Crypto contract breach damages clarified by Delaware Court

Given the volatility in value of cryptocurrency tokens, how should damages for failing to deliver promised tokens be calculated? A recent Delaware Superior Court ruling in Diamond Fortress Techs., Inc. v. EverID, Inc., 2022 WL 1114528, 2022 Del. Super. LEXIS 151 (Del. Super. Ct. Apr. 14, 2022), provides some answers to this "novel" question.

The plaintiffs in this case licensed certain software to the defendant for use in developing a cryptocurrency trading platform in return for distributions of the defendant's tokens once the defendant's initial coin offering (ICO) took place. But plaintiffs never received any tokens after the ICO occurred.

Plaintiffs sued for breach of contract and took a default judgment. But the court held a hearing on "the appropriate methodology and value source" for setting damages, observing that "no Delaware court has yet grappled with the question [of w]hen the consideration to be paid on a contract is in cryptocurrency and the contract is breached, how does the Court calculate the judgment to be entered?"

The court began its analysis by noting that "[b]efore the Court can fashion a proper damages award, it must first determine how to classify cryptocurrency, i.e., is it a security/investment contract, a commodity, property, or currency?"

The court noted the "lack of consensus" on this issue. It cited instances where cryptocurrencies have been treated for regulatory purposes as a commodity under federal commodities trading laws and treated as an "investment contract" security under federal securities laws. It noted the possibility that cryptocurrencies could even be subject to concurrent regulation by multiple agencies. The court also reviewed how cryptocurrencies would be treated under certain proposed but unenacted federal legislation now under consideration.

The court then surveyed various decisions that have found particular cryptocurrencies to meet the definition of an "investment contract" under the US Supreme Court's "Howey test", from S.E.C. v. W.J. Howey Co., 328 U.S. 293, 298-99 (1946), and thus to be a "security" under federal law. Employing the "fact-specific" test from Howey, the Delaware court concluded that defendant's crypto token—like many other such tokens that courts and regulators have analyzed—qualified as a "security."

Armed with this determination, the Delaware court then proceeded to examine the calculation of damages. The court noted that contract breach damages in Delaware are "based on the reasonable expectations of the parties that existed before or at the time of the breach," in order to "place the injured party . . . in the same place as he would been if the contract had been performed." But the court also noted that here "the damages were unforeseeable at the time of contracting" and that any damages determination needed to account for "the volatile and unregulated nature of cryptocurrency."

Given this, the court stated:

"The damages calculation here is two-fold. First, the Court must find a reliable cryptocurrency valuation source to ensure the proper input of values. Then the Court must ascertain the proper method for calculating the damages such that it will place the Plaintiffs in the same position they would have been had the Agreements been fully performed."

As a source of valuation data, the court looked to CoinMarketCap, a web service now owned by Binance that provides aggregated cryptocurrency market data. The court cited various decisions where other courts had used CoinMarketCap as a valuation tool and deemed it to be a "reliable source" of valuation data, also observing that CoinMarketCap was referenced in the pending congressional legislation that the court had previously noted. The court declared itself "satisfied CoinMarketCap is a reliable cryptocurrency valuation tool" and thus would "rely on historical pricing data published by CoinMarketCap to determine the proper USD value" of the crypto tokens that the defendant failed to deliver to the plaintiffs.

Having determined that the defendant's crypto tokens met the definition of "securities" under federal law, the court declared that the defendant's failure to deliver tokens to the plaintiff was "analogous to Delaware's 'failure to deliver securities' cases, where damages are determined by the highest market price of the security within a reasonable time of a plaintiff's discovery of the breach." In such cases, Delaware applies what is known as "the New York Rule," under which damages are measured by:

"the highest intermediate value reached by the stock between the time of the wrongful act complained of and a reasonable time thereafter, to [allow] the party injured to place himself in the position he would have been in had not his rights been violated."

This rule, the court explained, tries to straddle the competing objectives of not requiring the injured party to "reenter the market"—which could expose it to losses from the market's volatility—while also avoiding "windfall award to injured parties."

"Accordingly, the measure of damages . . . is the higher value of either: (1) [the security's] value at the time of [the loss] or (2) its highest intermediate value between notice of [that loss] and a reasonable time thereafter during which the [security] could have been replaced."

As for what qualifies as a "reasonable time thereafter," the court cited Delaware cases to conclude that "two or three months has been accepted as a reasonable period of time to replace an asset on the open market." The court thus awarded the plaintiffs damages based on the highest price for the defendant's tokens shown on CoinMarketCap in the three months following the date when the defendant was obliged to issue its crypto tokens to the plaintiffs, as well as prejudgment interest on that amount through the entry of the court's ruling.

The ruling in Diamond Fortress provides a clear detailed analysis of how judgment amounts denominated in US dollars should be calculated for the breach of a contract to deliver or make a payment in a cryptocurrency, at least where that cryptocurrency meets the definition of a "security" under federal law. It remains to be seen whether the same or a similar analysis would be applied in calculating damages in relation to crypto and other blockchain tokens in contexts where their status as "securities" is less clear or is disputed, as has been the case for Bitcoin and certain other early cryptocurrencies, or when claimed "utility tokens" are involved.