Fabrizio D'Aloia v Persons Unknown Category A, Binance Holdings Limited, Polo Digital Assets Inc, Gate Technology Corp, Aux Cayes Fintech Co Ltd, Bitkub Online Co Ltd, Persons Unknown Category B (EWHC 2342 (Ch), 12 Sep 2024)
D’Aloia will be a case name recognised by those with an interest in crypto law. As previously reported (see CMS Law-Now here), on 24 June 2022, the High Court granted Mr D’Aloia (“Claimant”) an order permitting service of proceedings on persons unknown via a non-fungible token (NFT) .
The claim against Binance Holdings Limited has since been settled, and the claim against Aux Cayes Fintech Co Ltd has been struck out. A summary judgment application has been made against Persons Unknown Category A (“First Defendants”), Polo Digital Assets Inc, (“Third Defendants”), Gate Technology Corp (“Fourth Defendants”), and Persons Unknown Category B (“Seventh Defendants”).
On 12 Sep 2024, Deputy Judge Farnhill sitting at the High Court handed down a substantial judgment concerning the remaining issues between the Claimant and Bitkub Online Co Ltd (“Bitkub”), a crypto exchange.
Factual Background
The Claimant alleges that a fraud was perpetrated on him by persons unknown in which he was induced to hand over cryptocurrency (specifically, Circle’s USDC and Tether’s USDT, although only the USDT is relevant to this judgment) valued at around £2.5m. The First Defendants passed the cryptocurrency through a number of blockchain wallets before it was withdrawn as fiat currency by the Seventh Defendants. The Third Defendants, the Fourth Defendants, and Bitkub were the cryptocurrency exchanges with whom the Seventh Defendants held their accounts.
The Claimant believed he had made investments through a website associated with a regulated US brokerage. In reality, the site was a scam alleged to have been operated by the First Defendants.
The position tendered at trial by the Claimant was that some of the assets transferred by the Claimant pursuant to the fraud ended up in a Bitkub custodial (i.e. centralised) wallet associated with a Ms. Hlangpan (“82e6 Wallet”). Whilst Ms Hlangpan’s wallet contained approximately USDT 400,000, USDT 46,291 was argued to be either the Claimant’s funds or their traceable proceeds (“Identifiable Cryptocurrency”), which the Claimant claimed was held by Bitkub on constructive trust.
Findings
In considering whether Bitkub held the Claimant’s cryptocurrency on constructive trust and whether Bitkub was liable to the Claimant as constructive trustee, the following issues were addressed by the Court:
- Whether the stablecoin (USDT) which formed the subject matter of the Claimant’s claim against Bitkub is considered property under English law.
Whilst this was not a contested issue at trial, the Court nonetheless made a finding that USDT is neither a chose in action nor a chose in possession, but rather a different form of property which can be the subject of tracing and can constitute trust property in the same way as other property. That finding fits neatly into the definition proposed by the Property (Digital Assets etc) Bill, which was introduced to Parliament just the day before the date of this judgment.
- Whether the Claimant could establish that his Identifiable Cryptocurrency reached the 82e6 Wallet for which Bitkub holds the private key.
This issue required the Court to examine a number of sub-issues relating to tracing and following (which the judgment helpfully reminds us are distinct):
(i) Is tracing at common law possible through a mixed fund?
The Court found that it was not, holding that tracing through a mixed fund is only available to the Claimant in respect of his equitable claims.
(ii) Was it possible to follow the USDT to the 82e6 Wallet?
The Court considered whether the property interest in USDT is a chose in action or a chose in possession. If a chose in action, it could not be followed because once the USDT passed through a mixed fund it ceased to be identifiable. If a chose in possession, it could, in principle, be followed provided it remained identifiable.
(iii) Can USDT be followed through a mixture?
The Court held that, as a matter of law, it was possible for USDT to be followed through mixed funds, but in this case the USDT was not successfully followed as a matter of fact. The expert evidence for the Claimant had failed to convince the Court that the Identifiable Cryptocurrency was, in fact, that belonging to the Claimant. Therefore, the Claimant could not establish equitable title and certainty of subject matter in the Identifiable Cryptocurrency.
- Whether Bitkub had been enriched by the Identifiable Cryptocurrency, and, if so, whether that was at the expense of the Claimant.
The receipt of USDT 400,000 enriched Bitkub, however as the Claimant failed to effectively follow his funds into the 82e6 Wallet, the enrichment was not at the Claimant’s expense.
- Can the first in first out (FIFO) charge methods described in Charity Commission for England and Wales v Framjee [2014] EWHC 2507 (Ch) be applied in the context of tracing misappropriated cryptocurrency?
The Court recognised the relevance of the ‘first in, first out’ (FIFO) principle in tracing cryptocurrency transactions, helping to clarify how stolen assets were converted into fiat currency. However, it cautioned that FIFO should not be the sole tracing method for cryptocurrencies. The Court acknowledged the complexity of modern money laundering techniques and stressed that equitable remedies should reflect the true nature of the transaction, as observed in Foskett v McKeown [2001]. The focus should not be limited to the chronological sequence of events.
- The basis of a constructive trust on Bitkub in the circumstances.
The Claimant argued that a constructive trust would arise upon rescission of a fraudulent contract with the scam website, even if it was voidable rather than void, citing Bristol & West Building Society v Mothew [1998]. The constructive trust would apply prospectively from the moment of rescission. Bitkub, referencing Halley v The Law Society [2003], contended that no trust could arise as the beneficial interest never passed. Bitkub also argued that the rescission-based trust was not adequately pleaded, as required by PD 16 paragraph 8.2.
The Court found that a trust, if established, would be based on the rescission of the (fraudulently induced) contract, such recission taking place upon service of the proceedings. The First Defendants, as counterparty to the rescinded contract would therefore be the relevant trustees, rather than Bitkub.
- Whether a constructive trust could be imposed on Bitkub following the rescission of a voidable transaction due to fraudulent misrepresentation.
A constructive trust could potentially be imposed on Bitkub if assets from the fraudulent transaction can be traced to Bitkub and if it is shown that Bitkub received the assets with knowledge of the fraud or in circumstances where retaining them would be unjust. Whilst a trust could be imposed upon third parties who receive trust property and who are not bona fide purchasers for value without notice, the Claimant failed to demonstrate that Bitkub received any of his funds, and it appears that the funds had been paid away, leaving no property against which a proprietary claim could be asserted in any event. Moreover, no claim for knowing receipt was pleaded, making it unlikely that a constructive trust could be imposed on Bitkub in this case even if the Claimant had been able to prove his assets were held by Bitkub.
- Whether the defence of bona fide purchaser for value without notice is recognised in respect to the transfer of cryptoassets?
The judgment confirms that the defence is available in respect of USDT, although it was not made out in this case (nor was it required to be given that the trust was not imposed on Bitkub).
- If the defence of bona fide purchaser for value without notice is available for cryptoassets, what is the standard of notice that applies?
The Court acknowledged that, while the bona fide purchaser defence may be applicable to cryptoassets, the standard of notice that applies is the same as in traditional cases involving property. This means that the recipient of the cryptoassets must not have actual or constructive notice of any prior equitable claim or fraud at the time of acquiring the assets. As Bitkub had actual notice of suspicious activity on Ms Hlangpan’s account, there would have been no defence of bona fide purchaser available to Bitkub.
- Whether Bitkub could be fairly excused from any breach of duty as a trustee on the basis that it acted honestly and reasonably.
Whilst arguments were advanced at trial, findings on the issue of whether Bitkub acted unreasonably in allowing Ms. Hlangpan to withdraw funds despite suspicious circumstances and breaches of withdrawal limits were ultimately not made by the Court. Given the finding of no constructive trust, there was no breach of duty to consider.
Conclusion
The Claimant failed to show on the balance of probabilities that any of his USDT ever arrived at the 82e6 Wallet and therefore his claim failed. Nonetheless, this is a useful judgment because of the analysis it contains of the complexities involved in tracing and following in crypto frauds, and for its analysis of the law of constructive trusts. With frauds leading to claims against exchanges increasingly being framed as breach of trust claims, this judgment is a thorough examination of the relevant factual and legal issues that the Court will consider.
Whilst it has been accepted that a constructive trust could arise over the Claimant’s funds in the hands of the First Defendants, the USDT 400,000 received by Bitkub had been paid away and no claim was asserted against Bitkub for knowing receipt. Therefore, the judgment concluded that since the Claimant could not prove that Bitkub received anything from the Claimant and since there is no legal link connecting the Claimant with Bitkub via the pleaded case, the claim could not succeed against Bitkub.
Whilst the Court did not criticise counsel for the Claimant at trial (who had not been involved in preparing the pleadings), a significant part of the judgment is dedicated to what precise claims had been pleaded, and whether they reflected the case advanced at trial. This case therefore serves as a stark reminder to lawyers of the importance of getting pleadings and expert evidence right to ensure that a case is properly made out as you intend to argue it at trial.
Article co-authored by Ana-Maria Curavale, Trainee Solicitor at CMS.
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