimant’s interests in obtaining the order against the possible harm or detriment to the defendant-respondent in complying with the order.On this front, the court had no difficulty in finding a “clear benefit” to LMN in granting the requested order, and it was satisfied that “the potential detriment to Ds [defendants] could be eliminated or at least very effectively mitigated by C’s undertakings as to expenses and damages, the restriction on collateral use, and the provision in the order that Ds are not required to do anything which would contravene local law.”
5. Undertakings provided:LMN provided undertakings covering the defendants’ expenses and any potential damage suffered as a result of the order and an undertaking not to use the information obtained pursuant to the court order for collateral purposes, such as suing the defendants, without prior authorisation by the court. These undertakings satisfied this fifth and final principle under the authorities following Bankers Trust.

Regarding the existence of a ‘gateway’ for service out under the relevant Practice Direction 6B, the court held that “there clearly was” one, invoking the new ‘gateway’ under PD 6B paragraph 3.1(25), which applies precisely in cases such as that before the court. Namely, where a claimant is seeking an information order regarding “(i) the true identity of a defendant or a potential defendant; and/or (ii) what has become of the property of a claimant or applicant; and (b) the claim or application is made for the purpose of proceedings […] which […] are intended to be commenced either by service in England and Wales or CPR rule 6.32, 6.33 or 6.36 [these rules concerning service out of the jurisdiction]”.  LMN’s case fell within the first limb above (it was seeking the true identity of the hackers); and it submitted evidence of its intention to commence proceedings in England and Wales and serve out of the jurisdiction (hence the application).

The final consideration under the test for service out of the jurisdiction required the court to determine whether England and Wales was the proper place in which to bring the claim.  In ruling in LMN’s favour on this point, Mr Justice Butcher had regard for the following factors:

1. LMN being an English registered company;
2. there being good grounds for considering the cryptocurrencies to be located or deemed to be located in England (i.e. the “situs” was England);
3. relevant documents being in England (the court did not specify what these documents were); and
4. English law “at least arguably governs the proprietary claim”.

Having satisfied itself that (a) LMN had a serious case to be tried on the merits; (b) one of the procedural ‘gateways’ for service out existed; and (c) England and Wales was the appropriate forum for bringing the litigation, the court granted an order permitting service out on several of the defendant-respondent crypto exchanges which were incorporated respectively in Japan, Cayman Islands, the USA, Singapore, the Republic of Seychelles, and South Africa.

Service by alternative means

The court also granted LMN’s application to permit service by alternative means, pursuant to CPR 6.15, 6.27 and 6.37(5)(b), on the basis that there was a “good reason” for such permission to be granted.  Given the nature of the alleged fraud and the need to move swiftly to seek recovery of the misappropriated cryptocurrencies, the court readily found that the “good reason” for permitting alternative service existed: LMN obtained orders permitting it to serve relevant court documents “by email at a number of specified email addresses and in one case additionally by posting a link to the documents on the online contact form on the relevant Defendant’s website.”

Confidentiality orders

Reflecting the English legal system’s pragmatism in aid of remedying fraud, Mr Justice Butcher made confidentiality orders which directed the defendants “not to inform persons (other than subsidiaries) of the proceedings or the contents of the order” concerning service out of the jurisdiction and by alternative means.  The rationale for the confidentiality orders was, in effect, not to defeat the purpose of LMN’s substantive application for information orders by publicising the recovery efforts for which LMN was laying the groundwork.

Information orders: Bankers Trust relief

Having assessed the merits for the purposes of granting an order permitting LMN to serve its Claim Form out of the jurisdiction, the court relied upon the same analysis for the purposes of granting the substantive relief LMN requested, namely the information orders under the Bankers Trust jurisdiction.

In addition, the court rejected one of the defendant’s submissions to the effect that, rather than initiating proceedings before the English courts as against foreign-domiciled defendants, the proper approach was for the claimant to speculatively initiate multiple parallel proceedings in foreign jurisdictions thought to be the location of the misappropriated assets.  Mr Justice Butcher viewed such an option as “impractical and contrary to the interests of justice” and one that would “be productive of increased costs, and delay, and reduce the possibility of effective location of the fruits of fraud.”

Instructively for those seeking similar relief to LMN, the resulting Bankers Trust order granted by the court required the defendant exchanges to provide to LMN, “in respect of any customer account(s) which the Target Cryptocurrency [i.e. the misappropriated assets] was allocated to and/or received on behalf of: (a) the name the account is held in; (b) all ‘Know Your Customer’ information and documents provided in respect of the account(s); (c) any other information and documents held in relation to the account(s) which does (or which the relevant Defendant consider is likely to) identify the holder of the account(s), including email addresses, residential addresses, phone numbers and bank account details […].”

Further, the court directed the defendants to each provide to LMN, “to the best of the Defendant’s ability: (a) an explanation as to what has become of the Target Cryptocurrency […]; (b) the balance in the customer account referred to under sub-paragraph (a) above: (i) immediately before it was allocated and/or received the Target Cryptocurrency; and (ii) at the time of that Defendant’s response pursuant to this order”.

Crypto-exchanges, and other entities that may take custody of or facilitate transactions involving cryptoassets, would be wise to pay heed to the scope of the court’s information orders insofar as they at least impliedly signal the types of information that the English courts may reasonably expect such entities to hold in respect of their customers and the assets such entities process.  One would expect that a failure to comply with such orders would need to be accompanied by good reasons to avoid being in contempt or otherwise subject to sanction.

LMN’s analysis: Cryptocurrency not held on trust

A final point of note is that LMN contended that, in operating a cryptocurrency exchange, “[…] it does not hold the cryptocurrencies on trust.  Rather, it holds cryptocurrency in its own name and, in a manner analogous to conventional banking, owes a personal obligation to pay the relevant amount to each customer.”  The court did not consider it necessary to decide whether or not LMN’s analysis was correct for the purpose of these applications. However, the question of whether an exchange is operating more akin to a bank or is holding digital assets on trust, with the onerous obligations that entails, is likely to be one of the key battlegrounds in future litigation.