Does the court need a crypto wallet? Delivery up in crypto frauds – Law v Persons Unknown

Posted: 17/08/2023

A recent update in the developing crypto jurisprudence will be crucial to recoveries of cryptocurrency where the proceeds of fraud are held by unknown parties at identifiable cryptocurrency exchanges (CEX). It also raises considerations as to whether the court should have its own cryptocurrency wallet for payments into court, both in relation to applications for delivery up and security for costs.

In Joseph Keen Shing Law v Persons Unknown & Huobi Global Limited (decided in January 2023 but reported recently) Mr Justice Pelling KC issued further guidance on the interim remedy of delivery up of cryptocurrency that provides new options to victims.

This case builds on the growing body of case law concerning cryptocurrency in the courts of England and Wales and, in particular, the case of Jones v Persons Unknown [2022] EWHC 2543 (Comm), which is thought to be the first order for delivery up of cryptocurrency where it had been established that it was held by the CEX on a constructive trust.

The case

In the Law case, claims were brought by a victim of fraud, against three unknown defendants who were the owners of wallets held with the fourth defendant, Huobi Global Limited, a Seychelles-registered CEX. Given the overwhelming evidence that the proceeds of that fraud had been credited to these wallets, the claimant obtained a worldwide freezing order and, subsequently, default judgment.

In this application, the claimant sought an order requiring Huobi to deliver up the cryptocurrency held in two of these wallets into the jurisdiction of England and Wales, so that it could be used to satisfy the default judgment against the other defendants. Delivery up is available as an interim remedy under (inter alia) CPR 25.1(1)(c)(i) and is one of the tools that a court can use to ensure the effectiveness of freezing orders. 

The defendants did not participate in the litigation, but Huobi had indicated a willingness to cooperate with any order of the English court. 

The judgment

Mr Justice Pelling KC granted an order for the cryptocurrency held by Huobi to be transferred into England and Wales. Although Huobi was not permitting the other defendants to withdraw the cryptocurrency, the judge noted that the situation may change and, therefore, transfer into England and Wales was justified on an exceptional basis.

He demanded the conversion of the cryptocurrency into fiat currency, either by Huobi or by the claimant’s solicitors, and to be transferred into court pending an application pursuant to CPR 72.10(1)(b) for an order that the funds be used to satisfy the default judgment. This was justified, despite the freezing orders in place, due to the policy of ensuring effective enforcement of English judgments, the underlying fraud, and the fact that it could be clearly specified which goods or sums were to be transferred.

Given the prospect that the application under CPR 72.10 could fail, requiring the funds realised to be transferred back to the defendants, or converted back into cryptocurrency (if that is the election of the defendants), Mr Justice Pelling KC required that the claimant give a cross undertaking in damages. This would cover the cost of converting the cryptocurrency to fiat currency and vice versa. as well as any other additional and incidental costs. 

The judge’s analysis

In this case, the judge considered the principles identified in Gee on Commercial Injunctions, which ought to be adopted when considering whether to order the transfer of assets, otherwise subject to a worldwide freezing order, into more direct control by the court. 

These principles firstly require that the ‘claimant must show by clear evidence that the defendant is likely, unless restrained by order, to dispose or deal with the assets so as to deprive the claimant of the fruits of any judgment that may be obtained’. Mr Justice Pelling KC found that this had been satisfied, particularly as the claimant had obtained a worldwide freezing order, which would have been gained by satisfying this test. 

Secondly, ‘the court should be slow to make a delivery up order unless there is some evidence or inference that the property was acquired by the defendant as the result of alleged wrongdoing’. The judge noted that this was more realistically concerned with pre- (rather than post) judgment orders. Therefore, this principle ‘cannot seriously be in dispute… having regard to the judgments that have been entered’. 

Thirdly, the order is to specify clearly what is being transferred, which the judge held was plainly satisfied.

Fourthly, ‘an order for delivery up should generally not be made to anyone other than the claimant’s solicitor or a receiver appointed by the High Court, and the court should appoint a receiver unless satisfied that the claimant’s solicitors have or can arrange suitable safe custody for what is being delivered’.

Although the judge noted that delivery up to the claimant’s solicitors was an option that he could have adopted, he did not consider that it was the most convenient or appropriate in the circumstances. Mr Justice Pelling KC treated the cryptocurrency as cash or its equivalent (rather than assets) which the court could order to be paid into a blocked account or into court. 

However, given that the claimant was ultimately seeking to use the funds to satisfy the default judgment, it would be ‘more simple and straightforward’ to pay the funds into court so an application can be made under CPR 72.10, rather that the claimant having to ‘engage the full panoply of the third party debt order provisions’.

Given the modest sums involved, the judge considered that the option to appoint a receiver would only serve to erode the sums available for execution of the judgment due to the receiver’s fees.

Commentary

This is a key ruling which allows victims of crypto fraud to enforce a judgment by seeking delivery up of the fraudster’s crypto held in a wallet on a CEX. It follows the earlier judgment in Jones where delivery up to the claimant was also ordered but, in that case, it was established that the cryptocurrency was held by the CEX on a constructive trust. 

Enforcement of the order for delivery up
The effectiveness of an order for delivery up in respect of cryptocurrency held in a wallet on an overseas CEX will depend on the law of the jurisdiction in which the CEX is based and the extent to which the CEX will cooperate with an order of the courts of England and Wales. In the Law case, Huobi had indicated its intention to cooperate with any order that the English court might make. Accordingly, there was no issue of enforcement of the order for delivery up. 

Risks to claimants of conversion into fiat currency
In cases such as Law where delivery up requires conversion of the cryptocurrency into fiat currency and a cross-undertaking in damages to be given, the claimant will bear a risk that the execution is unsuccessful and they will be liable to pay the costs of converting the fiat currency back to cryptocurrency, if elected by the defendant, as well as any fluctuation in price since the date of conversion to fiat currency.

For instance, if the cryptocurrency increased in value and the successful defendant elects to have their cryptocurrency back, there will be insufficient funds in court to buy the same amount of cryptocurrency. It seems that in the Law case, the risk of the claimant not being successful in an application under CPR 72.10 was relatively low and, in any event, the amount of cryptocurrency in issue was modest. 

However, if there is a substantial amount of cryptocurrency converted into fiat currency for the purpose of a payment into court and the defendant subsequently engages in the proceedings and is successful, there is a risk that there could be a significant claim under any cross-undertaking in damages due to the volatility of cryptocurrencies.

Equally there could be an upside for the defendant if the price of the cryptocurrency has dropped in value. In this scenario, the successful defendant will no doubt elect to be paid the fiat currency in court rather than have their cryptocurrency returned.

However, where the value of the cryptocurrency is significantly higher than in the Law case, the costs of appointing a receiver are likely to be more proportionate and may reduce the claimant’s liability under a cross-undertaking in damages. 

Payment into the court or claimant’s cryptocurrency wallet
If the court were to have its own cryptocurrency wallet, or at least allow the claimant to hold the cryptocurrency in a wallet held to the order of the court, this should avoid the need to either give a cross-undertaking in damages or limit the extent of the liability under the undertaking (if a successful defendant elects to have the cryptocurrency back). It was perhaps less likely, in the Law case, that the court would not in due course grant an order under CPR 72.10, so there was less risk for the claimant. 

However, what about a situation where delivery up is earlier in the proceedings and prior to a judgment (or default judgment)? There would then be a greater risk to the claimant of fluctuations in the value of the cryptocurrency while the proceedings progress. If the claimant is unsuccessful in obtaining judgment, there could be a substantial liability under the cross-undertaking in damages, which there may not be, to the same extent, if the cryptocurrency is transferred into a wallet held either by the Court Funds Office, the claimant or an appointed specialist cryptocurrency receiver. 

Cryptocurrency as security for costs
A court-operated crypto wallet could also be used for payments into court in respect of security for costs, should the courts embrace crypto as a basis for providing adequate security. In Tulip Trading Ltd v Bitcoin Association for BSV & Ors [2022] EWHC 141 (Ch), the court held that due to the volatility of bitcoin, it could not result in protection for the defendants equal to a payment into court or first-class guarantee.

However, this decision did not consider whether other less volatile cryptocurrencies such as stablecoins or central bank digital currencies could provide adequate security. If they do, the court may need its own crypto wallet where security is to be provided by way of a payment of cryptocurrency into court. This would avoid the issue faced by the claimant in the Tulip case of creating a taxable gain for the purposes of capital gains tax, if the cryptocurrency has to be converted into fiat currency.

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