Proprietary injunction against a crypto-exchange? Not so fast…

Jahangir Piroozzadeh v Persons Unknown et al [2023] EWHC 1024 (Ch) (Piroozzadeh) is the first reported decision in which freezing injunctions relating to misappropriation of crypto-assets initially granted on a without notice basis have been discharged by the High Court on their return date (i.e. on the date the parties return to the court, all defendants having been given notice, for the purposes of arguing the substantive merits of the application and the continuation of the initial orders). The particular defendant that successfully had the freezing injunction against it discharged was the crypto-asset exchange Binance Holdings Limited (Binance), which the claimant alleged was a constructive trustee of the misappropriated Tether (or its proceeds), and on that basis liable to account to the claimant as beneficiary.

Background

In November 2021, a Canadian man Mr Piroozzadeh, was induced by a stranger with whom he had had unsolicited WhatsApp contact to transfer 870,818 Tether, equivalent to CAD$1.9 million (c.£1.13 million). Shortly thereafter, Mr Piroozzadeh, realised that he had fallen prey to scammers. In an attempt to retrieve his funds, he sought freezing injunctions from the English High Court against a number of entities and unknown individuals, alleged to have been involved in the scam, whether as parties through which the allegedly misappropriated Tether had passed, or as the scam’s principal architects.

Bona fide purchase for value and (im)practicalities

A decisive fact in Binance’s favour was that, on its “uncontradicted evidence”, “the [Binance] user does not retain any property in the Tether deposited with the exchange.” Rather, “the user’s account is credited with the amount of the deposit and they are then permitted to draw against any credit balance as in a conventional banking arrangement. The Tether, like other crypto assets, are then swept into a central unsegregated pool address known as a ‘hot wallet’ where they are treated as part of the eighth defendant’s [Binance’s] general assets. They are not specifically segregated to be held for the sole benefit of the user from whose account they have been transferred”. The result of this arrangement is that tracing Tether from a user’s account through to the general pool of assets (i.e. the ‘hot wallet’) would be “an essentially futile and close to impossible and possibly impossible exercise.”

Against the above procedural and factual backdrop, Binance made “four headline points” in support of discharging the injunction (which the court accepted):

1. first, that the claimant did not properly explain the defence likely to be available to Binance in respect of its alleged liability as a constructive trustee;
2. second, that the claimant did not explain why there was a sufficient risk of a breach of trust by Binance so as to justify an injunction;
3. third, that the claimant did not explain why damages would not be an adequate remedy; and
   
4. fourth, that the claimant did not explain how it was that Binance would, in practice, be able to comply with the order.

When a litigant applies to court on a without notice basis (i.e. without providing advance warning of the application to affected parties), and seeks court orders against parties who have not had an opportunity to consider the application evidence, or be heard by the court, that litigant is duty-bound “to make a fair presentation of the case at the without notice hearing”. As the Court stated in Piroozzadeh, “an applicant must show the utmost good faith and disclose his case fully and fairly. He must identify the crucial points for and against the application and not rely on general statements and the exhibiting of numerous documents.” Crucially, the litigant applying without notice “must identify any likely defences”. The Court determined that the plaintiff Mr Piroozzadeh had failed to discharge this duty of fair presentation.

In particular, the Court determined that he (meaning, in effect, his lawyers), failed to refer the court “to what really mattered as a defence”, which stemmed from Binance’s being a bona fide purchaser for value of the Tether deposited into Binance accounts (and thereafter swept into a ‘hot wallet’ of comingled Tether). According to this defence, once the Tether had been swept from the user accounts into the ‘hot wallets’, the users were credited in the amount of the value swept which thereby constituted Binance “a purchaser and no longer susceptible to any remedy at the suit of the claimant so long as it acted bona fide”. Although when the claimant initially obtained the injunctive relief (without notice), his lawyers told the judge that the cryptocurrency is transferred into a pool held by Binance, and that the users are credited, the claimant did not identify the possible legal consequences of that sequence. The ‘bona fide purchaser for value’ defence would be a complete answer to the claimant’s assertion that Binance held the Tether as constructive trustee (and, as a corollary, that Binance was in breach of trust).

As to the claimant explaining why damages would be an inadequate remedy (one of the requirements for obtaining injunctive relief), the Court found that “no explanation or evidence” was provided by the claimant regarding why damages would be inadequate as against Binance: indeed, “the claimant’s skeleton did not address the adequacy of damages against the eighth defendant [Binance] at all.” This was another reason for discharging the injunction against Binance, and for the Court’s determining that its being granted in the first place, albeit on an interim basis, was premised on shaky ground.

The final limb of Binance’s argument to resist the continuation of the injunction against it was that, as a practical matter, tracing the Tether or their traceable proceeds would be nearly impossible given the overwhelming evidence “that they had long since been mixed and dissipated in the pooled addresses.” The impracticability of tracing is a consideration that the claimant should have highlighted to the Court at first instance, this being a key determinant for whether a court will grant injunctive relief in the first place (because the courts avoid making orders that cannot practically be enforced).

LMN v Bitflyer Holdings Inc – An Instructive Contrast

We previously blogged about alleged victims of misappropriated crypto assets seeking the court’s assistance in aid of their recovery efforts in our post on LMN v Bitflyer Holdings Inc and others [2022] EWHC 2954 (Comm), which provides an instructive contrast to the approach taken by the first instance judge in Piroozzadeh.

In LMN, the applicant “sought a ‘rolled up’ hearing of applications for permission to serve the Defendants out of the jurisdiction and to serve by alternative means, and of the substantive application for information orders”. As in Piroozzadeh, this initial application was made without notice, and the court “agreed that this hearing should be held in private, in order that publicity should not defeat the object of the proceedings by giving notice to the putative fraudsters of the attempts to identify them.” However, by contrast to Piroozzadeh, the court at first instance declined to proceed with the application for the substantive relief without notice being given to the Defendants. In its reasons for declining to do so, the Court in LMN stated that it would have been inappropriate to consider a substantive application on a without notice basis because (as in Piroozzadeh): the alleged fraud occurred months before the court proceedings commenced; the application was not made against the putative fraudsters; and none of the Defendants (nor their affiliates) was alleged to have been itself in any way fraudulent.

Takeaways

Three key takeaways emerge from Piroozzadeh for claimants seeking injunctive relief, for practitioners advising them, and for crypto-exchanges:

1. Parties must adhere to the duty of fair presentation in the context of without notice applications for substantive relief: full and frank disclosure must be given to the court. If such disclosure is not provided, then it is likely that the court will address that at the earliest opportunity. The failure to satisfy the duty in the first place, although it may yield short-term benefit in the sense of obtaining an interim order, is liable to (at the very least) draw intense scrutiny from the court of each application brought by the claimant over the course of a proceeding, and (at worst) may taint the court’s view of the claimant’s action, rendering an already difficult task of proving a case all the more difficult.
2. As the Court identified, in cases involving alleged fraud by parties using exchanges which operate accounts akin to traditional cash deposit accounts, there was an “obvious solution to any perceived problem which was to proceed against the fraudsters and serve any order on the eighth defendant [i.e. the exchange] as a non-respondent.” This is the approach typically taken in cases of fraudsters moving fiat currency through bank accounts: a freezing order is obtained against the alleged fraudster; that order is then served on the bank whose account it is alleged the defrauded sums have flowed; and the bank then complies with the order (subject to applying for it to be varied).
3. As the courts continue to hear cases such as Piroozzadeh (and LMN), through which further information regarding the mechanics of crypto-exchanges enters the public record, in particular regarding the overlapping practices between traditional banking and crypto-exchanges, it is possible that regulators will take notice. Judicial findings of fact regarding these areas of overlap (for example how deposit amounts are swept into comingled pools of assets, and depositors are credited), may support regulatory efforts to bring crypto-exchanges under the umbrella of traditional banking and finance regulation.