Digital assets: Law Commission consults on private international law issues and draft legislation recognising a third category of personal property rights

On 22 February 2024, the Law Commission published two documents relating to digital assets: (i) a call for evidence on private international law issues relating to digital assets and electronic trade documents; and (ii) a consultation on draft legislation to confirm the existence of a third category of personal property for assets such as crypto-tokens.

The English courts have repeatedly demonstrated the flexibility of the common law in applying traditional concepts to novel circumstances and new types of asset, including cryptocurrency and NFTs. However, the Law Commission’s continued activity in this area, with a view to implementing targeted reforms, aims to increase legal certainty and facilitate the development of English law as a law of choice underpinning the use of blockchain technology. It is therefore to be welcomed.

Private international law 

The call for evidence on private international law issues derives from a 2022 request from the Ministry of Justice for the Law Commission to consider how private international law rules should apply in the digital context, bearing in mind the disputes likely to arise in that context (including contractual, tortious and property disputes), and to make any necessary recommendations for reform.

Digital assets can give rise to difficult questions of private international law, relating to which country’s courts should hear a dispute and which country’s law should be applied, leading to uncertainty for those who invest in and use such assets. The reason is obvious: such assets challenge the underlying territorial basis on which modern systems of private international law are premised, such as the location of an asset or where an event occurred.

The call for evidence sets out two main priorities for this stage of the project: understanding which issues relating to digital assets can be accommodated satisfactorily within existing private international law rules in England and Wales; and classifying the issues according to their prevalence in market and legal practice, so as to ensure a focus on issues that cause problems in practice. The aim will then be to classify all issues as high, medium or low priority for the next stage.

The project focuses in particular on crypto-tokens and electronic trade documents because these assets are prevalent in market practice, while also posing novel theoretical challenges to the traditional methods of private international law.

Responses are requested by 16 May 2024.

Personal property rights

In June 2023, the Law Commission published a report on digital assets in which it concluded that some digital assets, such as crypto-tokens, do not fit into the traditional binary categorisation of personal property as either “things in possession” (such as physical objects) or “things in action” (such as contractual rights), but are nevertheless treated by the common law as capable of being the object of personal property rights. The report referred to digital assets in this “third category” as “digital objects”, while noting that non-digital assets, such as milk quotas and certain carbon emissions allowances, could also fall into this category.

The report recommended, among other things, that legislation should be introduced to confirm and support the existing common law position by providing that a thing will not be deprived of legal status as an object of personal property rights merely because it falls outside the two traditional categories. However, the report concluded that it was not necessary or appropriate to try to define the hard boundaries of such a third category of personal property by way of legislation, taking the view that this was best left to the common law.

The Law Commission’s current consultation follows on from the 2023 report, proposing a simple draft Bill to implement the recommendation for new legislation which states that:

“A thing (including a thing that is digital in nature) is capable of being an object of personal property rights even though it is neither—
(a) a thing in possession, nor
(b) a thing in action.”

The consultation notes that a statutory confirmation will “provide a strong signal to market participants that the law of England and Wales will continue to protect personal property rights, even in new and emergent forms of property” and will “facilitate and encourage innovation based on the underlying principle that certain digital things can now be ‘owned'”.

Responses are requested by 22 March 2024.

Chris Bushell
Chris Bushell
Partner
+44 20 7466 2187
Rachel Lidgate
Rachel Lidgate
Partner
+44 20 7466 2418
Ajay Malhotra
Ajay Malhotra
Partner
+44 20 7466 7605
Charlie Morgan
Charlie Morgan
Partner
+44 20 7466 2733
Maura McIntosh
Maura McIntosh
Professional support consultant
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Philip Lis
Philip Lis
Senior associate
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Commercial Court takes rare decision to refuse enforcement of arbitration award on public policy grounds in crypto case

The Commercial Court has refused to enforce a foreign-seated arbitration award on the grounds that to do so would be contrary to public policy, including because it was contrary to certain protections provided under the Consumer Rights Act 2015 (CRA), which the judge held were an expression of UK public policy. The case suggests that businesses may have difficulties enforcing foreign judgments or arbitral awards against consumers in the UK, where the underlying contract had a close connection to the UK and the decision applied a (contractually agreed) foreign governing law without reference to the CRA: Payward Inc v Chechetkin [2023] EWHC 1780 (Comm).

Mr Chechetkin, a UK-based consumer, undertook various trading activities on Payward’s Kraken cryptocurrency trading exchange in 2020 and lost more than £600,000. Payward’s terms of service were governed by California law and contained a Judicial Arbitration and Mediation Service Rules (JAMS) arbitration clause with disputes to be determined by sole arbitrator seated in San Francisco.

Section 74 of the CRA specifies that where (as in this case) a consumer contract has a close connection with the UK, the CRA applies regardless of whether the parties have chosen a non-UK governing law. The arbitration award applied only California law, without taking account of the CRA. The judge held that this alone was sufficient to make the award unenforceable as a matter of public policy.

The judge also found that the arbitration clause was “unfair” pursuant to s.62 of the CRA, which provides that an unfair term of a consumer contract is not binding on the consumer. The judge was clear that the mere fact that a consumer contract provides for disputes to be resolved in arbitration does not make it unfair. However, this clause was unfair, as it contained a number of significant disadvantages for Mr Chechetkin – including that he had to use US attorneys, which was expensive and inconvenient, and that a US arbitrator was not an appropriate tribunal for the issues in the case.

For more information, see this post on our Arbitration Notes blog.

English court orders crypto exchange to transfer assets into England and Wales to facilitate enforcement of judgment

The English High Court has ordered a cryptocurrency exchange (Huobi) to transfer into the jurisdiction a defendant’s cryptocurrency held outside the jurisdiction to facilitate the claimant’s efforts to enforce its judgment against those assets. Under the court’s order, the cryptocurrency is first to be converted into fiat currency and then transferred to the Court Funds Office, either directly or via the claimant’s solicitors: Joseph Keen Shing Law v Persons Unknown & Huobi Global Limited.

Huobi neither consented to nor opposed the order. The court held that exceptional circumstances warranted such an order, noting that even though the exchange was cooperating with the claimant to prevent the other defendants (who had defrauded the claimant) from accessing their accounts, the situation could change to the claimant’s detriment and the court would have no control over Huobi as it was based outside England and Wales.

This decision (from January this year but only recently published) predates Piroozzadeh v Persons Unknown and Others [2023] EWHC 1024 (Ch) (which we have commented on here), in which the High Court discharged an interim proprietary injunction against cryptocurrency exchange Binance which had required it to preserve cryptocurrency that the claimant (the alleged victim of a fraud) claimed to be able to trace to the exchange.

Conversely, in this case, the claimant did not seek an injunction against the exchange, but rather an order seeking the transfer of the cryptocurrency it held, in an overseas account, into the jurisdiction and the court’s control. It is significant that in this case, unlike in Piroozzadeh, the claimant already had the benefit of a judgment against the fraudsters, albeit by default. While the court in this case adopted a highly claimant friendly approach, ultimately the effectiveness of such an approach against a cryptocurrency exchange located outside the court’s jurisdiction will rely on the exchange’s willingness to cooperate. Continue reading

High Court sets aside interim proprietary injunction against cryptocurrency exchange Binance

The High Court has discharged an interim proprietary injunction against the cryptocurrency exchange Binance which required it to preserve certain cryptocurrency that the claimant, the alleged victim of a cryptocurrency fraud, claimed to be able to trace to the exchange: Piroozzadeh v Persons Unknown and Others [2023] EWHC 1024 (Ch).

There have been a number of recent cases in which the High Court has granted interim proprietary injunctions against cryptocurrency exchanges on a without notice basis. This is the first decision we are aware of where a cryptocurrency exchange has challenged the grant of such an injunction, and it highlights a number of important points in relation to such applications.

Where the victim of a cryptocurrency fraud claims to be able to trace their assets to an account on a cryptocurrency exchange, and seeks an injunction to preserve those assets, the claimant’s legal advisers should consider whether it would be sufficient to obtain an injunction against the owner of the cryptocurrency account and to serve that injunction on the exchange as a third party (which is common practice in relation to bank accounts), rather than naming the cryptocurrency exchange as a respondent itself. If an injunction is inappropriately obtained against the cryptocurrency exchange itself and later discharged, the claimant may be left with a significant adverse costs order.

If the claimant does seek an injunction against the exchange itself, the claimant’s legal advisers should be careful to distinguish the position of the exchange from the position of other potential defendants (for example, the alleged fraudsters). Particular consideration should be given to:

  • Whether there is a proper basis for making an application against the exchange without notice. If the application is made without notice, the claimant must be careful to comply with the duty of full and frank disclosure.
  • Whether there is a serious issue to be tried in respect of a claim against the exchange itself, and the defences that the exchange might have to such a claim. If the application is made without notice, the potential defences must be clearly drawn to the court’s attention.
  • Whether damages would be an adequate remedy against the exchange in respect of any claim against it. If damages would be an adequate remedy, an injunction should not be granted.
  • Whether there are identifiable assets at the time the application is made which the exchange could be required to preserve. If the assets have been mixed or dissipated and are no longer identifiable, an injunction should not be granted because it would serve no useful purpose. Any injunction should also be drafted in a form which makes it clear what the exchange is required to do.

Herbert Smith Freehills LLP acts for Binance in relation to the claim. Continue reading

Self-proclaimed creator of Bitcoin can proceed with claim that Bitcoin branch networks breach his intellectual property rights

Dr Craig Wright claims to be the inventor of Bitcoin and to have authored the Bitcoin White Paper in 2008, created the Bitcoin File Format and mined the inaugural block in the Bitcoin Blockchain – the ‘Genesis Block’.  Despite the Bitcoin White Paper having promoted de-centralisation, Dr Wright is now seeking to prevent others from using his alleged intellectual property.

A recent decision of the English High Court, Wright v BTC Core [2023] EWHC 222 (Ch), means that Dr Wright can continue his claims in relation to his alleged database rights over the Bitcoin blockchain and copyright in the Bitcoin White Paper and can serve proceedings on the defendants out of the jurisdiction. The court concluded that – assuming the facts are as alleged by Dr Wright – those two claims are arguable. However, it dismissed a claim for copyright in the Bitcoin File Format as unarguable. [EDIT: Dr Wright successfully appealed this aspect of the decision – see the Court of Appeal’s decision of 23 July 2023, outlined on our Intellectual Property Notes blog.]

It remains to be seen what the outcome of this case will be (including whether this decision will be appealed to the Court of Appeal) and what implications (if any) it will have for the continued operation of the Bitcoin branch networks, BTC and BCH.

In another claim brought by a company of Dr Wright’s, Tulip Trading Ltd v van der Laan [2023] EWCA Civ 83, the Court of Appeal recently overturned a decision of the High Court that there was no arguable claim that developers of a blockchain network owe users a fiduciary duty. Our analysis of Tulip can be accessed here. Continue reading

Is the decentralised governance of Bitcoin a myth? Court of Appeal finds real issue to be tried as to whether developers owe fiduciary duties to Bitcoin owners

In the latest development in a line of cases involving Dr Craig Wright, who claims to be the creator of the Bitcoin system, the Court of Appeal has held that there is a realistic argument that Bitcoin developers, while acting as developers, owe fiduciary duties to the true owners of that property, which could include taking active steps to introduce code so that an individual owner’s Bitcoin can be transferred to safety: Tulip Trading Limited v Wladimir van der Laan and ors [2023] EWCA Civ 83.

While the effect of the judgment is not to decide whether such a duty exists, in general or in this specific instance, it means that the question will need to be determined at trial, once the relevant facts have been established. If a duty is found to exist, it would in the words of Lord Justice Birss “involve a significant development of the common law on fiduciary duties”.

At the heart of the judgment is a debate about the true nature of decentralisation in the context of the blockchain and, particularly, how the role of software developers fits into that. The Court of Appeal identified the key factual question of whether software developers should be considered a large and shifting class who cannot impose changes to the software, because those could be rejected by miners who would refuse to run them, potentially leading to a fork in the blockchain. In its obiter comments, the court suggested that, if the decentralised governance of Bitcoin really is a myth, then there is much to be said for the argument that Bitcoin developers, while acting as developers, owe fiduciary duties to the true owners of that property. Continue reading

High Court considers application of gateways for service out of the jurisdiction to cryptoassets removed from the jurisdiction

A recent High Court decision suggests that there is some doubt as to the proper construction of the gateways allowing service out of the jurisdiction for claims relating to property in the jurisdiction, and for claims in constructive or resulting trust relating to assets within the jurisdiction. In particular, the decision suggests that it may not be sufficient that the relevant property or assets are within the jurisdiction when the cause of action arose, if they are no longer within the jurisdiction when the application for permission to serve out is made: Osbourne v (1) Persons Unknown Category A (2) Persons Unknown Category B (3) Thembani Dube [2023] EWHC 39 (KB).

If this approach is adopted in other cases, it may present particular challenges to victims of fraud or theft of cryptoassets, given the ease and speed at which such assets may be transferred internationally. Even if the relevant time is when the cause of action arose, it may be difficult to rely on these gateways to serve proceedings out of the jurisdiction on defendants who later received the assets but were not party to the original theft. The same difficulty arises, in relation to such defendants, in relation to the gateway for claims in constructive or resulting trust arising out of acts committed within the jurisdiction.

In the present case, relating to stolen NFTs, the court accepted that there was a good arguable case that the assets were located in England and Wales when they were first transferred out of the claimant’s wallet, as the claimant was domiciled in England. However, given that the assets had subsequently been transferred to persons unknown who may have been domiciled outside the jurisdiction, it was not clear that the assets remained in England when any cause of action arose against further defendants as constructive trustees, or that the claims against those defendants arose out of acts committed within the jurisdiction.

However, the court did allow service out of the jurisdiction under the gateway for claims in constructive or resulting trust which are governed by English law. This gateway may provide a fallback in many cases where there is a theft of cryptoassets which, at the time, were located in England but the above gateways are unavailable due to subsequent transfers of the assets.

In addition, the court allowed service to be made by the alternative means of an NFT (in line with the recent decision in Jones v Persons Unknown [2022] EWHC 2543 (Comm), considered here). Continue reading

Information orders granted against cryptocurrency exchanges to help trace stolen cryptocurrency

In a further decision demonstrating the English court’s ability to apply the law flexibly to novel issues arising in relation to crypto assets, the High Court has granted information orders against various foreign cryptocurrency exchanges requiring the provision of information and documentation to help identify those who hold accounts into which stolen cryptocurrency was allegedly transferred, and what had since become of the cryptocurrency: LMN v Bitflyer Holdings Inc [2022] EWHC 2954 (Comm).

This is another in a string of decisions in which the English court has been prepared to treat cryptocurrency as a form of property, and to make orders aimed at assisting the recovery of stolen cryptocurrency.

The decision is also of interest as one of the first cases in which the court has granted permission to serve proceedings out of the jurisdiction under the new gateway for information orders, which was introduced in October this year in order to facilitate the making of Norwich Pharmacal and Bankers Trust applications against defendants overseas. It applies where there is an application for disclosure in order to obtain information regarding the true identity of a potential defendant and/or what has become of the claimant’s property, with a view to issuing proceedings that are intended to be commenced in England and Wales.

Herbert Smith Freehills acts for one of the cryptocurrency exchange defendants to the application. Continue reading

High Court orders delivery up of stolen Bitcoin against crypto exchange

The High Court held, on an uncontested summary judgment application, that the crypto exchange controlling the wallet into which the claimant’s stolen bitcoin was transferred sat in a position of constructive trustee as against the claimant. It ordered delivery up of the bitcoin as against the fraudsters as well as the exchange: Jones v Persons Unknown [2022] EWHC 2543 (Comm).

The court’s finding that the defendant crypto exchange should be treated as a constructive trustee in relation to the wallet containing stolen bitcoin is of interest not only for those investing in cryptoassets, but also for crypto exchanges and custodians that may control wallets operated by fraudsters.

The court also gave permission to serve the orders on the defendants out of the jurisdiction, and for alternative service including by means of a non-fungible token (NFT) air drop to bring the order to the defendants’ attention expeditiously. It is worth noting that, as a result of rule changes that came into force at the beginning of October, the court’s permission is no longer needed to serve an order (or other court document) out of the jurisdiction where the claim form was served on the defendant out of the jurisdiction with permission, or the court’s permission was not required for service. Continue reading

What the Crypto Winter means for insolvency

There has been no shortage of high-profile insolvencies in the crypto market in recent months across a range of market participants and geographies. These include the US Chapter 11 and Bahamas provisional liquidation of FTX as well as the US Chapter 11 filings of BlockFi, Singapore-based crypto hedge fund ThreeArrows Capital, US-based lender Celsius Network, US-based lender Voyager Digital, US-based crypto mining data centre Compute North and Germany-based crypto bank Nuri.

While the number of insolvencies poses questions about the risk management and governance of crypto businesses, this briefing by our Restructuring, Turnaround and Insolvency team addresses what it means legally and practically for users, lenders and other market participants when a crypto custodian falls into distress and even an insolvency process.