Crypto fraud: role of exchange as a constructive trustee

In a recent judgment the English court has discharged an interim proprietary injunction that was made against a crypto exchange and considered issues around the position of a crypto exchange as a constructive trustee.  This judgment could lead to changes in the way victims of crypto fraud have so far been seeking redress from the English courts.

Background

Between 29 June to 28 September 2021, Mr Jahangir Piroozzadeh transferred CAD$ 1,990,051 to two accounts. Separately, Mr Piroozzadeh transferred 870,818 Tether to wallets held with crypto exchanges.  

By December 2021, Mr Piroozzadeh realised that he had been the victim of a scam by fraudsters and instructed solicitors, experts, and investigation agents. Subsequently, Mr Piroozzadeh applied to the English court for an order without notice to the defendants (which included crypto exchanges) to restrain them from dealing with the Tether. The application also included an order requiring the crypto exchanges to preserve the Tether or its traceable proceeds on the basis that they were constructive trustees on receipt of the Tether.  These orders were granted and continued at the return date, noting that a crypto exchange had expressed its intention to contest the application.

Grounds for challenge

The crypto exchange challenged the order on the grounds that the application should never have been made without notice and that the claimant’s legal representatives failed in their duty of fair presentation.  There were four headline points in support of this challenge:

1. The court was not provided with a proper explanation of the defences likely to be available to the crypto exchange in respect of its alleged liability as a constructive trustee.
2. There was no explanation of why there was a sufficient risk of a breach of trust by the crypto exchange to justify an injunction. 
3. There was no explanation why damages would not be an adequate remedy. 
4. There was no explanation how the crypto exchange would in practice be able to comply with the order.

Threshold for without notice application

The court reiterated the principle that an order should not be made against a party without giving them an opportunity to be heard.  Although there are exceptions to this, urgency of itself is not sufficient to obviate the need for notice.  The fact that no wrongdoing was being alleged against the crypto exchange meant that secrecy was not justified vis-à-vis the crypto exchange.  If there were concerns that providing notice to the crypto exchange would somehow lead to tipping off the fraudsters, the claimant could have proceeded against the fraudster-defendants on a without notice basis and served any order on the crypto exchange as a non-respondent.  If specific relief against the crypto exchange was needed, it could have been obtained later.

Fair presentation of the case

The compounding factor to the lack of notice was that the judge held that the claimant failed in its duty to make a fair presentation of the case at the without notice hearing.

It was in this context that the judge considered the claimant’s case that the crypto exchange was a constructive trustee.  In that regard, the judge held that the claimant had not presented to the court at the without notice hearing the potential defences to this point.   It was also held that the previous case of D’Aloia v Persons Unknown & Others (please click here for our LawNow on this case) does not support the proposition without more that “exchanges are constructive trustees”.  The claimant had knowledge that the crypto exchange operated pooling re the cryptocurrency received and that it could rely on a bona fide purchaser defence, these were points that ought to have been brought to the court’s attention at the without notice hearing by the claimant.  This issue also permeated into the lack of explanation about how the crypto exchange could demonstrate practical compliance with the order in circumstances where, given the pooling structure it had, identification of the claimant’s Tether would have been affected. 

The claimant had also not discharged its burden to demonstrate why damages would not be an adequate remedy in the context of the order sought against the crypto exchange (which was different to the order sought against the fraudster-defendants).  The expectation is that should have been presented in a more comprehensive manner. 

Conclusion

Victims of crypto fraud have so far been bringing claims against fraudsters (who are typically identified as a group of “persons unknown”) and including crypto exchanges as defendants.  This is done to seek disclosure of account information from the crypto exchange but also to impose a role of constructive trustee on the crypto exchange to help preserve any crypto that remains in wallets held on the crypto exchange. 

The above judgment demonstrates that the proposition of crypto exchanges being constructive trustees cannot be taken for granted.  It will be fact dependent and needs careful consideration.  Also, there will need to be good reason for why crypto exchanges are added as defendants, particularly where applications are being made without notice to them.  This judgment could help streamline the process between victims and crypto exchanges by encouraging greater pre-action communication and limiting the scope of the orders being sought against crypto exchanges.  The goal being to build an ecosystem in which victims of crypto fraud can recover their crypto at minimal cost and without having to put the crypto exchanges off-side. 

Jahangir Piroozzadeh v Persons Unknown & Others [2023] EWHC 1024 (Ch) – please click here for copy of the judgment.